form_10q.htm
LSB Industries, Inc.

Form 10-Q (9-30-2009)

 
UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the quarterly period ended             September 30, 2009       
   
 
OR
   
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
 
For the transition period from   _____________to______________
   
 
Commission file number                  1-7677      
   
             LSB Industries, Inc.           
Exact name of Registrant as specified in its charter
 
          Delaware            
    73-1015226     
State or other jurisdiction of
incorporation or organization
I.R.S. Employer Identification No.
 
       16 South Pennsylvania Avenue, Oklahoma City, Oklahoma                     73107      
             Address of principal executive offices                        (Zip Code)
 
               (405) 235-4546                 
  Registrant's telephone number, including area code
 
                         None                             
Former name, former address and former fiscal year, if  changed since last report.
 
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  [X] Yes [  ] No

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files).  [  ] Yes [  ] No
 
 
1

 
 

(Facing Sheet Continued)

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer [  ] Accelerated filer [X]

Non-accelerated filer [  ] Smaller reporting company [  ]

(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). [  ] Yes [X] No

The number of shares outstanding of the Registrant's voting common stock, as of October 30, 2009 was 21,500,808 shares, excluding 3,867,462 shares held as treasury stock.
 
 


FORM 10-Q OF LSB INDUSTRIES, INC.

TABLE OF CONTENTS


 
   
     
 
PART I – Financial Information
Page
     
Item 1.
4
     
Item 2.
38
     
Item 3.
67
     
Item 4.
69
     
70
     
 
PART II – Other Information
 
     
Item 1.
72
     
Item 1A.
73
     
Item 2.
74
     
Item 3.
74
     
Item 4.
74
     
Item 5.
74
     
Item 6.
75
 
 

PART I
FINANCIAL INFORMATION

Item 1. Financial Statements

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at September 30, 2009 is unaudited)
 
 
September 30,
2009
 
December 31,
2008
 
(In Thousands)
           
Current assets:
           
Cash and cash equivalents
$
60,187
 
$
46,204
 
Restricted cash
 
31
   
893
 
Short-term investments
 
10,000
   
-
 
Accounts receivable, net
 
68,254
   
78,846
 
Inventories:
           
Finished goods
 
23,773
   
30,679
 
Work in process
 
2,784
   
2,954
 
Raw materials
 
20,700
   
27,177
 
Total inventories
 
47,257
   
60,810
 
Supplies, prepaid items and other:
           
Prepaid insurance
 
849
   
3,373
 
Prepaid advertising
 
1,369
   
-
 
Prepaid current income taxes
 
1,375
   
-
 
Precious metals
 
14,118
   
14,691
 
Supplies
 
4,949
   
4,301
 
Other
 
2,166
   
1,378
 
Total supplies, prepaid items and other
 
24,826
   
23,743
 
Deferred income taxes
 
7,015
   
11,417
 
Total current assets
 
217,570
   
221,913
 
             
Property, plant and equipment, net
 
114,202
   
104,292
 
             
Other assets:
           
Debt issuance costs, net
 
1,831
   
2,607
 
Investment in affiliate
 
3,808
   
3,628
 
Goodwill
 
1,724
   
1,724
 
Other, net
 
1,892
   
1,603
 
Total other assets
 
9,255
   
9,562
 
 
$
341,027
 
$
335,767
 


(Continued on following page)
 
 

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(Information at September 30, 2009 is unaudited)
 
September 30,
2009
 
December 31,
2008
 
(In Thousands)
Liabilities and Stockholders’ Equity
           
Current liabilities:
           
Accounts payable
$
33,594
 
$
43,014
 
Short-term financing
 
-
   
2,228
 
Accrued and other liabilities
 
28,523
   
39,236
 
Current portion of long-term debt
 
3,161
   
1,560
 
Total current liabilities
 
65,278
   
86,038
 
             
Long-term debt
 
100,367
   
103,600
 
             
Noncurrent accrued and other liabilities
 
10,549
   
9,631
 
             
Deferred income taxes
 
11,598
   
6,454
 
             
Contingencies (Note 12)
           
             
Stockholders' equity:
           
Series B 12% cumulative, convertible preferred stock, $100 par value; 20,000 shares issued and outstanding
 
2,000
   
2,000
 
Series D 6% cumulative, convertible Class C preferred stock, no par value; 1,000,000 shares issued
 
1,000
   
1,000
 
Common stock, $.10 par value; 75,000,000 shares authorized, 25,368,270 shares issued (24,958,330 at December 31, 2008)
 
2,537
   
2,496
 
Capital in excess of par value
 
129,406
   
127,337
 
Accumulated other comprehensive loss
 
-
   
(120
)
Retained earnings
 
41,044
   
19,804
 
   
175,987
   
152,517
 
Less treasury stock at cost:
           
Common stock, 3,867,462 shares (3,848,518 at December 31, 2008)
 
22,752
   
22,473
 
Total stockholders' equity
 
153,235
   
130,044
 
 
$
341,027
 
$
335,767
 
 
See accompanying notes.
 
