form_10k.htm
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, 2007
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
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 [X] Non-accelerated filer [
]
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 29, 2007, was
approximately $272 million. As a result, the Registrant is an accelerated filer
as of December 31, 2007. 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 were deemed to be owned by affiliates of the Registrant as of June
29, 2007. 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 or affiliates as of the date of this
Form 10-K.
As of
March 7, 2008 the Registrant had 21,106,292 shares of common stock outstanding
(excluding 3,448,518 shares of common stock held as treasury
stock).
FORM 10-K
OF LSB INDUSTRIES, INC.
TABLE OF
CONTENTS
|
|
|
Page
|
|
|
|
|
|
|
|
PART
I
|
|
|
|
|
|
|
|
|
5
|
|
|
|
|
|
|
|
17
|
|
|
|
|
|
|
|
23 |
|
|
|
|
|
|
|
23
|
|
|
|
|
|
|
|
25
|
|
|
|
|
|
|
|
28
|
|
|
|
|
|
|
|
29
|
|
|
|
|
|
|
PART
II
|
|
|
|
|
|
|
|
|
31
|
|
|
|
|
|
|
|
33
|
|
|
|
|
|
|
|
34
|
|
|
|
|
|
|
|
68
|
|
|
|
|
|
|
|
71
|
|
|
|
|
|
|
|
71
|
|
|
|
|
|
|
|
72
|
|
|
|
|
|
|
|
74
|
|
|
|
|
|
|
PART
III
|
|
|
|
|
|
|
|
|
79
|
|
|
|
|
|
|
|
85
|
|
|
FORM
10-K OF LSB INDUSTRIES, INC.
TABLE
OF CONTENTS
|
|
|
|
|
|
|
|
|
Page
|
|
|
|
|
|
|
|
100
|
|
|
|
|
|
|
|
106
|
|
|
|
|
|
|
|
110
|
|
|
|
|
|
|
PART
IV
|
|
|
|
|
|
|
|
|
112
|
PART I
General
LSB
Industries, Inc. (the "Company", “Registrant”, “LSB”, "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. 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 70,000 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, Wynn resorts, and many
others.
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 we believe our
Chemical Business has established leading regional market positions, a key
element in the success of this
business.
The primary raw material feedstocks (natural gas, anhydrous ammonia and sulfur)
of the Chemical Business are commodities, subject to price fluctuations and are
purchased at prices in effect at time of purchase.
The
Baytown Facility consumes approximately 125,000 tons of purchased anhydrous
ammonia per year. The majority of the Baytown Facility’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.
The El
Dorado Facility purchases approximately 220,000 tons of anhydrous ammonia and
40,000 tons of sulfur annually and produces and sells approximately 455,000 tons
of nitrogen-based products and approximately 120,000 tons of sulfuric acid per
year. The anhydrous ammonia is purchased pursuant to a supply agreement whereby
the El Dorado Facility secures the majority 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 the El Dorado Facility 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. Historically, the sulfur costs have been relatively stable;
however, the recent world sulfur shortages have led to significant increase in
the cost of this raw material.
The
Cherokee Facility normally consumes 4 to 6 million MMBtu’s of natural
gas annually and produces and sells approximately 305,000 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 2007 daily spot prices per
MMBtu, excluding transportation, ranged from $5.30 to $10.59.
Due to
the uncertainty of the sales prices of our products in relation to the cost of
sulfur, 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 pricing arrangements 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, anhydrous ammonia and sulfur. For 2007, approximately 60% of the
Chemical Business’ sales were made pursuant to sales agreements and/or pricing
arrangements that pass-through the cost of these raw materials. 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 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 can preclude the Chemical Business
from reaching full performance potential. Our primary efforts to improve the
results of our Chemical Business include maintaining the current level of
non-seasonal sales volumes with an emphasis on customers that will accept the
commodity risk inherent with natural gas and anhydrous ammonia, while
maintaining a strong presence in the agricultural sector.
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
|
|
58
|
%
|
|
61
|
%
|
|
54
|
%
|
|
Hydronic
fan coils
|
|
30
|
%
|
|
27
|
%
|
|
34
|
%
|
|
Other
HVAC products
|
|
12
|
%
|
|
12
|
%
|
|
12
|
%
|
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
Percentage
of our consolidated net sales:
|
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
|
28
|
%
|
|
27
|
%
|
|
21
|
%
|
|
Hydronic
fan coils
|
|
15
|
%
|
|
12
|
%
|
|
13
|
%
|
|
Other
HVAC products
|
|
6
|
%
|
|
6
|
%
|
|
5
|
%
|
|
|
|
49
|
%
|
|
45
|
%
|
|
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, as well as commercial
applications.
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; however, fan
coils are used in a wide variety of applications.
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 $589 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.
Production and
Backlog
We
manufacture our products 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. In addition, most of these customer orders are placed
well in advance of required delivery dates.
During
2006 and 2007, we invested approximately $10.6 million in production and
fabrication equipment, plant-wide process control systems and other upgrades
relating to our Climate Control Business. In addition to the spending on
equipment and systems, during 2006 and 2007, we invested a total of
approximately $3.8 million in facilities.
As a
result of record order intake level of our heat pump products during 2006 and
2007, our backlog of confirmed orders for these products had increased to high
levels and our lead times had pushed out beyond levels that we consider to be
optimum for good customer service. In order to work the backlog down and to
improve product lead times, we have increased unit capacity by approximately 65%
(through additional shifts, overtime, investment in
equipment, and facilities) since the end of 2005, with the potential for a
further increase in capacity by debottlenecking and the addition of certain
fabrication equipment. The facility expansion included a new 46,000 square foot
building next to our existing heat pump manufacturing facility and the
renovation of 110,000 square feet of an existing facility for a distribution
center.
Our fan
coil business also experienced significant increases in customer orders and
shipments during 2007 and was able to increase production capacity through
increased utilization of second shifts, equipment purchases, and the extension
and reconfiguration of production assembly lines. During 2007, we
also made capital investments to substantially increase our capacity of
tube-in-fin heat transfer coils used in geothermal and water source heat pumps
and hydronic fan coils.
For 2008,
we have committed to date to spend an additional $3.2 million for production
equipment and land for future expansion. Our investment in the Climate Control
Business will continue if order intake levels continue to warrant. These
investments have and will increase our capacity to produce and distribute our
Climate Control products.
As of
December 31, 2007 and 2006, the backlog of confirmed orders for our Climate
Control Business was approximately $54.5 million and $80.4 million,
respectively. The decrease in our backlog relates primarily to utilizing the
increased capacity discussed above. Our experience indicates that customers
generally do not cancel orders after we receive them. We expect to ship
substantially all the orders in the backlog within the next twelve
months.
Marketing and
Distribution
Distribution
Our
Climate Control Business sells its products to mechanical contractors, original
equipment manufacturers (“OEMs”) and distributors. Our sales to mechanical
contractors primarily occur through independent manufacturers' representatives,
who also represent complementary product lines not manufactured by us. OEMs
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 OEMs relating to our products of the Climate Control
Business:
|
Net
sales to OEMs as a percentage of:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales of the Climate Control Business
|
|
19
|
%
|
|
17
|
%
|
|
22
|
%
|
|
Consolidated
net sales
|
|
9
|
%
|
|
8
|
%
|
|
9
|
%
|
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 2008, however, changes in market
volatility, 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 six 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:
|
|
|
|
|
|
|
|
|
|
|
Agricultural
products
|
|
41
|
%
|
|
34
|
%
|
|
35
|
%
|
|
Industrial
acids and other chemical products
|
|
33
|
%
|
|
37
|
%
|
|
34
|
%
|
|
Mining
products
|
|
26
|
%
|
|
29
|
%
|
|
31
|
%
|
|
|
|
100
|
%
|
|
100
|
%
|
|
100
|
%
|
|
Percentage
of our consolidated net sales:
|
|
|
|
|
|
|
|
|
|
|
Agricultural
products
|
|
20
|
%
|
|
18
|
%
|
|
21
|
%
|
|
Industrial
acids and other chemical products
|
|
16
|
%
|
|
19
|
%
|
|
20
|
%
|
|
Mining
products
|
|
13
|
%
|
|
16
|
%
|
|
18
|
%
|
|
|
|
49
|
%
|
|
53
|
%
|
|
59
|
%
|
Agricultural
Products
Our
Chemical Business produces ammonium nitrate at the El Dorado Facility and
anhydrous ammonia, UAN, and ANA at the Cherokee Facility; all of which are
nitrogen based fertilizers. The Cherokee Facility 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 and ranchers 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. Our agricultural markets
include a high concentration of pastureland and row crops, which favor our
products. We sell these agricultural products to farmers, ranchers, fertilizer
dealers and distributors located in the Central and Southeastern United States,
which are in relatively close proximity to the El Dorado and Cherokee
Facilities. We develop our market position in these areas by emphasizing high
quality products, customer service and technical advice. During the past two
years, we have been successful in expanding outside our traditional markets by
barging to distributors on the Tennessee and Ohio rivers, and by railing into
certain Western States. The El Dorado Facility produces a high performance
ammonium nitrate fertilizer that, because of its uniform size, is easier to
apply than many competing nitrogen-based fertilizer products. The El Dorado
Facility establishes long-term relationships with end-users through its network
of wholesale and retail distribution centers and the Cherokee Facility sells
directly to agricultural customers.
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, ordnance, and other chemical products. In addition, at the El
Dorado Facility, we produce and sell blended and regular nitric acid and we are
a niche market supplier of sulfuric acid, primarily to the region’s key paper
manufacturers. At the Cherokee Facility, we are also a niche market supplier of
industrial and high purity ammonia for many specialty applications, including
chemicals to treat emissions from power plants.
We
compete based upon service, price, location of production and distribution
sites, product quality and performance. We also 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.
The
Baytown Facility 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 the Baytown Facility 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.
Discussions with Bayer have begun regarding a renewal in 2009.
Mining
Products
Our
Chemical Business manufactures industrial grade ammonium nitrate (“AN”) and 83%
AN solution for the mining industry. The El Dorado Facility is a party to a
long-term cost-plus supply agreement. Under this supply agreement, the El Dorado
Facility 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
Customer
The
following summarizes net sales to our major customer relating to our products of
the Chemical Business:
|
Net
sales to Orica as a percentage of:
|
|
|
|
|
|
|
|
|
|
Net
sales of the Chemical Business
|
19
|
%
|
|
20
|
%
|
|
19
|
%
|
|
Consolidated
net sales
|
9
|
%
|
|
10
|
%
|
|
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 published prices for natural
gas based upon the daily spot price at the Tennessee 500 pipeline pricing point
and for ammonia based upon the low Tampa metric price per ton as published by
Ferticon and FMB Ammonia reports.
|
|
Daily
Spot Natural Gas Prices Per MMBtu
|
|
Ammonia
Price Per Metric Ton
|
|
|
High
|
|
Low
|
|
High
|
|
Low
|
|
2005
|
$15.25
|
|
$5.50
|
|
$399
|
|
$235
|
|
2006
|
$ 9.90
|
|
$3.54
|
|
$395
|
|
$270
|
|
2007
|
$10.59
|
|
$5.30
|
|
$460
|
|
$295
|
As of
March 7, 2008, the published price of natural gas, as described above, was
approximately $9.61 per MMBtu and ammonia was $635 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 pricing 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 use
exchange-traded futures contracts to hedge the natural gas requirements for most
sales commitments with firm sales prices.
Interruptions
to the natural gas supply chain by the hurricanes of 2005 continued to
exacerbate natural gas prices into early 2006. The Cherokee Facility was forced
to temporarily curtail production in January and February of 2006 when major
customers reduced purchases due to the high natural gas raw material
pass-through costs. 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. During 2007, the Cherokee Facility did not curtail
production due to interruptions to their natural gas supply chain.
Under an
agreement, as amended, with its principal supplier of anhydrous ammonia, the El
Dorado Facility will purchase a majority of its anhydrous ammonia requirements
using a market price-based formula plus transportation to the El Dorado Facility
through at least 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. The Cherokee Facility’s natural gas feedstock
requirements are generally purchased at spot market
price. Periodically, the Cherokee Facility will hedge certain of its
natural gas requirements with exchange-traded futures contracts as discussed
above.
Historically,
the sulfur costs have been relatively stable; however, as of the date of this
report, the recent world sulfur shortages have led to a significant increase in
the cost of this raw material during the second half at 2007 and into
2008.
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" of this
Item 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. Based on our
current requirements, we believe there are no material capital expenditures to
be expended relating to our security controls. However, this expectation could
change in the near future.