 

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Nine and Three Months Ended September 30, 2009 and 2008
 
Nine Months
 
Three Months
 
2009
 
2008
 
2009
 
2008
 
(In Thousands, Except Per Share Amounts)
Net sales
$
416,538
   
$
569,427
   
$
127,778
   
$
210,920
 
Cost of sales
 
307,330
     
456,760
     
97,125
     
179,751
 
Gross profit
 
109,208
     
112,667
     
30,653
     
31,169
 
                               
Selling, general and administrative expense
 
70,548
     
62,633
     
26,127
     
22,411
 
Provisions for (recovery of) losses on accounts receivable
 
189
     
159
     
161
     
(133
)
Other expense
 
461
     
946
     
127
     
289
 
Other income
 
(222
)
   
(8,417
)
   
(32
)
   
(88
)
Operating income
 
38,232
     
57,346
     
4,270
     
8,690
 
                               
Interest expense
 
5,139
     
6,363
     
2,200
     
2,643
 
Gains on extinguishment of debt
 
(1,796
)
   
-
     
(53
)
   
-
 
Non-operating other income, net
 
(72
)
   
(1,125
)
   
(38
)
   
(263
)
Income from continuing operations before provisions for income taxes and equity in earnings of affiliate
 
 
34,961
     
 
52,108
     
 
2,161
     
 
6,310
 
Provisions for income taxes
 
14,110
     
19,817
     
1,310
     
2,388
 
Equity in earnings of affiliate
 
(740
)
   
(697
)
   
(252
)
   
(235
)
Income from continuing operations
 
21,591
     
32,988
     
1,103
     
4,157
 
                               
Net loss (income) from discontinued operations
 
45
     
13
     
30
     
(4
)
Net income
 
21,546
     
32,975
     
1,073
     
4,161
 
                               
Dividends and dividend requirements on preferred stocks
 
306
     
306
     
-
     
-
 
Net income applicable to common stock
$
21,240
   
$
32,669
   
$
1,073
   
$
4,161
 
                               
Weighted-average common shares:
                             
Basic
 
21,279
     
21,156
     
21,487
     
21,237
 
                               
Diluted
 
23,623
     
24,884
     
22,633
     
22,654
 
                               
Income per common share:
                             
Basic
$
1.00
   
$
1.54
   
$
.05
   
$
.20
 
                               
Diluted
$
.95
   
$
1.40
   
$
.05
   
$
.18
 

 
See accompanying notes.

 

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)
Nine Months Ended September 30, 2009
 
 
 
Common Stock Shares
 
Non-Redeemable Preferred Stocks
 
 
Common
Stock Par Value
 
 
Capital in Excess of Par Value
 
Accumulated Other Comprehensive Loss
 
 
 
Retained Earnings
 
 
Treasury Stock-Common
 
 
 
 
Total
 
(In Thousands)
Balance at December 31, 2008
24,958
$
3,000
$
2,496
$
127,337
 
$
(120
)
$
19,804
   
$
(22,473
)
$
130,044
 
                                           
Net income
                       
21,546
           
21,546
 
Amortization of cash flow hedge
                 
120
                 
120
 
Total comprehensive income
                                     
21,666
 
Dividends paid on preferred stocks
                       
(306
)
         
(306
)
Stock-based compensation
           
768
                       
768
 
Exercise of stock options
408
     
41
 
839
                 
(279
)
 
601
 
Excess income tax benefit associated with stock-based compensation
           
 
458
                       
 
458
 
Conversion of shares of redeemable preferred stock to common stock
 
2
         
 
4
                       
 
4
 
Balance at September 30, 2009
25,368
$
3,000
$
2,537
$
129,406
 
$
-
 
$
41,044
   
$
(22,752
)
$
153,235
 
 
Note: For the nine and three months ended September 30, 2009, total comprehensive income was $21,666,000 and $1,073,000, respectively. For the nine and three months ended September 30, 2008, total comprehensive income was $33,193,000 and $4,290,000, respectively.
 
 
See accompanying notes.
 
 

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30, 2009 and 2008
 
 
2009
 
2008
 
(In Thousands)
Cash flows from continuing operating activities:
             
Net income
$
21,546
   
$
32,975
 
Adjustments to reconcile net income to net cash provided by continuing operating activities:
             
Net loss from discontinued operations
 
45
     
13
 
Deferred income taxes
 
9,373
     
4,424
 
Gain on extinguishment of debt
 
(1,796
)
   
-
 
Gain on litigation judgment associated with property, plant and equipment
 
-
     
(3,943
)
Losses on sales and disposals of property and equipment
 
340
     
130
 
Depreciation of property, plant and equipment
 
11,573
     
9,784
 
Amortization
 
605
     
914
 
Stock-based compensation
 
768
     
577
 
Provisions for losses on accounts receivable
 
189
     
159
 
Provision for (realization of) losses on inventory
 
(3,186
)
   
400
 
Provision for losses on firm sales commitments
 
1,310
     
-
 
Provision for impairment of long-lived assets
 
-
     
192
 
Equity in earnings of affiliate
 
(740
)
   
(697
)
Distributions received from affiliate
 
560
     
555
 
Changes in fair value of commodities contracts
 
(236
)
   
4,931
 
Changes in fair value of interest rate contracts
 
(314
)
   
(237
)
Cash provided (used) by changes in assets and liabilities:
             
Accounts receivable
 
11,889
     
(36,043
)
Inventories
 
16,418
     
(17,969
)
Other supplies and prepaid items
 
(238
)
   
(3,254
)
Accounts payable
 
(8,957
)
   
14,410
 
Customer deposits
 
(2,279
)
   
(269
)
Deferred rent expense
 
(1,424
)
   
(2,909
)
Other current and noncurrent liabilities
 
(7,420
)
   
5,178
 
Net cash provided by continuing operating activities
 
48,026
     
9,321
 
               
Cash flows from continuing investing activities:
             
Capital expenditures
 
(22,221
)
   
(22,348
)
Proceeds from litigation judgment associated with property, plant and equipment
 
-
     
5,948
 
Payment of legal costs relating to litigation judgment associated with property, plant and equipment
 
-
     
(1,884
)
Proceeds from sales of property and equipment
 
14
     
63
 
Purchase of short-term investments
 
(10,000
)
   
-
 
Proceeds from (deposit of) restricted cash
 
862
     
(73
)
Other assets
 
(289
)
   
(305
)
Net cash used by continuing investing activities
 
(31,634
)
   
(18,599
)

 (Continued on following page)

 

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
Nine Months Ended September 30, 2009 and 2008


 
2009
 
2008
 
(In Thousands)
Cash flows from continuing financing activities:
             
Proceeds from revolving debt facilities
$
396,794
   
$
475,372
 
Payments on revolving debt facilities
 
(396,794
)
   
(475,372
)
Proceeds from other long-term debt, net of fees
 
8,566
     
-
 
Acquisition of 5.5% convertible debentures
 
(7,953
)
   
-
 
Payments on other long-term debt
 
(1,600
)
   
(869
)
Payments of debt issuance costs
 
(26
)
   
-
 
Payments on short-term financing
 
(2,228
)
   
(919
)
Proceeds from exercise of stock options
 
601
     
771
 
Purchase of treasury stock
 
-
     
(3,421
)
Excess income tax benefit associated with stock-based compensation
 
631
     
3,412
 
Dividends paid on preferred stocks
 
(306
)
   
(306
)
Net cash used by continuing financing activities
 
(2,315
)
   
(1,332
)
               
Cash flows of discontinued operations:
             
Operating cash flows
 
(94
)
   
(136
)
Net increase (decrease) in cash and cash equivalents
 
13,983
     
(10,746
)
               
Cash and cash equivalents at beginning of period
 
46,204
     
58,224
 
Cash and cash equivalents at end of period
$
60,187
   
$
47,478
 
               
Supplemental cash flow information:
             
               
Cash payments for income taxes, net of refunds
$
6,521
   
$
16,814
 
               
Noncash investing and financing activities:
             
               
Receivables associated with a property insurance claims
$
1,210
   
$
-
 
Current other assets, accounts payable and long-term debt associated with property, plant and equipment
$
3,866
   
$
5,309
 
Debt issuance costs associated with the acquisition of the 5.5% convertible debentures
$
351
   
$
-
 

See accompanying notes.
 