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, such
as CF Industries, Dyno Nobel North America, Terra Industries and Potash Corp. of
Saskatchewan, many of whom 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, 2007, we employed 1,788 persons. As of that date, our Climate
Control Business employed 1,363 persons, none of whom was represented by a
union, and our Chemical Business employed 360 persons, with 138 represented by
unions under currently unexecuted negotiated agreements which the parties expect
to execute in the near future. Assuming the union agreements are executed in
their current form, the agreements will expire in July through November of
2010.
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 effluents 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 Facility 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 the El Dorado Facility a NPDES
water discharge permit in 2004, and the El Dorado Facility had until June 1,
2007 to meet the compliance deadline for the more restrictive limits under the
2004 NPDES permit. In order to meet the El Dorado Facility’s June 2007 limits,
the El Dorado Facility has significantly reduced the contaminant levels of its
wastewater.
The El
Dorado Facility has demonstrated its ability to comply with the more restrictive
permit limits, and the rules which support the more restrictive dissolved
minerals rules have been revised to authorize a permit modification to adopt
achievable dissolved minerals permit limits. The ADEQ has agreed to issue a
consent administrative order to authorize the El Dorado Facility to continue
operations without incurring permit violations pending the modification of the
permit to implement the revised rule and to dispose of the El Dorado Facility’s
wastewater into the creek adjacent to the El Dorado Facility. A draft
of the proposed consent administrative order has been prepared by the ADEQ and
submitted to the El Dorado Facility for review. We are currently
reviewing the proposed consent administrative order.
To meet
the June 2007 permit limits, the El Dorado Facility has conducted a study of the
creek adjacent to the El Dorado Facility to determine whether a permit
modification allowing for the discharge into the creek is appropriate. On
September 22, 2006, the Arkansas Pollution Control and Ecology Commission
approved the results of the study that showed that the proposed permit
modification is appropriate and the proposal to allow the El Dorado Facility to
dispose of its wastewater into the creek. A public hearing was
held on the matter on November 13, 2006 with minimal opposition. As a
result, the El Dorado Facility has been discharging its wastewater into the
creek.
In
addition, the El Dorado Facility has entered into a consent administrative order
(“CAO”) that recognizes the presence of nitrate contamination in the shallow
groundwater at the El Dorado Facility. 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 CAO requires the El Dorado Facility to continue semi-annual
groundwater monitoring, to continue operation of a groundwater recovery system
and to submit a human health and ecological risk assessment to the ADEQ. 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. As an interim measure, the El Dorado
Facility has installed two recovery wells to recycle groundwater 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, 2007.
2. Air
Matters
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 the El Dorado Facility’s sulfuric acid plant
and certain other alleged air emission violations, the El Dorado Facility is
required to implement additional air emission controls at the El Dorado Facility
no later than February 2010. We currently estimate the remaining environmental
compliance related expenditures to be approximately $5.6 million, which has been
committed for 2008.
In
December 2006, the El Dorado Facility entered into a new CAO (“2006 CAO”) with
the ADEQ to resolve a problem with ammonia emissions from certain nitric acid
units. The catalyst suppliers had represented the volume of ammonia emissions
anticipated. The representation was the basis for the permitted emission limit,
but the representation of the catalyst suppliers was not accurate. The ADEQ
allowed the El Dorado Facility to re-evaluate the catalyst performance and
required the El Dorado Facility to submit a permit modification with the
appropriate ammonia limits. The permit modification was submitted to
ADEQ on June 11, 2007, and is currently under review. Until the permit is
modified, the 2006 CAO authorizes the El Dorado Facility to continue to operate
certain nitric acid units (even though the El Dorado Facility is in
non-compliance with the permitted emission limit for ammonia), provided that
during this period of time, the El Dorado Facility monitors and reports the
ammonia on a monthly basis.
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
December 2002, Slurry and Universal Tech Corporation (“UTeC”), both subsidiaries
within our Chemical Business, sold substantially all of their operating assets
but retained ownership of the real property. At December 31, 2002, even though
we continued to own the real property, we did not assess our continuing
involvement with our former Hallowell Facility to be significant and therefore
accounted for the sale as discontinued operations. In connection with this sale,
UTeC leased the real property 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”), the prior owner of the Hallowell Facility has agreed,
within certain limitations, to pay and has been paying one-half of the costs
incurred under the Slurry Consent Order subject to reallocation.
Based on
additional modeling of the site, Slurry and Chevron are pursuing 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 proposed previously. On
September 12, 2007, the KDHE approved our proposal to perform two years of
surface and groundwater monitoring and to implement a Mitigation Work Plan to
acquire additional field data in order to more accurately characterize the
nature and extent of contaminant migration off-site. The two-year monitoring
program will terminate in February 2009. As a result of receiving approval from
the KDHE for our proposal, we recognized a reduction in our share of the
estimated costs associated with this remediation by $377,000. This reduction is
included in the net income from discontinued operations of $348,000 for 2007 (in
accordance with Statement of Financial Accounting Standards (“SFAS”)
144.
At
December 31, 2007, the total estimated liability (which is included in current
and noncurrent accrued and other liabilities) in connection with this
remediation matter is approximately $378,000 and Chevron’s share for these costs
(which is included in accounts receivable and other assets) is approximately
$194,000. 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.
Risks Related to Us and Our
Business
Cost
and the lack of availability of raw materials could materially affect our
profitability and liquidity.
Our sales
and profits are heavily affected by the costs and availability of primary raw
materials. These primary raw materials, which are purchased from
unrelated third parties, are subject to considerable price volatility.
Historically, when there have been rapid increases in the cost of these primary
raw materials, we have sometimes been unable to timely increase our sales prices
to cover all of the higher costs incurred. While we periodically enter into
exchange-traded futures contracts to hedge against price increases in certain of
these raw materials, there can be no assurance that we will effectively manage
against price fluctuations in those raw materials.
Anhydrous
ammonia and natural gas represent the primary raw material feedstocks in the
production of most of the products of the Chemical Business. 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 that do not provide for the pass-through of raw material costs.
In addition, the Climate Control Business depends on raw materials such as
copper and steel, which have shown considerable price volatility. As a result,
in the future, we may not be able to pass along to all of our customers the full
amount of any increases in raw
material
costs. There can be no assurance that future price fluctuations in
our raw materials will not have an adverse effect on our financial condition,
liquidity and results of operations.
Additionally,
we depend on certain vendors to deliver the primary raw materials and other key
components that are required in the production of our products. Any disruption
in the supply of the primary raw materials and other key components could result
in lost production or delayed shipments. We have suspended in the
past, and could suspend in the future, production at our chemical facilities due
to, among other things, the high cost or lack of availability of such primary
raw materials. Accordingly, our financial condition, liquidity and results of
operations could be materially affected in the future by the lack of
availability of primary raw materials and other key components.
Periodically,
our Chemical Business may not generate significant positive cash
flows.
Due, in
part, to extensive capital expenditures, our Chemical Business may not generate
significant positive cash flows periodically. Continuing significant cash flow
expenditures by this business could have a material adverse effect on our
financial condition and liquidity.
Our
Climate Control and Chemical Businesses and their customers are sensitive to
certain economic cycles.
Our
Climate Control Business can be 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.
Our
Chemical Business also can be affected by cyclical factors such as inflation,
global energy policy and costs, global market conditions and economic downturns
in specific industries. Certain sales of our Chemical Business are
sensitive to the level of activity in the agricultural, mining, automotive and
housing industries. A decline in the activity in these industries in the United
States has in the past, and could in the future, have a material adverse effect
on the results of our Chemical Business.
Weather
conditions adversely affect our Chemical Business.
The
agricultural products produced and sold by our Chemical Business have in the
past, and could 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 effluents at
or from the Chemical Business’ facilities. Further, a number of our Chemical
Business’ facilities are dependent on environmental permits to operate, the loss
or modification 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, distribution centers, and our
customers, as well as in the transportation of our products. These costs
could have a material impact on our financial condition and results of
operation. The cost of such regulatory changes, if significant enough, could
lead some of our customers to choose alternate products
to ammonium nitrate, which would have a significant impact on our Chemical
Business.
A
substantial portion of our sales is dependent upon a limited number of
customers.
During
2007, four customers of our Chemical Business accounted for 44% of its net sales
and 22% of our consolidated sales, and our Climate Control Business had one
customer that accounted for 17% of its net sales and 8% 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.
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.
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 February 29, 2008, an aggregate of 3,395,743
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 represent approximately 19.5% of the voting power
of our issued and outstanding voting securities as of that date. In
addition, the Golsen Group also beneficially owned options and other convertible
securities that allowed its members to acquire an additional 116,500 shares of
our common stock within 60 days of February 29, 2008. 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 (which may include warranty and product
liability claims). 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.
We
have not paid dividends on our outstanding common stock in many
years.
We have
not paid cash dividends on our outstanding common stock in many years, and we do
not currently anticipate paying cash dividends on our outstanding common stock
in the foreseeable future. However, our board of directors has not made a
definitive decision whether or not to pay such dividends in
2008.
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 the Cherokee Facility,
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.
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 Securities and Exchange Commission (“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.
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.
Our
net operating loss carryforwards are subject to certain limitations and have not
been audited or approved by the Internal Revenue Service.
Our net
operating loss (“NOL”) carryforwards have resulted from certain historical
losses. At December 31, 2006, we had regular NOL carryforwards of approximately
$49.9 million, all of which we have utilized or anticipate utilizing to reduce
our federal income tax liability for 2007 and 2008. In future periods, our net
income and liquidity will be negatively affected as we recognize and pay income
taxes without the benefit of these NOL carryforwards. In addition, the amount of
these NOL carryforwards utilized has not been audited or approved by the
Internal Revenue Service.
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
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) 53,982,012 shares of
common stock and 4,229,415 shares of preferred stock as of December 31, 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 2007, approximately 87% of the productive
capacity of this manufacturing facility was being utilized, based primarily on
two ten-hour shifts per day and a four-day work week. In addition, we acquired a
new 46,000
square
foot building adjacent to our existing heat pump manufacturing facility,
primarily used for storage of raw material inventory, and we renovated 110,000
square feet of an existing facility for a distribution center.
Our
Climate Control Business conducts its fan coil manufacturing operation in a
facility located in Oklahoma City, Oklahoma, consisting of approximately 265,000
square feet. We own this facility subject to a mortgage. For 2007, 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. The fan coil manufacturing operation increased the utilization of a
second shift in order to increase its production capacity during
2007.
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 2007,
approximately 57% 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.
Chemical
Business
Our
Chemical Business primarily conducts manufacturing operations (a) on 150 acres
of a 1,400 acre tract of land located at the El Dorado Facility, (b) on 160
acres of a 1,300 acre tract of land located at the Cherokee Facility and (c) on
leased property within Bayer’s complex in the Baytown, Texas. The Company and/or
its subsidiaries own all of its manufacturing facilities except the Baytown
Facility. The Baytown Facility is leased pursuant to a long-term lease with an
unrelated third party. Certain real property and equipment located at the El
Dorado and Cherokee Facilities are being used to secure a $50 million term loan.
For 2007, the following facilities were utilized based on continuous
operation:
|
|
El
Dorado Facility (1)
|
92
|
%
|
|
|
|
Cherokee
Facility (2)
|
95
|
%
|
|
|
|
Baytown
Facility
|
91
|
%
|
|
(1) The
percentage of capacity for the El Dorado Facility relates to its nitric acid
capacity. The El Dorado Facility has capacity to produce other nitrogen products
in excess of its nitric acid capacity.
(2) The
percentage of capacity for the Cherokee Facility relates to its ammonia
production capacity. The Cherokee Facility has additional capacity for nitric
acid, ammonium nitrate and urea in excess of its ammonia
capacity.
In
addition to the El Dorado and Cherokee Facilities, 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:
|
·
|
certain
environmental matters relating to air and water issues at our El Dorado
Facility; and
|
|
·
|
certain
environmental remediation matters at our former Hallowell
Facility.
|
2. 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 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.
Our ERISA counsel has advised us that, based on certain assumptions and
representations made by us to them, they believe that the possibility of an
unfavorable non-appealable verdict against us in a lawsuit if the PBGC attempts
to hold us liable for under-funding of the Zeller Plan is
remote.
MEI
Drafts
Masinexportimport
Foreign Trade Company (“MEI”) has given notice to the Company and Summit Machine
Tool Manufacturing Corp. (“Summit”), 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, which 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, 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.
During
2007, Cromus, alleged to be a Romanian company and an assignee of MEI, filed a
lawsuit against us and two of our subsidiaries, Summit Machine Tool
Manufacturing Corp. (“Summit”) and Hercules Energy Mfg. Corp., Jack Golsen, our
CEO, Mike Tepper, an officer of our company, Bank of America Corporation and
others in the New York Supreme Court, in the case styled Cromus, as the assignee of
MEI vs. Summit, Index No. 114890107 (NY Sup. Ct., NY Co. The
complaint seeks $1,533,000 plus interest from 1990, $1,000,000 for failure to
purchase certain equipment and $1,000,000 in punitive damages. We intend to
contest this matter vigorously. As of December 31, 2007, no liability
has been established relating to these alleged damages.