 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note 1: Basis of Presentation The accompanying condensed consolidated financial statements include the accounts of LSB Industries, Inc. (the "Company", "We", "Us", or "Our") and its subsidiaries. We are a manufacturing, marketing and engineering company. Primarily through our wholly-owned subsidiary ThermaClime, Inc. (“ThermaClime”) and its subsidiaries, we are principally engaged in the manufacture and sale of geothermal and water source heat pumps and air handling products (the "Climate Control Business") and the manufacture and sale of chemical products (the "Chemical Business"). The Company and ThermaClime are holding companies with no significant assets or operations other than cash, cash equivalents, short-term investments, and our investments in our subsidiaries. Entities that are 20% to 50% owned and for which we have significant influence are accounted for on the equity method. All material intercompany accounts and transactions have been eliminated.
 
In the opinion of management, the unaudited condensed consolidated financial statements of the Company as of September 30, 2009 and for the nine and three-month periods ended September 30, 2009 and 2008 include all adjustments and accruals, consisting only of normal, recurring accrual adjustments which are necessary for a fair presentation of the results for the interim periods. These interim results are not necessarily indicative of results for a full year due, in part, to the seasonality of our sales of agricultural products and the timing of performing our major plant maintenance activities. Our selling seasons for agricultural products are primarily during the spring and fall planting seasons, which typically extend from March through June and from September through November.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles (“GAAP”) have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). These condensed consolidated financial statements should be read in connection with the consolidated financial statements and notes thereto included in our Form 10-K for the year ended December 31, 2008.

Certain reclassifications have been made in our condensed consolidated financial statements for the nine months ended September 30, 2008 to conform to our condensed consolidated financial statement presentation for the nine months ended September 30, 2009, including the change in our classification of principal payments under capital lease obligations from “capital expenditures” that are included in net cash used by continuing investing activities to “payments on other long-term debt” that are included in net cash used by continuing financing activities. This change in classification is consistent with the underlying principles of GAAP. This change resulted in a decrease in net cash used by continuing investing activities and an increase in net cash used by financing activities of $345,000 for the nine months ended September 30, 2008.

In connection with the preparation of our condensed consolidated financial statements, we evaluated subsequent events after the balance sheet date of September 30, 2009 through November 5, 2009, which is the date our condensed consolidated financial statements were issued.
 
 
10 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 2: Recently Issued Accounting Pronouncements In March 2008, the Financial Accounting Standards Board (“FASB”) issued new accounting standards requiring enhanced disclosures about an entity’s derivative and hedging activities for the purpose of improving the transparency of financial reporting. The new disclosure requirements became effective for the Company on January 1, 2009 and were applied prospectively. See Note 13 - Derivatives, Hedges and Financial Instruments.

In April 2009, the FASB issued new accounting standards requiring disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies. The new disclosure requirements became effective for the Company on April 1, 2009 and were applied prospectively. See Note 13 – Derivatives, Hedges and Financial Instruments.

In May 2009, the FASB issued new accounting standards establishing principles and reporting requirements for subsequent events, which became effective for the Company for the quarterly period ended June 30, 2009. The provisions of these accounting standards were applied prospectively. See Note 1 – Basis of Presentation.

Note 3: Changes in Accounting Estimates  During the three months ended September 30, 2009, we had the following changes in accounting estimates, relating primarily to our Climate Control Business:
 
·  
a decrease in our estimated costs to complete a construction contract of $575,000, which contract was substantially completed during the third quarter,
·  
a decrease in our inventory shrink reserves of $238,000, and
·  
an increase in our accrued vacation of $205,000.

The net effect of these changes in accounting estimates increased income from continuing operations by $608,000 and net income by $371,000 for the nine and three months ended September 30, 2009. In addition, these changes in accounting estimates increased basic and diluted net income per share by $.02 and $.02, respectively, for the nine months ended September 30, 2009 and $.02 and $.02, respectively, for the three months ended September 30, 2009.
 
Note 4: Short-Term Investments  As part of our cash management program, we began maintaining a portfolio of investments. Currently, these investments consist of certificates of deposit with a maturity of 13 weeks. These investments are carried at cost which approximates fair value.  None of these investments were in excess of the federally insured limits.
 
11 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 5: Accounts Receivable

 
September 30,
2009
 
December 31,
2008
 
(In Thousands)
Trade receivables
$
66,262
   
$
78,092
 
Insurance claims
 
1,866
     
252
 
Other
 
952
     
1,231
 
   
69,080
     
79,575
 
Allowance for doubtful accounts
 
(826
)
   
(729
)
 
$
68,254
   
$
78,846
 

Note 6: Inventories 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 September 30, 2009 and December 31, 2008, inventory reserves for certain slow-moving inventory items (primarily Climate Control products) were $744,000 and $514,000, respectively. In addition, inventory reserves for certain nitrogen-based inventories provided by our Chemical Business were $154,000 and $3,627,000, at September 30, 2009 and December 31, 2008, respectively, because cost exceeded the net realizable value.