The
Jayhawk Group and the University of Kansas Endowment Fund
During
July 2007, we mailed to all holders of record of our Series 2 Preferred a notice
of redemption of all of the outstanding shares of Series 2 Preferred. The
redemption of our Series 2 Preferred was completed on August 27, 2007, the
redemption date. The terms of the Series 2 Preferred required that for each
share of Series 2 Preferred so redeemed, we would pay, in cash, a
redemption price equal to $50.00 plus $26.25 representing dividends in arrears
thereon pro-rata to the date of redemption. There were 193,295 shares
of Series 2 Preferred outstanding, net of treasury stock, as of the date the
notice of redemption was mailed. Pursuant to the terms of the Series 2
Preferred, the holders of the Series 2 Preferred could convert each share into
4.329 shares of our common stock, which right to convert terminated 10 days
prior to the redemption date. If a holder of the Series 2 Preferred elected to
convert his, her or its shares into our common stock pursuant to its terms, the
Certificate of Designations for the Series 2 Preferred provided, and it is our
position, that the holder that so converts would not be entitled to receive
payment of any dividends in arrears on the shares so converted. The Jayhawk
Group, a former affiliate of ours, converted 155,012 shares of Series 2
Preferred into 671,046 shares of common stock. The Jayhawk Group has advised us
that it may bring legal action against us for all dividends in arrears
(approximately $4 million) on the shares of Series 2 Preferred that it converted
after receipt of the notice of redemption. The Company believes the likelihood
that the Jayhawk Group may recover the dividends in arrears is not probable.
Therefore, no liability has been established at December 31,
2007.
During
the first quarter of 2008, the University of Kansas Endowment Charitable Gift
Fund (“KU”) filed a lawsuit against us in the U.S. District Court, for the
District of Kansas at Kansas City, styled The KU Endownment Charitable
Gift Fund vs. LSB Industries, Inc., Case No. 08-CV-2066. KU alleges that
we improperly refused to accept 11,200 shares of Series 2 Preferred, which KU
received as a gift from the controlling party of the Jayhawk Group, in our
issuer exchange tender offer. Under the issuer exchange tender offer,
we offered to exchange each outstanding share of Series 2 Preferred for 7.4
shares of our common stock and a waiver of all dividends in arrears, except for
certain shares of Series 2 Preferred owned by the Jayhawk Group (including its
controlling party, Kent McCarthy) and the Golsen Group pursuant to an agreement
entered into between us and the Jayhawk Group. The gift to KU by the
controlling party of the Jayhawk Group was made after the announcement of the
issuer exchange tender offer, and it is our position, among other things, that
the tender of the shares given as a gift was made contrary to the agreement
between us and the Jayhawk Group and contrary to the terms of our issuer
exchange tender offer. KU alleges, among other things, that it
suffered losses because it was required to convert the 11,200 shares of Series 2
Preferred pursuant to the conversion terms of the Series 2 Preferred, which was
4.3 shares of our common stock for each share of Series 2 Preferred, and that
the conversion was less favorable than the terms of issuer exchange tender
offer. KU alleges that the refusal to accept the 11,200 shares of
Series 2 Preferred was in violation of §14(d) of the Securities Exchange Act of
1934 (“34 Act”), a violation of §10b and Rule 10b-5 and §18 of the 34 Act, the
Kansas Uniform Securities Act and common law fraud. We intend to
vigorously defend this matter. As of December 31, 2007, no liability has been
established relating to this claim. We have placed the carrier under
our Executive Organizational Liability Insurance Policy Including Securities
Liability (“Policy”) on notice of this claim and litigation. This matter is
being defended by our insurance carrier under the Policy under a reservation of
rights. Our Policy is subject to a $250,000 self insured retention for
securities actions.
We
received a letter dated May 23, 2007 from a law firm representing a stockholder
of ours demanding that we investigate potential short-swing profit liability
under Section 16(b) of the Exchange Act of the Jayhawk Group. The stockholder
alleges that the surrender by the Jayhawk Group of 180,450 shares of our Series
2 Preferred in our issuer exchange tender offer in March 2007 was
a sale which was subject to Section 16 and matchable against prior purchases of
Series 2 Preferred by the Jayhawk Group. The Jayhawk Group advised us that they
do not believe that they are liable for short-swing profits under Section 16(b).
The provisions of Section 16(b) provide that if we do not file a lawsuit against
the Jayhawk Group in connection with these Section 16(b) allegations within 60
days from the date of the stockholder’s notice to us, then the stockholder may
pursue a Section 16(b) short-swing profit claim on our behalf. We engaged our
outside corporate/securities counsel to investigate this matter. After
completion of this investigation,
we attempted to settle the matter with the Jayhawk Group but were unable to
reach a resolution satisfactory to all parties. On October 9, 2007, the law firm
representing the stockholder initiated a lawsuit against the Jayhawk Group
pursuing a Section 16(b) short-swing profit claim on our behalf up to
approximately $819,000. During the first quarter of 2008, the parties have
agreed to settle this claim by a payment to us by the Jayhawk Group of $180,000,
of which we will receive approximately $125,000 after attorneys’ fees. This
settlement is subject to a definitive settlement agreement.
Securities
and Exchange Commission Inquiry
The 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 ended 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.
|
Other
Claims and Legal Actions
Wetherell v. Climate
Master, a proposed class action filed by Donna Wetherell, individually
and as a class action representative, Plaintiff, and Climate Master, Inc.,
Defendant, in the Circuit Court of the First Judicial Circuit, Johnson County,
Illinois on September 14, 2007 alleges that certain evaporator coils sold by one
of our subsidiaries in the Climate Control Business, Climate Master, Inc.
(“Climate Master”) in the state of Illinois from 1990 to approximately 2003 were
defective. The complaint requests certification as a class action for the State
of Illinois, which request has not yet been heard by the court. The
plaintiff asserts claims based upon negligence, strict liability, breach of
implied warranties, and the Illinois Consumer Fraud and Deceptive Business
Practices Act. Climate Master has timely filed its pleadings to remove
this action to federal court. Climate Master has also filed its answer denying
the plaintiff’s claims and asserting several affirmative defenses. Climate
Master’s insurers have been placed on notice of this matter. Currently the
Company is unable to determine the amount of damages or the likelihood of any
losses resulting from this claim. In addition, the Company intends to vigorously
defend Climate Master in connection with this matter. Therefore, no
liability has been established at December 31, 2007.
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 2007.
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 79
first became a director in 1969. His term was renewed for 3 years at the
annual meeting in 2007. Mr. Golsen, founder of the Company, is our
Chairman of the Board of Directors and Chief Executive Officer and has
served in those capacities 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. Mr. Golsen is a Trustee of
Oklahoma City University. During his career, he acquired or
started the companies which formed LSB. He has served on the
boards of insurance companies, several banks and was Board Chairman of
Equity Bank for Savings N.A. which was formerly owned by
LSB.
|
|
|
|
|
|
Barry H. Golsen
(1)
|
|
Vice
Chairman of the Board, President, and President of the Climate Control
Business. Mr. Golsen, age 57, 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 67, 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 66, 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 65, 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 48, 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.
|
|
|
(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
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
|
|
$
|
15.71
|
|
$
|
11.41
|
|
$
|
7.48
|
|
$
|
5.87
|
|
|
|
Second
|
|
$
|
23.70
|
|
$
|
14.76
|
|
$
|
9.19
|
|
$
|
6.95
|
|
|
|
Third
|
|
$
|
25.25
|
|
$
|
17.00
|
|
$
|
10.25
|
|
$
|
8.25
|
|
|
|
Fourth
|
|
$
|
28.85
|
|
$
|
20.54
|
|
$
|
13.20
|
|
$
|
8.50
|
|
Stockholders
As of
March 7, 2008, we had 698 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 $50
million revolving credit facility (the “Working Capital Revolver Loan”) and the
new $50 million loan agreement due 2012 (the “Secured Term Loan”). Under the
terms of these 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, and
|
|
|
·
|
outstanding
loans entered into subsequent to November 2, 2007 in excess of $2.0
million at any time.
|
As of
December 31, 2007, we have issued and outstanding 1,000,000 shares of Series D
Preferred, 585 shares 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, only when declared by
our board of directors, payable as follows:
|
·
|
Series
D Preferred at the rate of $.06 a share payable on October 9, which
dividend is cumulative;
|
|
·
|
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.
|
Holders
of our common stock are entitled to receive dividends only when declared by our
board of directors. We have not paid cash dividends on our outstanding common
stock in many years, and we do not currently anticipate paying cash dividends on
our outstanding common stock in the foreseeable future. However, our board of
directors has not made a definitive decision whether or not to pay such
dividends in 2008.
|
|
Years
ended December 31,
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
|
|
2006
|
|
2005
|
|
2004
|
|
2003
|
|
|
(Dollars
In Thousands, Except Per Share
Data)
|
|
Selected
Statement of Operations Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net
sales
|
$
|
586,407
|
|
$
|
491,952
|
|
|
$
|
397,115
|
|
|
$
|
363,984
|
|
|
$
|
317,026
|
|
|
Interest
expense (1)
|
$
|
12,078
|
|
$
|
11,915
|
|
|
$
|
11,407
|
|
|
$
|
7,393
|
|
|
$
|
6,097
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
from continuing operations before cumulative effect of accounting change
(1) (2)
|
$
|
46,534
|
|
$
|
15,768
|
|
|
$
|
5,634
|
|
|
$
|
745
|
|
|
$
|
3,705
|
|
|
Cumulative
effect of accounting change
|
$
|
-
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(536
|
)
|
|
$
|
-
|
|
|
Net
income
|
$
|
46,882
|
|
$
|
15,515
|
|
|
$
|
4,990
|
|
|
$
|
209
|
|
|
$
|
3,705
|
|
|
Net
income (loss) applicable to common stock
|
$
|
41,274
|
|
$
|
12,885
|
|
|
$
|
2,707
|
|
|
$
|
(2,113
|
)
|
|
$
|
1,378
|
|
|
Income
(loss) per common share applicable to common
stock:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Basic:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before cumulative effect of accounting
change
|
$
|
2.09
|
|
$
|
.92
|
|
|
$
|
.25
|
|
|
$
|
(.12
|
)
|
|
$
|
.11
|
|
|
Net
income (loss) from discontinued operations
|
$
|
.02
|
|
$
|
(.02
|
)
|
|
$
|
(.05
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Cumulative
effect of accounting change
|
$
|
-
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
Net
income (loss)
|
$
|
2.11
|
|
$
|
.90
|
|
|
$
|
.20
|
|
|
$
|
(.16
|
)
|
|
$
|
.11
|
|
|
Diluted:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Income
(loss) from continuing operations before cumulative effect of accounting
change
|
$
|
1.82
|
|
$
|
.77
|
|
|
$
|
.22
|
|
|
$
|
(.12
|
)
|
|
$
|
.10
|
|
|
Net
income (loss) from discontinued operations
|
$
|
.02
|
|
$
|
(.01
|
)
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
$
|
-
|
|
|
Cumulative
effect of accounting change
|
$
|
-
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
(.04
|
)
|
|
$
|
-
|
|
|
Net
income (loss)
|
$
|
1.84
|
|
$
|
.76
|
|
|
$
|
.18
|
|
|
$
|
(.16
|
)
|
|
$
|
.10
|
|
|
Selected Balance Sheet
Data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
assets
|
$
|
307,554
|
|
$
|
219,927
|
|
|
$
|
188,963
|
|
|
$
|
167,568
|
|
|
$
|
161,813
|
|
|
Redeemable
preferred stock
|
$
|
56
|
|
$
|
65
|
|
|
$
|
83
|
|
|
$
|
97
|
|
|
$
|
103
|
|
|
Long-term
debt, including current portion
|
$
|
122,107
|
|
$
|
97,692
|
|
|
$
|
112,124
|
|
|
$
|
106,507
|
|
|
$
|
103,275
|
|
|
Stockholders'
equity
|
$
|
94,283
|
|
$
|
43,634
|
|
|
$
|
14,861
|
|
|
$
|
9,915
|
|
|
$
|
8,862
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selected
other data:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cash
dividends declared per common share
|
$
|
-
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
|
(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 change
includes a gain on extinguishment of debt of $4.4 million for
2004.
|
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, 2007
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.
|
2007
Results
LSB's
2007 sales were $586.4 million compared to $492.0 million in 2006, operating
income was $59.0 million compared to $27.1 million in 2006 and income from
continuing operations was $46.5 million compared to $15.8 million in 2006. Net
income was $46.9 million in 2007 compared to $15.5 million for
2006.
Our
Climate Control Business continued to report strong sales and operating results
due to beginning backlogs and strong new order flow for the year. Our
Climate Control Business net sales were $286.4 million compared to $221.2
million in 2006, a 29.5% increase. Operating income before allocation of
corporate overhead was $34.2 million, a 34.5% increase over the $25.4 million in
2006.
Our
Chemical Business reported improved results in 2007 with net sales of $288.8
million compared to $260.7 million in 2006, a 10.8% increase. Operating income
before allocation of corporate overhead was $35.0 million compared to $9.8
million in 2006, an increase of 257.8%. As indicated above, the
increase in 2007 operating income included certain non-recurring income items
totaling $7.1 million that are discussed below.
For 2007,
net income also included a litigation settlement of $3.3 million and insurance
recoveries totaling $3.8 million, which are described more fully below under
Chemical Business.
In
addition, net income for 2007 was impacted by our provision for income taxes.
For 2007 and recent prior years, our provisions for income taxes have included
benefits from the utilization of NOL carryforwards. The net
provisions for income taxes in 2007 and 2006 were $2,540,000 and $901,000,
respectively. The 2007 provision included a current provision for federal income
taxes of $5,260,000 for regular federal income tax and alternative minimum
income tax (“AMT”). The 2007 provision also included a current
provision of state income taxes of $1,980,000 which includes the provision for
2007 state income taxes, as well as, $1,047,000 for uncertain state income tax
positions recognized in accordance with FIN 48.
The 2007
provisions are partially offset by a benefit for deferred income taxes of
$4,700,000 resulting from the reversal of valuation allowance on deferred tax
assets, the benefit of AMT credits, and other temporary differences. At December
31, 2006, we had regular NOL carryforwards of approximately $49.9 million and
other temporary differences. Prior to 2007, we had valuation allowances in place
against the net deferred tax assets arising from the NOL carryforwards and other
temporary differences. As the result of improving financial results during 2007
and our expectation of generating taxable income in the future, we determined
that the valuation allowance was no longer required as of September 30, 2007. As
a result, we reversed the valuation allowance as a benefit for income taxes and
recognized deferred tax assets and deferred tax liabilities. At December 31,
2007, we had net current deferred tax assets of $10.0 million and net
non-current deferred tax liabilities of $5.3 million.
The
existence of the valuation allowance in prior years, and the reversal of the
valuation allowance during 2007, caused our effective tax rate to be
substantially lower in 2007 and prior years than we anticipate it being in
future periods. In future periods we anticipate that our effective tax rate will
more closely approximate the regular federal and state statutory tax rates,
substantially increasing the income tax expense we recognize each
year.
At
December 31, 2007, we have federal NOL carryforwards of only approximately $2.9
million remaining. We anticipate fully utilizing the federal NOL carryforwards
in 2008 at which time we will begin paying federal income taxes at regular
corporate tax rates.
Due to
regular tax NOL carryforwards with a full valuation allowance, the only current
tax expense for 2006 was for federal AMT and state income taxes
as discussed above.
Climate
Control Business
Our
Climate Control Business has consistently generated annual profits and positive
cash flows and continues to do so. As indicated above, Climate Control’s net
sales and operating income for 2007 were higher than in 2006. The
increase in sales and operating income as compared to 2006 is attributable to
strong demand for the geothermal and water source heat pumps, which reported a
sales increase of $30.9 million and hydronic fan coils that reported a sales
increase of $26.3 million.
Most of
the products of our Climate Control Business are produced to customer orders
that are placed well in advance of required delivery dates. As a result, our
Climate Control Business maintains a significant backlog that eliminates the
necessity to carry substantial inventories other than for firm customer orders.
As a result of strong order flow in the recent past, our Climate Control backlog
of confirmed orders had increased to high levels and our lead times had pushed
out beyond levels that we consider to be optimum for good customer service. In
order to work the backlog down and to improve product lead times, we increased
production capacity. We invested $7.6 million in 2006, an additional $6.8
million in 2007 and currently have committed approximately $3.2 million for
additional plant and equipment capacity and land for future expansion. At
December 31, 2007, the backlog of confirmed orders was approximately $54 million
compared to $62 million at September 30, 2007 and $80 million at December 31,
2006. We expect to ship substantially all the orders in the backlog within the
next twelve months.
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
presence in new markets. Climate Control Business's profitability over the last
few years has been affected by operating losses of certain new product lines
being developed during that time. Our emphasis has been to increase the sales
levels of these operations above the breakeven point. During 2007, the results for
these new products reflected modest improvement. Although these new products
have not yet achieved profitability, we continue to believe that these new
products have good long-term prospects.
Management
continues to focus on the following objectives for Climate Control:
|
·
|
increasing
the sales and operating margins of all
products,
|
|
·
|
developing
and introducing new and energy efficient products,
and
|
|
·
|
improving
production and product delivery
performance.
|
Our
Chemical Business has production facilities in Baytown, Texas (the “Baytown
Facility”), El Dorado, Arkansas (the “El Dorado Facility”) and Cherokee, Alabama
(the “Cherokee Facility”). The Baytown and El Dorado Facilities produce nitrogen
products from anhydrous ammonia that is delivered by pipeline and sulfuric acid
from recovered elemental sulfur delivered by truck and rail. The
Cherokee Facility produces anhydrous ammonia and nitrogen products from natural
gas that is delivered by pipeline.
As
indicated above, Chemicals net sales and operating income for 2007 were higher
than in 2006. The increase in sales and operating income as compared to 2006 is
attributable to strong demand for agricultural products and consistent demand
for the industrial and mining products, Also operating income for 2007 and 2006
included the following unusual income items:
|
Settlement
of litigation
|
$
|
3.3
|
|
$ |
-
|
|
Insurance
recoveries of business interruption claims
|
|
3.8
|
|
|
0.9
|
|
Total
|
$
|
7.1
|
|
$ |
0.9
|
The $3.3 million reflects the net proceeds of $2.7 million
received by the Cherokee Facility and the retention by the Cherokee Facility of
a disputed $0.6 million accounts payable as a result of the settlement agreement
with Dynegy, Inc. and one of its subsidiaries to settle a previously reported
lawsuit.
The $3.8
million is a result of the settlement of a business interruption claim filed by
the Cherokee Facility with their insurers. The proceeds from this settlement
were used for general working capital purposes.
The
increase in operating income relative to sales (excluding the unusual income
items noted above) is primarily a result of increased gross profit margins,
resulting from higher nitrogen fertilizer demand in our agricultural markets.
Low wheat and corn stocks-to-use ratios, as well as low inventories of other
crops, resulted in strong demand for nitrogen fertilizer in 2007, which has had
a positive effect on the approximate one-third of our sales which are sold in
the agricultural markets.
Our
primary raw material feedstocks, anhydrous ammonia, natural gas and sulfur, are
commodities subject to significant price fluctuations, and are generally
purchased at prices in effect at the time of purchase. Due to the uncertainty of
these commodity markets, we have developed customers that purchase our products
pursuant to agreements and/or pricing formulas that provide for the pass through
of raw material and other variable costs and certain fixed costs. Approximately
60% percent of our Chemical Business’ products sold in 2007 were to those
customers.
Our
Chemical Business uses precious metals as a catalyst in the manufacturing
process. During 2007, we had accumulated precious metals in excess of
our production requirements. Therefore we sold a portion of the excess metals.
As a result, we recognized a gain of $2.0 million which increased gross profit
and operating profit of our Chemical Business compared to
2006. However, this increase to gross profit and operating profit of
$2.0 million was partially offset by a net decrease of $1.8 million due
primarily to the increase in precious metals expense of approximately $1.5
million compared to 2006 as the result of cost increases for these
metals.
Our
Chemical Business continues to focus on growing our non-seasonal industrial
customer base with an emphasis on customers accepting the risk inherent with raw
material costs, while at the same time, maintaining a strong presence in the
seasonal agricultural sector, when the potential for favorable gross profit
margins is available. The operation’s strategy is to maximize production
efficiency of the facilities, thereby lowering the fixed cost of each ton
produced.
Completion of Tender
Offer
During
November 2006, the Company entered into the Jayhawk Agreement with the Jayhawk
Group. Under the Jayhawk Agreement, the Jayhawk Group agreed to tender 180,450
shares of the 346,662 shares of the Series 2 Preferred, if the Company made an
exchange or tender offer for the Series 2 Preferred. In addition, as a condition
to the Jayhawk Group’s obligation to tender such shares of Series 2 Preferred in
an exchange/tender offer, the Jayhawk Agreement further provided that 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/tender 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 a tender 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 tender offer
expired on March 12, 2007 and our board of directors accepted the shares
tendered on March 13, 2007. The terms of the tender 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 tender offer and the waiver of all rights
to dividends in arrears on the Series 2 Preferred tendered. As a result of this
tender offer, we issued 2,262,965 shares of our common stock for 305,807 shares
of Series 2 Preferred that were tendered. As a result, we effectively settled
the dividends in arrears on the Series 2 Preferred tendered totaling
approximately $7.3 million ($23.975 per share). Because the exchange was
pursuant to terms other than the original conversion terms, the transaction was
considered an extinguishment of the preferred stock. In addition, the
transaction qualified as an induced conversion under SFAS
84. Accordingly, we recorded a charge (stock dividend) to accumulated
deficit of approximately $12.3 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 March 13, 2007, the date the
shares so tendered were accepted by our board of directors.
Included
in the amounts discussed above and pursuant to the Jayhawk Agreement and the
terms of the tender 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. As a result, we effectively
settled the dividends in arrears on these shares of Series 2 Preferred tendered
totaling approximately $4.96 million with $4.33 million relating to the Jayhawk
Group and $0.63 million relating to the Golsen Group.
Stock
Options Receiving Stockholders' Approval
We
adopted SFAS 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”) using the
modified prospective method effective January 1, 2006, which required us to
measure and recognize
the cost of employee services received in exchange for an award of equity
instruments based on the grant date fair value of the award. As previously
reported, on June 19, 2006, the Compensation and Stock Option Committee of our
board of directors granted 450,000 shares of non-qualified stock options (the
“Options”) to certain Climate Control Business employees, which were subject to
shareholders’ approval. The option price of the Options is $8.01 per share which
is based on the market value of our common stock at the date the board of
directors granted the shares (June 19, 2006). The Options 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 the Options was estimated,
using an option pricing model, as of the date we received shareholders’ approval
which occurred during our 2007 annual shareholders’ meeting on June 14, 2007.
Under SFAS 123(R) for accounting purposes, the grant date and service inception
date is June 14, 2007.
As
previously reported, the total fair value for the Options was estimated to be
approximately $6.9 million, or $15.39 per share, using a Black-Scholes-Merton
option pricing model. As of June 14, 2007, we began amortizing the total
estimated fair value of the Options to selling, general, and administrative
expense (“SG&A”) which will continue through June 18, 2016 (a
weighted-average vesting period of 8.46 years). As a result, we incurred
stock-based compensation expense of $0.4 million for 2007. At December 31, 2007,
the total stock-based compensation expense not yet recognized is approximately
$6.5 million relating to the non-vested options.
During
2005, we accounted for our stock option plans under the recognition and
measurement principles of APB Opinion No. 25 (“APB 25”) and related
interpretations. Under APB 25, stock-based compensation cost was not reflected
in our results of operations, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the
date of grant. If we had applied the fair value recognition
provisions of SFAS 123(R) to stock-based compensation during 2005, using a
Black-Scholes-Merton option pricing model, net income would have decreased by
approximately $0.5 million.
Liquidity and Capital
Resources
The
following is our cash, total interest bearing debt and stockholders’ equity at
December 31,:
|
|
$
|
58.2
|
|
$
|
2.3
|
|
|
|
|
|
|
|
|
Long-term
debt
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2007
Debentures due 2012
|
$ |
60.0 |
|
$ |
-
|
|
Secured
Term Loan due 2012
|
|
50.0
|
|
|
-
|
|
Senior
Secured Loan due 2009
|
|
-
|
|
|
50.0
|
|
Working
Capital Revolver Loan
|
|
-
|
|
|
26.0
|
|
2006
Debentures due 2011
|
|
-
|
|
|
4.0
|
|
Other
|
|
12.1
|
|
|
17.0
|
|
Total
long-term debt
|
$
|
122.1
|
|
$
|
97.7
|
|
|
|
|
|
|
|
| Total
stockholder's equity |
$
|
94.3
|
|
$
|
43.6
|
As
indicated above, our capital structure and liquidity at December 31, 2007, are
improved from that at December 31, 2006. Although long-term debt is
$24.4 million higher, there is $58 million cash on hand and the $50 million
Working Capital Revolver Loan is undrawn and available to fund operations, if
needed. Long-term debt, before the use of cash on hand to pay down debt, dropped
from 2.2 times stockholders’ equity at December 31, 2006, to 1.3 times at
December 31, 2007.