Changes in our inventory reserves are as follows:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Balance at beginning of period
$
4,141
   
$
473
   
$
1,064
   
$
583
 
Provisions for (realization of) losses
 
(3,186
)
   
400
     
(162
)
   
216
 
Write-offs/disposals
 
(57
)
   
(138
)
   
(4
)
   
(64
)
Balance at end of period
$
898
   
$
735
   
$
898
   
$
735
 

The provision for (realization of) losses is included in cost of sales in the accompanying condensed consolidated statements of income.

Note 7: 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. 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. 

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 our manufacturing equipment. When we accumulate precious metals in excess of our production requirements, we may sell a portion of the excess metals.
 
12 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 7: Precious Metals (continued)
 
Precious metals expense, net, consists of the following:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Precious metals expense
$
4,354
   
$
6,209
   
$
1,075
   
$
1,855
 
Recoveries of precious metals
 
(2,456
)
   
(1,343
)
   
(234
)
   
(551
)
Precious metals expense, net
$
1,898
   
$
4,866
   
$
841
   
$
1,304
 

Precious metals expense, net is included in cost of sales in the accompanying condensed consolidated statements of income.

Note 8: Investment in Affiliate  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”). As of September 30, 2009, the Partnership and general partner to the Partnership are indebted to a term lender (“Term Lender”) of the Project for approximately $2,470,000 with a term extending to December 2010. CHI has pledged its limited partnership interest in the Partnership to the Term Lender as part of the Term 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. In accordance with GAAP, no liability is required to be established for this pledge since it was entered into prior to January 1, 2003. CHI has no recourse provisions or available collateral that would enable CHI to recover its partnership interest should the Term Lender be required to perform under this pledge.

Note 9: Product Warranty  Our Climate Control Business sells equipment that has an expected life, under normal circumstances and use, that extends over several years. As such, we provide warranties after equipment shipment/start-up covering defects in materials and workmanship.

Generally, the base warranty coverage for most of the manufactured equipment in the Climate Control Business is limited to eighteen months from the date of shipment or twelve months from the date of start-up, whichever is shorter, and to ninety days for spare parts. The warranty provides that most equipment is required to be returned to the factory or an authorized representative and the warranty is limited to the repair and replacement of the defective product, with a maximum warranty of the refund of the purchase price. Furthermore, companies within the Climate Control Business generally disclaim and exclude warranties related to merchantability or fitness for any particular purpose and disclaim and exclude any liability for consequential or incidental damages. In some cases, the customer may purchase or a specific product may be sold with an extended warranty. The above discussion is generally applicable to such extended warranties, but variations do occur depending upon specific contractual obligations, certain system components, and local laws.
 
13 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 9: Product Warranty (continued)

Our accounting policy and methodology for warranty arrangements is to measure and recognize the expense and liability for such warranty obligations using a percentage of net sales, based upon our historical warranty costs. We also recognize the additional warranty expense and liability to cover atypical costs associated with a specific product, or component thereof, or project installation, when such costs are probable and reasonably estimable.  It is possible that future warranty costs could exceed our estimates.
 
Changes in our product warranty obligation are as follows:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Balance at beginning of period
$
2,820
   
$
1,944
   
$
3,038
   
$
2,278
 
Add: Charged to costs and expenses
 
5,050
     
3,406
     
1,904
     
1,119
 
Deduct: Costs and expenses incurred
 
(4,115
)
   
(3,032
)
   
(1,187
)
   
(1,079
)
Balance at end of period
$
3,755
   
$
2,318
   
$
3,755
   
$
2,318
 

Note 10: Current and Noncurrent Accrued and Other Liabilities

 
September 30,
2009
 
December 31,
2008
 
(In Thousands)
Accrued payroll and benefits
  $ 7,128     $ 6,422  
Deferred revenue on extended warranty contracts
    4,730       4,028  
Accrued warranty costs
    3,755       2,820  
Fair value of derivatives
    3,391       8,347  
Accrued death benefits
    3,186       2,687  
Accrued insurance
    2,608       2,971  
Accrued contractual manufacturing obligations
    2,072       2,230  
Accrued property and franchise taxes
    1,900       693  
Accrued losses on firm sales commitments
    1,310       -  
Accrued interest
    1,227       2,003  
Accrued executive benefits
    1,103       1,111  
Customer deposits
    963       3,242  
Accrued commissions
    936       2,433  
Accrued income taxes
    664       1,704  
Accrued precious metals costs
    587       1,298  
Billings in excess of costs and estimated earnings on uncompleted contracts
    -       1,882  
Deferred rent expense
    -       1,424  
Other
    3,512       3,572  
      39,072       48,867  
Less noncurrent portion
    10,549       9,631  
Current portion of accrued and other liabilities
  $ 28,523     $ 39,236  
 
 
14 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 11: Long-Term Debt

 
September 30,
 
December 31,
 
2009
 
2008
 
(In Thousands)
Working Capital Revolver Loan due 2012 (A)
$
-
 
$
-
 
5.5% Convertible Senior Subordinated Notes due 2012 (B)
 
30,400
   
40,500
 
Secured Term Loan due 2012 (C)
 
50,000
   
50,000
 
Other, with a current weighted-average interest rate of 6.30%, most of which is secured by machinery, equipment and real estate
 
23,128
   
14,660
 
   
103,528
   
105,160
 
Less current portion of long-term debt
 
3,161
   
1,560
 
Long-term debt due after one year
$
100,367
 
$
103,600
 

(A)  ThermaClime and its subsidiaries (the “Borrowers”) are parties to a $50 million revolving credit facility (the “Working Capital Revolver Loan”) that provides for advances based on specified percentages of eligible accounts receivable and inventories for ThermaClime, and its subsidiaries. The Working Capital Revolver Loan, as amended, accrues interest at a base rate (generally equivalent to the prime rate) plus .50% or LIBOR plus 1.75% and matures on April 13, 2012. The interest rate at September 30, 2009 was 3.75%. Interest is paid monthly, if applicable.

The facility provides for up to $8.5 million of letters of credit. All letters of credit outstanding reduce availability under the facility. At September 30, 2009, amounts available for borrowing under the Working Capital Revolver Loan were $49.2 million. Under the Working Capital Revolver Loan, as amended, the lender also requires the Borrowers to pay a letter of credit fee equal to 1% per annum of the undrawn amount of all outstanding letters of credit, an unused line fee equal to .375% per annum for the excess amount available under the facility not drawn and various other audit, appraisal and valuation charges.

The lender may, upon an event of default, as defined, terminate the Working Capital Revolver Loan and make the balance outstanding due and payable in full, if any. The Working Capital Revolver Loan is secured by the assets of all the ThermaClime entities other than El Dorado Nitric Company and its subsidiaries (“EDNC”) but excluding the assets securing the $50 million secured term loan discussed in (C) below and certain distribution-related assets of El Dorado Chemical Company (“EDC”). EDNC is neither a borrower nor guarantor of the Working Capital Revolver Loan. The carrying value of the pledged assets is approximately $217 million at September 30, 2009.

The Working Capital Revolver Loan, as amended, requires ThermaClime to meet certain financial covenants, including an EBITDA requirement of greater than $25 million, a minimum fixed charge coverage ratio of not less than 1.10 to 1, and a maximum senior leverage coverage ratio of not greater than 4.50 to 1, which requirements are measured quarterly on a trailing twelve-month basis and as defined in the agreement. ThermaClime was in compliance with those covenants for the twelve-month period ended September 30, 2009. The Working Capital
 
15 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 11: Long-Term Debt (continued)

Revolver Loan also contains covenants that, among other things, limit the Borrowers’ (which does not include the Company) ability, without consent of the lender and with certain exceptions, to:

·  
incur additional indebtedness,
·  
incur liens,
·  
make restricted payments or loans to affiliates who are not Borrowers,
·  
engage in mergers, consolidations or other forms of recapitalization, or
·  
dispose assets.

The Working Capital Revolver Loan also requires all collections on accounts receivable be made through a bank account in the name of the lender or their agent.

(B)  In June 2007, we entered into a purchase agreement with each of twenty two qualified institutional buyers (“QIBs”), pursuant to which we sold $60 million aggregate principal amount of the 5.5% Convertible Senior Subordinated Notes (the “2007 Debentures”) in a private placement to the QIBs pursuant to the exemptions from the registration requirements of the Securities Act of 1933, as amended (the “Act”), afforded by Section 4(2) of the Act and Regulation D promulgated under the Act. We received net proceeds of approximately $57 million, after discounts and commissions. In connection with the closing, we entered into an indenture (the “Indenture”) with UMB Bank, as trustee (the “Trustee”), governing the 2007 Debentures. The Trustee receives customary compensation from us for such services.

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, which began on January 1, 2008.

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.