During
2007, we completed the following transactions that favorably affected our
liquidity and capital resources:
|
·
|
converted
the remaining $4.0 million of the 7% Convertible Senior Subordinated
Debentures (the “2006 Debentures”) into 564,789 shares of our common
stock;
|
|
·
|
exchanged,
converted or redeemed the remaining 499,102 shares, net of treasury stock,
of Series 2 Preferred, along with all cumulative dividends in
arrears;
|
|
·
|
prepaid
the $50 million Senior Secured Loan due 2009 from proceeds of a new $50
million secured term loan due 2012, at a lower interest rate and less
collateral; and
|
|
·
|
finalized
a private placement of the 5.5% Convertible Senior Subordinated Notes due
2012 (the “2007 Debentures”) pursuant to which we sold $60.0 million
aggregate principal amount to twenty-two qualified institutional
buyers.
|
The 2007
Debentures bear interest at the annual rate of 5.5% and mature on July 1, 2012.
We received net proceeds of approximately $57.0 million, after discounts and
commissions.
We used
the net proceeds from the 2007 Debentures for the following:
|
·
|
$2.0
million to redeem 25,820 outstanding shares of our Series 2 Preferred
(including dividends in arrears);
|
|
·
|
$3.9
million to repay certain outstanding mortgages and equipment
loans;
|
|
·
|
$2.1
million to pay dividends in arrears on our outstanding shares of Series B
Preferred and Series D Preferred,
|
|
·
|
$25.0
million was loaned to ThermaClime to reduce the outstanding borrowing
under the Working Capital Revolver Loan;
and
|
|
·
|
the
remaining balance of approximately $24.0 million invested in money market
investments.
|
In
November 2007, ThermaClime and certain of its subsidiaries entered into the $50
million Secured Term Loan with a certain lender. Proceeds from the
Secured Term Loan were used to repay the Senior Secured Loan due 2009. The
Secured Term Loan matures on November 2, 2012 and accrues interest at a defined
LIBOR rate plus 3%. The interest rate at December 31, 2007 was 7.90%. The
Secured Term Loan requires only quarterly interest payments with the final
payment of interest and principal at maturity.
The
Secured Term Loan is secured by the real property and equipment located at the
El Dorado and Cherokee Facilities. The carrying value of the pledged assets is
approximately $48 million at December 31, 2007.
The
Secured Term Loan borrowers are subject to numerous covenants under the
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
Working Capital Revolver Loan is a $50.0 million credit facility that provides
for advances to ThermaClime and its subsidiaries based upon specified
percentages of eligible accounts receivable and inventories. At December 31,
2007, there were no borrowings outstanding under this loan and approximately
$0.8 million of the line was being used for issued and outstanding letters of
credit. 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 property and
equipment financing in order to fund operations and pay
obligations. In connection with the new Secured Term Loan due 2012,
the lenders of the Working Capital Revolver Loan released their second position
security liens to the assets which collateralize the Term Loan and agreed to
certain other modifications to the Working Capital Revolver Loan agreement,
including, among other things, a .25% reduction to the interest
rate.
The
Working Capital Revolver Loan and the Secured Term Loan have financial covenants
that are discussed below under “Loan Agreements – Terms and
Conditions”.
ThermaClime’s
ability to maintain 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.
Income Taxes
In 2007
and prior years, our effective tax rate has been minimal due to the availability
of NOL carryforwards. At December 31, 2007, we have federal NOL
carryforwards of only approximately $2.9 million remaining. We
anticipate fully utilizing the federal NOL carryforwards in 2008 and we will
begin paying federal income taxes at regular corporate tax
rates.
Filing
Requirements Pursuant to Sarbanes Oxley
As of
June 29, 2007, our public float held by non-affiliates exceeded the $75 million
threshold but was less than the $700 million threshold. As a result, we became
an accelerated filer on December 31, 2007. Therefore, we have been and will
continue to incur additional costs to meet the requirements as an accelerated
filer for the year ended December 31, 2007 and future periods.
Capital
Expenditures
General
Cash used
for capital expenditures in 2007 was $14.8 million, including $5.8 million
primarily for product equipment and other upgrades and for additional capacity
in our Climate Control Business and $8.6 million for our Chemical Business,
primarily for process and reliability improvements of existing facilities. As
discussed below, our current commitment for 2008 includes additional spending
for production equipment in our Climate Control Business and spending for
process and reliability improvement in our Chemical Business, including $5.6
million related to certain air emissions abatement.
Other
capital expenditures for 2008 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
$14.1 million for 2008. The expenditures include $10.9 million for our Chemical
Business and $3.2 million for our Climate Control Business. We plan to fund
these expenditures from working capital, which may include utilizing our Working
Capital Revolver Loan.
The
committed capital expenditures for our Chemical Business includes approximately
$5.6 million for certain capital expenditures required to expand capacity and
bring the El Dorado Facility’s sulfuric acid plant air emissions to lower
limits.
Certain
events relating to our Chemical Business
Pryor Facility - We are
evaluating the feasibility of activating all or a portion of our ammonia and
urea chemical plant in Pryor, Oklahoma (the “Pryor Facility”). The feasibility
study is based on producing and marketing approximately 325,000 tons of UAN
fertilizer per year. A final decision to activate the Pryor Facility has not
been made. If we decide to activate the Pryor Facility and the activation
project is approved by our board of directors, this project could take
approximately twelve months to obtain the necessary permits and complete the
plant improvements. The preliminary estimated total cost to activate the Pryor
Facility is approximately $15 million to $20 million with approximately
one-half of these costs to be expensed as incurred.
El Dorado Facility - El Dorado Chemical Company (“EDC”) produces
industrial grade ammonium nitrate for Orica USA, Inc. (“Orica”) under a
multi-year supply agreement which contract includes required minimum annual and
monthly volumes. Orica has notified EDC that it will significantly reduce its
expected purchases for the month of March 2008 below the required minimum
monthly volume. It is currently unknown when Orica will resume
purchasing at the contractual volumes. Under the terms of the contract, Orica
must pay liquidated damages if it fails to purchase the minimum monthly volume,
which liquidated damages compensate EDC for product not taken at the minimum
monthly contractual volume. Orica has indicated that it believes the contract
may not require the payment of certain components of the normal
formula price to EDC when Orica pays liquidated damages in lieu of purchasing
product at the minimum monthly contractual level. The amount in question is
approximately $230,000 for March 2008, although
Orica has agreed to pay such amount to EDC.
Baytown Facility - The Baytown Facility is operated by EDNC, a
subsidiary within our Chemical Business, under the Bayer Agreement with Bayer
and a leveraged lease agreement with a financial institution (“lessor”) all of
which expire in June 2009. Under the lease agreement, EDNC, as lessee, has the
right to acquire the leased facility by exercising a fixed price purchase option
(“purchase option”). The option price is approximately $17.6 million. Under the
agreements between EDNC and Bayer, Bayer may, at its option, require
EDNC to
exercise
the purchase option or refuse to allow EDNC to exercise the purchase
option. If Bayer directs EDNC to exercise the purchase option, Bayer
is responsible to pay the option price to the lessor. We have had preliminary
discussions with Bayer regarding a renewal of the Bayer Agreement between EDNC
and Bayer which may require EDNC to exercise the purchase option
under the lease agreement. If required by Bayer as a condition to renewing the
agreements with Bayer, we may, in our sole discretion, agree to pay the purchase
option as part of the renewal agreements, provided the economics of the
transaction are acceptable to us. For 2007, the Baytown Facility contributed
approximately 19% of the net sales of our Chemical Business and approximately 9%
of our consolidated net sales.
Stock
Repurchase Authorization
Our board
of directors enacted a stock repurchase authorization for an unstipulated number
of shares for an indefinite period of time commencing March 12, 2008. The stock
repurchase authorization will remain in effect until such time as of our board
of directors decides to end it.
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 $50
million Working Capital Revolver Loan and the new $50 million Secured Term Loan.
Under the terms of these 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, and
|
|
|
·
|
outstanding
loans entered into subsequent to November 2, 2007 in excess of $2.0
million at any time.
|
We have
not paid cash dividends on our outstanding common stock in many years. Pursuant
to our exchange/tender offer in March 2007, we issued approximately 2.3 million
shares of our common stock in exchange for approximately 0.3 million shares of
the Series 2 Preferred in accordance with the terms of the Series 2 Preferred.
As a result, we effectively settled the dividends in arrears totaling
approximately $7.3 million. Based on the terms of the tender offer,
we
recorded a charge (stock dividend) to accumulated deficit of approximately $12.3
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 of the Series 2 Preferred.
During
2007, we paid cash dividends of approximately $678,000 on the 25,820 shares of
Series 2 Preferred, which we redeemed pursuant to the notice of redemption we
mailed to all holders of record of our Series 2 Preferred on July 12, 2007. The
holders of 167,475 shares of our Series 2 Preferred exercised their right to
convert each share into 4.329 shares of our common stock. For the holders that
converted the shares of Series 2 Preferred into common stock, it is our position
that the holders were not entitled to any dividends in arrears on those shares
so converted. See “Related Party Transactions” of this MD&A as to certain
comments made by the Jayhawk Group relating to our redemption and amounts paid
to the Golsen Group as a result of the redemption and shares issued to the
Jayhawk Group as a result of conversions of its Series 2 Preferred.
In
addition, our board of directors declared and we paid dividends on the Series B
Preferred, Series D Preferred and noncumulative redeemable preferred stock
totaling approximately $1,890,000, $360,000 and $6,000, respectively. These
dividends were paid with a portion of the net proceeds of the 2007 Debentures
and working capital. As a result, there were no unpaid dividends in arrears at
December 31, 2007. See “Related Party Transactions” of this MD&A for a
discussion as to the Golsen Group’s ownership of the Series B Preferred and
Series D Preferred.
We do not
currently anticipate paying cash dividends on our outstanding common stock in
the foreseeable future. However, our board of directors has not made a
definitive decision whether or not to pay such dividends in 2008.
Compliance
with Long-Term Debt Covenants
As
discussed below under “Loan Agreements - Terms and Conditions”, the Secured Term
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 2008 indicate that ThermaClime
will be able to meet all required financial covenant tests for the year ending
December 31, 2008.
Loan Agreements - Terms and
Conditions
5.5% Convertible Senior Subordinated
Debentures – As previously reported and as discussed above under
“Liquidity and Capital Resources,” on June 28, 2007, we completed a private
placement to twenty-two qualified institutional buyers, pursuant to which we
sold $60.0 million aggregate principal amount of the 2007 Debentures. We
received net proceeds of approximately $57 million, after discounts and
commissions. The 2007 Debentures bear interest at the rate of 5.5% per year
and mature on July 1, 2012. Interest is payable in arrears on January 1 and
July 1 of each year, beginning on January 1, 2008. In addition, the
2007 Debentures are unsecured obligations and are subordinated in right of
payment to all of our existing and future senior indebtedness, including
indebtedness under our revolving debt facilities. The 2007 Debentures are
effectively subordinated to all present and future liabilities, including trade
payables, of our subsidiaries.
The 2007
Debentures are convertible by the holders in whole or in part into shares of our
common stock prior to their maturity. The conversion rate of the 2007 Debentures
for the holders electing to convert all or any portion of a debenture is 36.4
shares of our common stock per $1,000 principal amount of debentures
(representing a conversion price of $27.47 per share of common stock), subject
to adjustment under certain conditions as set forth in the
Indenture.
Working Capital Revolver Loan
– ThermaClime’s Working Capital Revolver Loan is available to fund its working
capital requirements, if necessary. 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. In connection with the Secured Term Loan (discussed below), the
Working Capital Revolver Loan was amended. The amendment includes the release of
the lenders second position security liens to the assets that collateralize the
Secured Term Loan and certain other modifications to the terms of the Working
Capital Revolver Loan, including among other things, an interest rate reduction
of .25% and an extended maturity date of April 13, 2012. As a result of using a
portion of the proceeds from the 2007 Debentures to pay down the Working Capital
Revolver Loan, at December 31, 2007, there were no outstanding borrowings. At
March 7, 2008, the net credit available for additional borrowings under our
Working Capital Revolver Loan was approximately $49.2 million. The Working
Capital Revolver Loan requires that ThermaClime meet certain financial covenants
measured quarterly. ThermaClime was in compliance with those covenants for the
twelve-month period ended December 31, 2007.
Secured Term Loan - In November 2007,
ThermaClime and certain of its subsidiaries entered into the $50 million Secured
Term Loan with a certain lender. Proceeds from the Secured Term Loan
were used to repay the previous Senior Secured Loan as discussed above under
“Liquidity and Capital Resources.” The Secured Term Loan matures on
November 2, 2012.