During the nine and three months ended September 30, 2009, we acquired $10.1 million and $0.9 million, respectively, aggregate principal amount of the 2007 Debentures for approximately $8.0 million and $0.8 million, respectively, with each purchase being negotiated. As a result, we recognized a gain on extinguishment of debt of approximately $1.8 million and $0.1 million, respectively, after writing off the unamortized debt issuance costs associated with the 2007 Debentures acquired.

As the result of the acquisitions made during the fourth quarter of 2008 and the first nine months of 2009, only $30.4 million of the 2007 Debentures remain outstanding at September 30, 2009. In addition, see discussion concerning $5.0 million of the 2007 Debentures being held by Jack E. Golsen, our Chairman of the Board and Chief Executive Officer, members of his immediate family (spouse and children), including Barry H. Golsen, our Vice Chairman and President,
 
16 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 11: Long-Term Debt (continued)

entities owned by them and trusts for which they possess voting or dispositive power as trustee (collectively, the “Golsen Group”) in Note 19-Related Party Transactions.

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.

We may redeem some or all of the 2007 Debentures at any time on or after July 2, 2010, at a price equal to 100% of the principal amount of the 2007 Debentures, plus accrued and unpaid interest, all as set forth in the Indenture. The redemption price will be payable at our option in cash or, subject to certain conditions, shares of our common stock (valued at 95% of the weighted average of the closing sale prices of the common stock for the 20 consecutive trading days ending on the fifth trading day prior to the redemption date), subject to certain conditions being met on the date we mail the notice of redemption.

If a designated event (as defined in the Indenture) occurs prior to maturity, holders of the 2007 Debentures may require us to repurchase all or a portion of their 2007 Debentures for cash at a repurchase price equal to 101% of the principal amount of the 2007 Debentures plus any accrued and unpaid interest, as set forth in the Indenture. If a fundamental change (as defined in the Indenture) occurs on or prior to June 30, 2010, under certain  circumstances, we will pay, in addition to the repurchase price, a make-whole premium on the 2007 Debentures converted in connection with, or tendered for repurchase upon, the fundamental change. The make-whole premium will be payable in our common stock or the same form of consideration into which our common stock has been exchanged or converted in the fundamental change. The amount of the make-whole premium, if any, will be based on our stock price on the effective date of the fundamental change. No make-whole premium will be paid if our stock price in connection with the fundamental change is less than or equal to $23.00 per share.

At maturity, we may elect, subject to certain conditions as set forth in the Indenture, to pay up to 50% of the principal amount of the outstanding 2007 Debentures, plus all accrued and unpaid interest thereon to, but excluding, the maturity date, in shares of our common stock (valued at 95% of the weighted average of the closing sale prices of the common stock for the 20 consecutive trading days ending on the fifth trading day prior to the maturity date), if the common stock is then listed on an eligible market, the shares used to pay the 2007 Debentures and any interest thereon are freely tradable, and certain required opinions of counsel are received.

(C)  ThermaClime and certain of its subsidiaries are parties to a $50 million loan agreement (the “Secured Term Loan”) with a certain lender. The Secured Term Loan matures on November 2, 2012. The Secured Term Loan accrues interest at a defined LIBOR rate plus 3%, which LIBOR rate is adjusted on a quarterly basis. The interest rate at September 30, 2009 was approximately 3.48%. The Secured Term Loan requires only quarterly interest payments with the final payment of interest and principal at maturity.
 
17 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 11: Long-Term Debt (continued)

The Secured Term Loan is secured by the real property and equipment located at our El Dorado, Arkansas chemical production facility (“El Dorado Facility”) and at our Cherokee, Alabama chemical production facility (“Cherokee Facility”). The carrying value of the pledged assets is approximately $62 million at September 30, 2009.

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 September 30, 2009, the carrying value of the restricted net assets of ThermaClime and its subsidiaries was approximately $76 million. As defined in the agreement, the Secured Term Loan borrowers are also subject to a minimum fixed charge coverage ratio of not less than 1.10 to 1 and a maximum leverage ratio of not greater than 4.50 to 1, both measured quarterly on a trailing twelve-month basis.  The Secured Term Loan borrowers were in compliance with these financial covenants for the twelve-month period ended September 30, 2009.

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.

The Working Capital Revolver Loan agreement (discussed in (A) above) 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.

Note 12: 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 or realizable and earned.

Following is a summary of certain legal matters involving the Company.

A.
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.
 
18 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

We will recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. 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 or replace, as needed, with non-asbestos insulation through our standard repair and maintenance activities to prevent deterioration. Since 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.