The
Secured Term Loan accrues interest at a defined LIBOR rate plus 3%. The interest
rate at December 31, 2007 was 7.90%. The Secured Term Loan requires only
quarterly interest payments with the final payment of interest and principal at
maturity.
The
Secured Term Loan is secured by the real property and equipment located at the
El Dorado and Cherokee Facilities. The carrying value of the pledged assets is
approximately $48 million at December 31, 2007.
The
Secured Term Loan borrowers are subject to numerous covenants under the
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. At December 31, 2007, the
carrying value of the restricted net assets of ThermaClime and its subsidiaries
was approximately $60 million. The Secured Term Loan borrowers are also subject
to a minimum fixed charge coverage ratio and a maximum leverage ratio, both
measured quarterly on a trailing twelve-month basis. The Secured Term Loan
borrowers were in compliance with these financial covenants for the year ended
December 31, 2007.
The
maturity date of the Secured Term Loan can be accelerated by the lender upon the
occurrence of a continuing event of default, as defined.
A
prepayment premium equal to 1% of the principal amount prepaid is due to the
lender should the borrowers elect to prepay on or prior to November 6, 2009.
This premium is reduced to 0.5% during the following twelve-month period and is
eliminated thereafter.
Cross - Default Provisions -
The Working Capital Revolver Loan agreement and the Secured Term Loan contain
cross-default provisions. If ThermaClime fails to meet the financial covenants
of the Secured Term 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
Jayhawk
Jayhawk
Capital Management, L.L.C., and certain of its affiliates (collectively, the
“Jayhawk Group”), a former significant shareholder and affiliate, were
participants to various investment transactions in certain issues of the
Company’s debt and equity securities during the past several years, which both
increased and decreased their ownership interest in the Company. During August
2007, the two directors appointed by the holders of our Series 2 Preferred were
no longer eligible to serve on our board and as of December 31, 2007, the
Jayhawk Group had decreased its ownership in our debt and equity securities to
the level whereby they are no longer considered a related party. However, the
Jayhawk Group was a participant in the following transactions related to our
debt and equity securities during the period it was considered a related
party:
During
2006, a member of the Jayhawk Group purchased $1,000,000 principal amount of the
2006 Debentures. In April 2007, the Jayhawk Group converted all of such 2006
Debentures into 141,040 shares of our common stock, at the conversion rate of
141.04 shares per $1,000 principal amount of 2006 Debentures (representing a
conversion price of $7.09 per share pursuant to the Indenture covering the 2006
Debentures). During 2007, we paid the Jayhawk Group $70,000 of which $46,000
relates to interest earned on the 2006 Debentures and $24,000 relates to
additional consideration paid to convert the 2006 Debentures.
On
March 25, 2003, the Jayhawk Group purchased from us in a private placement
pursuant to Rule 506 of Regulation D under the Securities Act, 450,000 shares of
common stock and a warrant for the purchase of up to 112,500 shares of common
stock at an exercise price of $3.49 per share. In connection with
such sale, we entered into a Registration Rights Agreement with the Jayhawk
Group, dated March 23, 2003. During 2007, the Jayhawk Group exercised the
warrant and purchased 112,500 shares of our common stock at the exercise price
of $3.49 per share. The aggregate 562,500 shares of our common stock were
registered for resale under the Form S-1 Registration Statement, No. 333-145721,
declared effective by the SEC on November 19, 2007.
During
November 2006, we entered into an agreement (the “Jayhawk Agreement”) with the
Jayhawk Group. Under the Jayhawk Agreement, the Jayhawk Group agreed, that if we
made an exchange or tender 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
upon certain conditions being met. The Jayhawk Agreement further provided that
the Golsen Group would exchange or tender 26,467 shares of Series 2 Preferred
beneficially owned by them, as a condition to the Jayhawk Group’s tender of
180,450 of its shares of Series 2 Preferred. Pursuant to the Jayhawk Agreement
and the terms of our exchange tender offer, during March 2007, the Jayhawk Group
and members of 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 in our tender offer. As a result, we
effectively settled the dividends in arrears totaling approximately $4.96
million, with $4.33 million relating to the Jayhawk Group and $0.63 million
relating to the Golsen Group.
We
received a letter, dated May 23, 2007, from a law firm representing a
stockholder of ours demanding that we investigate potential short-swing profit
liability under Section 16(b) of the Exchange Act of the Jayhawk Group. The
stockholder alleges that the surrender by the Jayhawk Group of 180,450 shares of
our Series 2 Preferred in our issuer exchange tender offer in March 2007 was a
sale which was subject to Section 16 and matchable against prior purchases
of Series 2 Preferred by the Jayhawk Group. The Jayhawk Group advised us that
they do not believe that they are liable for short-swing profits under
Section 16(b). The provisions of Section 16(b) provide that if we do
not file a lawsuit against the Jayhawk Group in connection with these
Section 16(b) allegations within 60 days from the date of the stockholder’s
notice to us, then the stockholder may pursue a Section 16(b) short-swing
profit claim on our behalf. After completion of the investigation of this matter
by our outside corporate/securities counsel, we attempted to settle this matter
with the Jayhawk Group, but were unable to reach a resolution satisfactory to
all parties. On October 9, 2007, the law firm representing the stockholder
initiated a lawsuit against the Jayhawk Group pursing a Section 16(b)
short-swing profit claim on our behalf up to $819,000. During the first quarter
of
2008, the parties have agreed to settle this claim by a payment to us by the
Jayhawk Group of $180,000, of which we will receive approximately $125,000 after
attorneys’ fees. This settlement is subject to a definitive
settlement agreement.
The
redemption of all of our outstanding Series 2 Preferred was completed on
August 27, 2007. The holders of shares of Series 2 Preferred had the right
to convert each share into 4.329 shares of our common stock, which right to
convert terminated 10 days prior to the redemption date. The Certificate of
Designations for the Series 2 Preferred provided, and it is our position, that
the holders of Series 2 Preferred that elected to convert shares of Series 2
Preferred into our common
stock
prior to the scheduled redemption date were not entitled to receive payment of
any dividends in arrears on the shares so converted. As a result, holders that
elected to convert shares of Series 2 Preferred were not entitled to any
dividends in arrears as to the shares of Series 2 Preferred converted. On or
about August 16, 2007, the Jayhawk Group elected to convert the 155,012
shares of Series 2 Preferred held by it, and we issued to the Jayhawk Group
671,046 shares of our common stock as a result of such conversion.
The
Company has been advised by the Jayhawk Group, in connection with the Jayhawk
Group’s conversion of its holdings of Series 2 Preferred, the Jayhawk Group may
bring legal proceedings against us for all dividends in arrears on the
Series 2 Preferred that the Jayhawk Group converted after receiving a
notice of redemption. The 155,012 shares of Series 2 Preferred converted by the
Jayhawk Group after we issued the notice of redemption for the Series 2
Preferred would have been entitled to receive approximately $4.0 million of
dividends in arrears on the August 27, 2007 redemption date, if such shares
were outstanding on the redemption date and had not been converted and into
common stock.
As a
holder of Series 2 Preferred, the Jayhawk Group participated in the nomination
and election of two individuals to serve on our board of directors in accordance
with the terms of the Series 2 Preferred. As the result of the exchanges,
conversions and redemption of the Series 2 Preferred during 2007, resulting in
less than 140,000 shares of Series 2 Preferred being outstanding, the right of
the holders of Series 2 Preferred to nominate and elect two individuals to serve
on our board of directors terminated pursuant to the terms of the Series 2
Preferred. Therefore the two independent directors elected by the holders of our
Series 2 Preferred no longer serve as directors on our board of directors and
the Jayhawk Group is no longer considered an affiliate of ours.
Golsen
Group
In
connection with the completion of our March 2007 tender offer for our
outstanding shares of our Series 2 Preferred, members of the Golsen Group
tendered 26,467 shares of Series 2 Preferred in exchange for our issuance to
them of 195,855 shares of our common stock. As a result, we effectively
settled approximately $0.63 million in dividends in arrears on
the shares of Series 2 Preferred tendered. The tender by the Golsen Group was a
condition to Jayhawk’s Agreement to tender shares of Series 2 Preferred in the
tender offer. See discussion above under “Jayhawk.”
After our
exchange tender offer of our Series 2 Preferred, the Golsen Group held 23,083
shares of Series 2 Preferred. Pursuant to our redemption of the remaining
outstanding Series 2 Preferred during August 2007, the Golsen Group redeemed
23,083 shares of Series 2 Preferred and received the cash redemption amount of
approximately $1.76 million pursuant to the terms of our redemption of all of
our outstanding Series 2 Preferred. The redemption price was $50.00 per share of
Series 2 Preferred, plus $26.25 per share in dividends in arrears pro-rata to
the date of redemption. The holders of shares of Series 2 Preferred had the
right to convert each share into 4.329 shares of our common stock, which right
to convert terminated 10 days prior to the redemption date. Holders that
converted shares of Series 2 Preferred were not entitled to any dividends in
arrears as to the shares of Series 2 Preferred converted.
Cash
Dividends
As
discussed above, during 2007, we paid cash dividends to the Golsen Group of
approximately $606,000 related to 23,083 shares of Series 2 Preferred
redeemed.
In
September 2007, we paid the dividends in arrears on our outstanding
preferred stock utilizing a portion of the net proceeds of the sale of the 2007
Debentures and working capital, including approximately $2,250,000 of dividends
in arrears on our Series B Preferred and our Series D Preferred, all
of the outstanding shares of which are owned by the Golsen Group.
Quail
Creek Bank
Bernard
Ille, a member of our board of directors, is a director of Quail Creek Bank,
N.A. (the “Bank”). The Bank was a lender to one of our subsidiaries. During
2007, the subsidiary made interest and principal payments on outstanding debt
owed to the Bank in the respective amount of $.1 million and $3.3 million in
2007. At December 31, 2006, the subsidiary’s loan payable to the Bank was
approximately $3.3 million, (none at December 31, 2007) with an annual
interest rate of 8.25%. The loan was secured by certain of the subsidiary’s
property, plant and equipment. This loan was paid in full in June 2007 utilizing
a portion of the net proceeds of our sale of the 2007 Debentures.
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:
Changes in Accounting
Estimates
|
·
|
as
discussed under “Overview - 2007 Results”, we reversed the valuation
allowance on our deferred tax balances which resulted in recognition of a
deferred tax benefit of $4,700,000 which is included in our provision for
income taxes and
|
|
·
|
the
recognition of $1.0 million of additional state income taxes included in
our provision for income taxes as discussed above under “Overview - 2007
Results”.
|
The net
effect of these changes in accounting estimates increased income from continuing
operations and net income by $3.7 million for 2007. In addition, these changes
in accounting estimates increased basic and diluted net income per share by
$0.19 and $0.16, respectively, for 2007.
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, six customers account for approximately 26% of our
total net receivables at December 31, 2007. We do not believe this concentration
in these six customers represents a significant credit risk due to the financial
stability of these customers. At December 31, 2007 and 2006, our allowance for
doubtful accounts of $1.3 million and $2.3 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 (“FIFO”) basis. Finished goods and
work-in-process inventories include material, labor and manufacturing overhead
costs. At December 31, 2007 and 2006, 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 $13,000 and $426,000,
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 $460,000 and $829,000 at December 31, 2007
and 2006, respectively.
Precious Metals - Precious metals are used
as a catalyst in the Chemical Business manufacturing process. Precious
metals are carried at cost, with cost being determined using the FIFO
basis. As of December 31, 2007 and 2006, precious metals were $10.9 million and
$6.4 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 2007, 2006 and 2005, the
amounts expensed for precious metals were approximately $6.4 million, $4.8
million and $3.1 million, respectively. These precious metals expenses are
included in cost of sales. Occasionally, during major maintenance and/or capital
projects, we may be able to perform procedures to recover precious metals
(previously expensed) which have accumulated over time within the manufacturing
equipment. For 2007, 2006 and 2005, we recognized recoveries of precious
metals at historical FIFO costs of approximately $1.8 million, $2.1 million and
$1.6 million, respectively. When we accumulate precious metals in excess of our
production requirements, we may sell a portion of the excess metals. We
recognized gains of $2.0 million for 2007 (none in 2006 and 2005) from the sale
of excess precious metals. These recoveries and gains 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, 2007, 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. 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 $120,000
relating to Corporate assets during 2005 (none in 2007 and 2006) and $250,000,
$286,000 and $117,000 relating to certain capital spare parts and idle assets in
our Chemical Business during 2007, 2006 and 2005, 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
commercial insurance coverage for our contractual exposure on group health
claims and statutory limits under workers’ compensation obligations. We also
carry excess umbrella insurance of $50 million for most general liability risks
excluding environmental risks. We have a separate $30 million insurance policy
covering pollution liability at our El Dorado and Cherokee Facilities. Our
accrued insurance liabilities are based on estimates of 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, 2007 and
2006, our accrued insurance liabilities were $3.0 million and $1.6 million,
respectively, and are included in accrued and other liabilities in the
consolidated balance sheets. It is possible that the actual development of
claims could exceed our estimates. Amounts recoverable from our insurance
carriers over the self-insured limits are included in accounts
receivable.
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, 2007 and 2006, our accrued product warranty obligations were $1.9
million and $1.3 million, respectively and are included in current and
noncurrent accrued and other liabilities in the consolidated balance
sheets.
Plant Turnaround Costs - We
expense the costs as they are incurred relating to planned major maintenance
activities (“Turnarounds”) of our Chemical Business as described as the direct
expensing method within Financial Accounting Standards Board (“FASB”) Staff
Position No. AUG AIR-1.
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). The liability for these benefits under the 1992
Agreements is $1,040,000 and $979,000 as of December 31, 2007 and 2006,
respectively, and is included in current and noncurrent accrued and other
liabilities in the 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, 2007, the liability for death benefits is $2.1 million ($1.4
million at December 31, 2006) which is included in current and noncurrent
accrued and noncurrent liabilities in the consolidated balance
sheets.
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, 2007, liabilities totaling $0.4 million have been accrued
relating to a consent administrative order (“CAO”) covering the El Dorado
Facility 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 from
our surface and groundwater monitoring and mitigation work plan. In addition, we
will be required to make capital expenditures as it relates to the
AirCAO.
Asset Retirement Obligations -
We are obligated to monitor certain discharge water outlets at our Chemical
Business facilities should we discontinue the operations of a
facility. We also have certain facilities in our Chemical Business
that contain asbestos insulation around certain piping and heated surfaces which
we plan to maintain in an adequate condition to prevent leakage through our
standard repair and maintenance activities. We do not believe the annual costs
of the required monitoring and maintenance activities would be significant and
we currently have no plans to discontinue the use of these facilities and the
remaining life of the facilities is indeterminable, an asset retirement
liability has not been recognized. Currently, there is insufficient information
to estimate the fair value of the asset retirement obligations. However, we will
continue to review these obligations and record a liability when a reasonable
estimate of the fair value can be made in accordance with FIN
47.
Income Taxes - We account for
income taxes in accordance with SFAS 109 and we adopted FIN No. 48 – Accounting
for Uncertainty in Income Taxes (“FIN 48”) on January 1, 2007. We
recognize deferred tax assets and liabilities for the expected future tax
consequences attributable to tax net operating loss (“NOL”) carryforwards, tax
credit carryforwards, and differences between the financial statement carrying
amounts and the tax basis of our assets and liabilities. We establish
valuation allowances if we believe it is more-likely-than-not that some or all
of deferred tax assets will not be realized. Deferred tax assets and liabilities
are measured using enacted tax rates expected to apply to taxable income in the
years in which those temporary differences are expected to be recovered or
settled. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date. We
do not recognize a tax benefit unless we conclude that it is more likely than
not that the benefit will be sustained on audit by the taxing authority based
solely on the technical merits of the associated tax position. If the
recognition threshold is met, we recognize a tax benefit measured at the largest
amount of the tax benefit that, in our judgment, is greater than 50% likely to
be realized. We record interest related to unrecognized tax positions
in interest expense and penalties in operating other expense.
Income
tax benefits credited to equity relate to tax benefits associated with amounts
that are deductible for income tax purposes but do not affect earnings. These
benefits are principally generated from employee exercises of non-qualified
stock options.
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 Secured Term 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, 2007, 2006
and 2005 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
|
$
|
286,365
|
|
|
$
|
221,161
|
|
|
$
|
156,859
|
|
|
Chemical
|
|
288,840
|
|
|
|
260,651
|
|
|
|
233,447
|
|
|
Other
|
|
11,202
|
|
|
|
10,140
|
|
|
|
6,809
|
|
|
|
$
|
586,407
|
|
|
$
|
491,952
|
|
|
$
|
397,115
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Gross
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
83,638
|
|
|
$
|
65,496
|
|
|
$
|
48,122
|
|
|
Chemical
|
|
44,946
|
|
|
|
22,023
|
|
|
|
16,314
|
|
|
Other
|
|
4,009
|
|
|
|
3,343
|
|
|
|
2,330
|
|
|
|
$
|
132,593
|
|
|
$
|
90,862
|
|
|
$
|
66,766
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Operating
income (loss):
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
34,194
|
|
|
$
|
25,428
|
|
|
$
|
14,097
|
|
|
Chemical
|
|
35,011
|
|
|
|
9,785
|
|
|
|
7,591
|
|
|
General
corporate expense and other business operations, net
|
|
(10,194
|
)
|
|
|
(8,074
|
)
|
|
|
(6,835
|
)
|
|
|
|
59,011
|
|
|
|
27,139
|
|
|
|
14,853
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest
expense
|
|
(12,078
|
)
|
|
|
(11,915
|
)
|
|
|
(11,407
|
)
|
|
Non-operating
income, net:
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
|
2
|
|
|
|
1
|
|
|
|
-
|
|
|
Chemical
|
|
109
|
|
|
|
311
|
|
|
|
362
|
|
|
Corporate
and other business operations
|
|
1,153
|
|
|
|
312
|
|
|
|
1,199
|
|
| Provision
for income taxes |
|
(2,540 |
) |
|
|
(901 |
) |
|
|
(118 |
) |
Equity
in earnings of affiliate - Climate Control
|
|
877
|
|
|
|
821
|
|
|
|
745
|
|
|
Income
from continuing operations
|
$
|
46,534
|
|
|
$
|
15,768
|
|
|
$
|
5,634
|
|
Year Ended December 31, 2007
Compared to Year Ended December 31, 2006
Net
Sales
The
following table contains certain information about our net sales in different
industry segments for 2007 and 2006:
|
|
2007
|
|
2006
|
|
Change
|
|
Percentage
Change
|
|
Net
sales:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Geothermal
and water source heat pumps
|
$
|
165,115
|
|
|
$
|
134,210
|
|
|
$
|
30,905
|
|
|
23.0
|
%
|
|
Hydronic
fan coils
|
|
85,815
|
|
|
|
59,497
|
|
|
|
26,318
|
|
|
44.2
|
%
|
|
Other
HVAC products
|
|
35,435
|
|
|
|
27,454
|
|
|
|
7,981
|
|
|
29.1
|
%
|
|
Total
Climate Control
|
$
|
286,365
|
|
|
$
|
221,161
|
|
|
$
|
65,204
|
|
|
29.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Chemical:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Agricultural
products
|
$
|
117,158
|
|
|
$
|
89,735
|
|
|
$
|
27,423
|
|
|
30.6
|
%
|
|
Industrial
acids and other chemical products
|
|
95,754
|
|
|
|
95,208
|
|
|
|
546
|
|
|
0.6
|
%
|
|
Mining
products
|
|
75,928
|
|
|
|
75,708
|
|
|
|
220
|
|
|
0.3
|
%
|
|
Total
Chemical
|
$
|
288,840
|
|
|
$
|
260,651
|
|
|
$
|
28,189
|
|
|
10.8
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
$
|
11,202
|
|
|
$
|
10,140
|
|
|
$
|
1,062
|
|
|
10.5
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
net sales
|
$
|
586,407
|
|
|
$
|
491,952
|
|
|
$
|
94,455
|
|
|
19.2
|
%
|
Climate
Control Business
|
·
|
Net
sales of our geothermal and water source heat pump products increased
primarily as a result of increases in original equipment manufacturer
(“OEM”), export and commercial shipments. In total, the number of
geothermal and water source heat pump products shipments increased
by approximately 10% in 2007 as compared to 2006. In addition, an
increase of approximately 13% relates to the change in product mix and
price increases. The price increases were instituted in response to rising
raw material and component purchase prices. Due to the significant backlog
of customer orders at the time the price increases were put into effect,
the impact of customer price increases trail cost increases in raw
material and component purchase prices. In 2007, the impact of price
increases is estimated to be approximately 4%. We continue to maintain a
market share leadership position based on data supplied by the
Air-Conditioning and Refrigeration
Institute;
|
|
·
|
Net
sales of our hydronic fan coils increased primarily due to a 16% increase
in the number of units sold due to an increase in large customer orders as
well as a 25% increase in average unit sales prices as the result of the
change in product mix, lower discounting, and higher selling prices driven
by raw material cost increases;
|
|
·
|
Net
sales of our other HVAC products increased primarily as the result of
engineering and construction services due to work completed on
construction contracts.
|
Chemical
Business
The El
Dorado and Cherokee Facilities produce all the chemical products described in
the table above and the Baytown Facility produces only nitric acid products. The
volume of tons sold and the sales prices for the Chemical Business increased 3%
and 7%, respectively, compared with 2006.
|
·
|
Overall,
volume at the El Dorado Facility remained essentially the same while sales
prices increased 10%. However, our product mix shifted in 2007 from
industrial acids products to agricultural products driven by increased
agricultural demand. The increase in sales prices includes a 17% increase
relating to our nitrogen fertilizer
products.
|
|
·
|
Overall
volume at the Cherokee Facility increased 7% and sales prices increased
11%. The Cherokee Facility also experienced the same market-driven demand
for nitrogen fertilizer products in 2007, which resulted in a 54% increase
in volume and a 32% increase in sales prices relating to these products.
Additionally, there were low demand and production curtailments
experienced throughout the first quarter of 2006 as the result of
reduction in orders from several key customers due to the high cost of
natural gas caused by the effects of Hurricane
Katrina.
|
|
·
|
Volume
increased 5% while sales prices remained essentially the same at the
Baytown Facility.
|
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 2007 and 2006:
|
|
2007
|
|
2006
|
|
Change
|
|
Percentage
Change
|
|
Gross
profit:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
83,638
|
|
|
$
|
65,496
|
|
|
$
|
18,142
|
|
|
27.7
|
%
|
|
Chemical
|
|
44,946
|
|
|
|
22,023
|
|
|
|
22,923
|
|
|
104.1
|
%
|
|
Other
|
|
4,009
|
|
|
|
3,343
|
|
|
|
666
|
|
|
19.9
|
%
|
|
|
$
|
132,593
|
|
|
$
|
90,862
|
|
|
$
|
41,731
|
|
|
45.9
|
%
|
|
Gross
profit percentage (1):
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
|
29.2
|
%
|
|
29.6
|
%
|
|
(0.4
|
)%
|
|
Chemical
|
|
15.6
|
%
|
|
8.4
|
%
|
|
7.2
|
%
|
|
Other
|
|
35.8
|
%
|
|
33.0
|
%
|
|
2.8
|
%
|
|
Total
|
|
22.6
|
%
|
|
18.5
|
%
|
|
4.1
|
%
|
(1) As a
percentage of net sales
The
increase in gross profit in our Climate Control Business was a direct result of
the increase in sales volume, change in product mix, and price increases as
discussed above. Our gross profit percentage as a percentage of sales decreased
by 0.4% primarily due to raw material costs increases being incurred ahead of
customer price increases becoming effective as well as changes in product mix.
The
increase in gross profit of our Chemical Business relates primarily to improved
margins on agricultural products sold by the El Dorado and Cherokee Facilities.
Comparing 2007 with 2006, there was little change in the cost of the El Dorado
and Cherokee Facilities’ primary feedstocks, ammonia and natural
gas. As a result, the higher selling prices and volumes as discussed
above are the primary reasons for the increase in the gross profit
percentage.
During
2007 and 2006, we recorded the realization of losses on certain nitrogen-based
inventories of approximately $0.4 million and $1.0 million, respectively. In
addition, during 2007, we realized insurance recoveries of approximately $3.8
million relating to a business interruption claim associated with the Cherokee
Facility. In 2006, we realized insurance recoveries of approximately $0.9
million relating to a business interruption claim associated with the El Dorado
Facility. The above transactions contributed to an increase in gross profit for
each respective period.
As
discussed above under “Overview-Chemical Business,” our Chemical Business uses
precious metals as a catalyst in the manufacturing process. During 2007, we had
accumulated precious metals in excess of our production requirements. Therefore
we sold a portion of the excess metals. As a result, we recognized a gain of
$2.0 million which increased gross profit compared to 2006. However, this
increase in gross profit of $2.0 million was partially offset by a decrease of
$1.8 million due primarily to the increase in precious metals expense of
approximately $1.5 million compared to 2006 as the result of cost increases for
these metals.
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 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 2007 and
2006:
|
Operating
income:
|
|
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
$
|
34,194
|
|
|
$
|
25,428
|
|
|
$
|
8,766
|
|
|
Chemical
|
|
35,011
|
|
|
|
9,785
|
|
|
|
25,226
|
|
|
General
corporate expense and other business operations, net
|
|
(10,194
|
)
|
|
|
(8,074
|
)
|
|
|
(2,120
|
)
|
|
|
$
|
59,011
|
|
|
$
|
27,139
|
|
|
$
|
31,872
|
|
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 $18.1 million as
discussed above. This increase in operating income was partially offset
primarily by increased personnel cost of $1.8 million as the result of increased
number of personnel and group healthcare costs, increased commissions and
warranty expenses of $1.6 million and $1.1 million, respectively, due to
increased sales volume and distribution/product mix increased shipping and
handling costs of $0.7 million due to increased sales volume and rising fuel
costs and increased consulting fees of $0.5 million primarily due to efforts to
promote governmental support in the geothermal market. In addition, our Climate
Control Business recognized income of $1.2 million in 2006 relating to an
arbitration award received relating to an arbitration case involving a
subsidiary within the Climate Control Business.
Operating Income - Chemical:
The net increase of our Chemical Business’ operating income primarily
relates to the net increase in gross profit of $22.9 million as discussed above.
Also as discussed above under “Overview - Chemical Business”, our Chemical
Business recognized income of approximately $3.3 million relating to a
litigation settlement during 2007.
General Corporate Expense and Other
Business Operations, Net: The net increase of $2.1 million in our general
corporate expense and other business operations, net relates primarily to an
increase of professional fees of $1.3 million primarily as the result of costs
incurred associated with the evaluation and audit of our internal controls and
procedures and related documentation for Sarbanes-Oxley requirements and an
increase of $1.0 million in personnel costs due, in part, to increased group
health care costs which was partially offset by the increase of $0.7 million in
gross profit classified as “Other” as discussed above.
Interest
Expense - Interest expense was $12.1 million for 2007 compared to $11.9
million for 2006, an increase of $0.2 million. This net increase includes $2.0
million relating to the 2007 Debentures, $0.6 million relating to the Secured
Term Loan and the $0.6 million change in the fair value of our interest rate
caps. This increase was partially offset by a decrease of $1.3 million as the
result of the conversions of the 2006 Debentures during 2006 and 2007, a
decrease of $1.1 million primarily due the pay down of the Working Capital
Revolver Loan during 2007, and a decrease of $0.6 million as the result of the
acquisition of the 10.75% Senior Unsecured Notes during 2006.
Provision
For Income Taxes - The provision for income taxes for 2007 was $2.5
million compared to $0.9 million for 2006. The increase of $1.6 million was
primarily the result of an increase in the federal and state income taxes
resulting from increased
taxable income and additional prior year state income taxes recorded under FIN
48. This increase was partially offset by the benefit of deferred taxes from the
reversal of valuation allowances discussed above under “Overview - 2007
Results”.
Net Loss
(Income) From Discontinued Operations - Net income from discontinued
operations was $0.3 million for 2007 compared to a net loss from discontinued
operations of $0.3 million for 2006. The loss incurred in 2006
relates primarily to provisions for our estimated costs to investigate and
delineate a site in Hallowell, Kansas as a result of meetings with the KDHE
during 2006. However, on September 12, 2007, the KDHE approved our proposal to
perform surface and groundwater monitoring and to implement a mitigation work
plan to acquire additional field data. As a result of receiving approval from
the KDHE for our proposal, net income from discontinued operations for 2007
relates primarily to the reduction of our liability for the estimated costs
associated with this remediation.
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
The El
Dorado and Cherokee Facilities produce all the chemical products described in
the table above and the Baytown Facility 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 the El Dorado Facility 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 the Baytown Facility increased 24% as the result of a closing of a
chemical facility within our market and other various spot sales
opportunities;
|
|
·
|
Volume
at the Cherokee Facility 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
|
|
22,023
|
|
|
|
16,314
|
|
|
|
5,709
|
|
|
35.0
|
%
|
|
Other
|
|
3,343
|
|
|
|
2,330
|
|
|
|
1,013
|
|
|
43.5
|
%
|
|
|
$
|
90,862
|
|
|
$
|
66,766
|
|
|
$
|
24,096
|
|
|
36.1
|
%
|
|
Gross
profit percentage (1):
|
|
|
|
|
|
|
|
|
|
|
Climate
Control
|
|
29.6
|
%
|
|
30.7
|
%
|
|
(1.1
|
)%
|
|
Chemical
|
|
8.4
|
%
|
|
7.0
|
%
|
|
1.4
|
%
|
|
Other
|
|
33.0
|
%
|
|
34.2
|
%
|
|
(1.2
|
)%
|
|
Total
|
|
18.5
|
%
|
|
16.8
|
%
|
|
1.7
|
%
|
|
(1)
|
As
a percentage of net sales
|
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:
|
·
|
The
Cherokee Facility 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;
|
|
·
|
The
Baytown Facility due primarily to the increase in sales volume as
discussed above;
|
|
·
|
The
El Dorado Facility 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 the El Dorado Facility. 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 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
|
|
9,785
|
|
|
|
7,591
|
|
|
|
2,194
|
|
|
General
corporate expense and other business operations, net
|
|
(8,074
|
)
|
|
|
(6,835
|
)
|
|
|
(1,239
|
)
|
|
|
$
|
27,139
|
|
|
$
|
14,853
|
|
|
$
|
12,286
|
|
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 a subsidiary within the Climate Control
Business, 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 $5.7 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 2006 Debentures sold in March 2006
and $0.3 million of additional consideration paid in conjunction with the
conversion of a portion of the 2006 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 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.
Cash Flow From Continuing
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 2007,
net cash provided by continuing operating activities was $46.8 million,
including net income (which includes insurance recoveries of $3.8 million under
our business interruption insurance policy and a litigation settlement of $3.3
million), plus depreciation and amortization, deferred income taxes, and other
adjustments offset by cash used by the following changes in assets and
liabilities:
Accounts
receivable increased a net $4.4 million including:
|
·
|
an
increase of $2.4 million relating to the Chemical Business as the result
of increased sales at the Cherokee Facility as discussed above under
“Results of Operations” and a portion of the business interruption
insurance claim discussed above under “Overview – Chemical
Business”,
|
|
·
|
an
increase of $0.7 million relating to group health insurance claims in
excess of our self-insured limits,
|
|
·
|
a
net increase of $0.5 million relating to the Climate Control Business due
primarily to increased sales of hydronic fan coils and other HVAC products
relating to engineering and construction services as discussed above under
“Results of Operations” which was partially offset by a decrease in the
average number of days our receivable balances were outstanding relating
to our heat pump product customers,
and
|
|
·
|
an
increase of $0.6 million relating to the timing of payments received from
our customers of industrial
machinery.
|
Inventories
increased a net $11.0 million including:
|
·
|
a
net increase of $5.3 million relating to the Climate Control Business
primarily relating to heat pump and hydronic fan coil products due
primarily to increased levels of raw materials and finished goods on hand
as the result of the expansion of our facilities to meet customer demands
and the increase in number of construction contracts in progress partially offset
by a decrease in inventories held by our large custom air handler
operation as a result of an increase in sales and a decrease in production
during the fourth quarter of 2007,
|
|
·
|
an
increase of $3.9 million in the Chemical Business relating primarily to
the Cherokee Facility as a result of a significant amount of inventory on
hand which was not delivered to a customer until January 2008 and a
reduction of inventory on hand at the end of 2006 due to a Turnaround
performed in December 2006, and
|
|
·
|
an
increase of $1.8 million relating to our industrial machinery to meet
customer demand.
|
Other
supplies and prepaid items increased $4.9 million primarily due to an increase
in the cost of precious metals and additional metals purchased and recovered net
of the amount consumed in the manufacturing process and sold by our Chemical
Business.
Accounts
payable decreased $5.1 million primarily due to:
|
·
|
a
decrease of $3.9 million in our Chemical Business resulting primarily from
the payment of invoices relating to the Baytown Facility’s property taxes
and scheduled lease billings and the payment of invoices relating to a
Turnaround performed in December 2006 at the Cherokee Facility
and
|
|
·
|
a
decrease of $1.5 million in our Climate Control Business resulting
primarily from a decrease in the average number of days
outstanding partially offset by an increase in purchases of raw materials
to manufacture primarily hydronic fan coil and air handler
products.
|
Customer
deposits increased $6.6 million primarily due to:
|
·
|
an
increase of $7.8 million in our Chemical Business due to the increase in
deposits received on sales commitments by the Cherokee and El Dorado
Facilities partially offset by
|
|
·
|
a
decrease of $1.3 million in our Climate Control Business due primarily as
the result of recognizing the sales of large custom air handlers
associated with those deposits.
|
The
decrease in deferred rent expense of $0.9 million is due to the scheduled lease
payments in 2007 exceeding the rent expense recognized on a straight-line
basis.
The
increase in other current and noncurrent liabilities of $8.7 million
includes:
|
·
|
an
increase of $4.0 million of accrued income and property taxes due
primarily to the increase in income taxes resulting from increased taxable
income, increase in uncertain tax positions under FIN 48, and taxes in
additional state
jurisdictions,
|
|
·
|
an
increase of $1.3 million of accrued insurance due primarily to changes in our insurance programs and as
a result of an increase in group insurance claims as of December 31,
2007,
|
|
·
|
an
increase of $1.2 million of accrued payroll and related benefits primarily
relating to the Climate Control Business as the result of increases in the
number of personnel and compensation
incentives,
|
|
·
|
an
increase of $1.0 million of deferred revenue on extended warranty
contracts as the result of an increase in sales of our water source heat
pump products, and
|
|
·
|
and
a net increase of $1.2 million due to other individually immaterial
items.
|
Cash Flow from Continuing
Investing Activities
Net cash
used by continuing investing activities was $11.8 million for 2007, which
included $14.8 million for capital expenditures of which $5.8 million are for
the benefit of our Climate Control Business and $8.6 million are for our
Chemical Business and the purchase of interest rate cap contracts for $0.6
million. These expenditures were partially offset by proceeds from restricted
cash of $3.5 million, which was primarily used to pay down debt.
Cash Flow from Continuing
Financing Activities
Net cash
provided by continuing financing activities was $21.2 million, which primarily
consisted of:
|
·
|
net
proceeds of $57.0 million from the 2007 Debentures as discussed above
under “Liquidity and Capital
Resources”,
|
|
·
|
proceeds
of $50.0 million from the Secured Term Loan as discussed above under
“Liquidity and Capital Resources”,
|
|
·
|
net
proceeds of $2.4 million from other long-term debt primarily for working
capital purposes,
|
|
·
|
proceeds
of $1.9 million from the exercise of stock options and a
warrant,
|
|
·
|
excess
tax benefit of $1.7 million on stock options exercised, offset in part, by
the
|
|
·
|
payoff
of the Senior Secured Loan of $50.0 million as discussed above under
“Liquidity and Capital Resources”,
|
|
·
|
payments
of $26.4 million on revolving debt facilities, net of proceeds, primarily
from the use of proceeds from the 2007
Debentures,
|
|
|
·
|
payments
of $9.2 million on other long-term debt and debt issuance
costs,
|
|
·
|
dividend
payments of $2.9 million on preferred
stock,
|
|
·
|
payments
of $2.1 million on short-term financing and drafts payable, net of
proceeds, and
|
|
|
·
|
payments
of $1.3 million to acquire non-redeemable preferred
stock.
|
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, 2007, our investment was $3.4 million. For 2007, distributions received from
this Partnership were $0.8 million and our equity in earnings was $0.9 million.
As of December 31, 2007, the Partnership and general partner to the Partnership
is indebted to a term lender (“Lender”) of the Project 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, 2007 are summarized in the
following table.
Payments Due in the Year
Ending December 31,
|
Contractual
Obligations
|
|
Total
|
|
2008
|
|
2009
|
|
2010
|
|
2011
|
|
2012
|
|
Thereafter
|
|
Long-term
debt:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
5.5%
Convertible Senior Subordinated Notes
|
$
|
60,000
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
-
|
|
|
$
|
60,000
|
|
|
$
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Secured
Term Loan due 2012
|
|
50,000
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
-
|
|
|
|
50,000
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Capital
leases
|
|
1,230
|
|
|
|
514
|
|
|
|
236
|
|
|
|
253
|
|
|
|
165
|
|
|
|
62
|
|
|
|
-
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Other
|
|
10,877
|
|
|
|
529
|
|
|
|
806
|
|
|
|
900
|
|
|
|
954
|
|
|
|
1,010
|
|
|
|
6,678
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
long-term debt
|
|
122,107
|
|
|
|
1,043
|
|
|
|
1,042
|
|
|
|
1,153
|