1.  Discharge Water Matters

The El Dorado Facility located in El Dorado, Arkansas within our Chemical Business generates process wastewater, which includes cooling tower and boiler blowdowns, contact storm water and miscellaneous spills and leaks from process equipment. The process water discharge, storm-water runoff and miscellaneous spills and leaks are governed by 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 EDC 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 ammonia and nitrate permit limits, and believes that if it is required to meet the more restrictive dissolved minerals permit levels, it will be able to do so. The El Dorado Facility is currently having discussions with the ADEQ to modify and reduce the permit levels as to dissolved minerals, but, although the rule is a state rule, any revisions must also be approved by the United States Environmental Protection Agency (“EPA”) before it can become effective. Once the rule change is complete, the permit limits can be modified to incorporate achievable dissolved minerals permit levels. The ADEQ and the El Dorado Facility also entered into a Consent Administrative Order (“CAO”) which authorized the El Dorado Facility to continue operating through December 31, 2009 without incurring permit violations pending the modification of the permit to implement the revised rule. In March 2009, the EPA notified the ADEQ that it disapproved the dissolved mineral rulemaking due to insufficient documentation. Representatives of the El Dorado Facility, ADEQ and the EPA have met to determine what additional information was required by the EPA. During October 2009, representatives of the El Dorado Facility delivered to the ADEQ and the EPA an additional report as to a proposed plan relating to handling of, and rulemaking relating to, dissolved minerals by the El Dorado Facility. The ADEQ concurred to the proposed plan, and such is being reviewed by the EPA. Since this additional work will delay the final EPA approval of the dissolved mineral rulemaking, an extension of the CAO will be required. The ADEQ has indicated that it anticipates working out an extension of the CAO, and
 
19 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

representatives of the El Dorado Facility are working with the ADEQ to obtain an extension of the CAO. However, any extension of the CAO is subject to approval of the EPA.

In addition, EDC has entered into a CAO that recognizes the presence of nitrate contamination in the shallow groundwater at the El Dorado Facility. EDC is addressing the shallow groundwater contamination. 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. 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 September 30, 2009.

2.  Air Matters

In August 2008, an air permit modification was issued to EDC by the ADEQ, which sets new limits for ammonia emissions for the nitric acid units at the El Dorado Facility. EDC completed required compliance testing and all acid units were in compliance with the new ammonia emissions limits.

In addition, the EPA has sent information requests to most, if not all, of the nitric acid plants in the United States, including to us relating to our El Dorado, Cherokee and Baytown Facilities, requesting information under Section 114 of the Clean Air Act as to construction and modification activities at each of these facilities over a period of years to enable the EPA to determine whether these facilities are in compliance with certain provisions of the Clean Air Act. In connection with a review by our Chemical Business of these facilities in obtaining information for the EPA pursuant to the EPA’s request, our Chemical Business management believes, subject to further review, investigation and discussion with the EPA, that certain changes to its production equipment may be needed in order to comply with the requirements of the Clean Air Act. If changes to the production equipment at these facilities are required in order to bring this equipment into compliance with the Clean Air Act, the amount of capital expenditures necessary in order to bring the equipment into compliance is unknown at this time but could be substantial.

Further, if the equipment at any of our El Dorado, Cherokee and/or Baytown Facilities does not meet the requirements of the Clean Air Act, our Chemical Business could be subject to penalties in an amount not to exceed $27,500 per day as to each facility not in compliance and require such facility to be retrofitted with the “best available control technology.” Currently, we believe that certain facilities within our Chemical Business may be required to pay certain penalties and may be required to make certain capital improvements to certain emission equipment as a result of the above described matter; however, at this time we are unable to determine the amount of any penalties that may be assessed, or the cost of additional capital improvements that may be required, by the EPA. Therefore no liability has been established at September 30, 2009.
 
20 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

3.  Other Environmental Matters

In December 2002, two of our subsidiaries within our Chemical Business, sold substantially all of their operating assets relating to a Kansas chemical facility (“Hallowell Facility”) 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, our subsidiary leased the real property to the buyer under a triple net long-term lease agreement. However, our subsidiary retained the obligation to be responsible for, and perform the activities under, a previously executed consent order to investigate the surface and subsurface contamination at the real property and a corrective action strategy based on the investigation. In addition, certain of our subsidiaries agreed to indemnify the buyer of such assets for these environmental matters. The successor (“Chevron”) of a prior owner of the Hallowell Facility has agreed, within certain limitations, to pay and has been paying one-half of the costs of the interim measures as to the Hallowell Facility approved by the Kansas Department of Environmental Quality, subject to reallocation. As the result of completing the work relating to these interim measures, no liability remains outstanding at September 30, 2009.

Based on additional modeling of the site, our subsidiary and Chevron are pursuing a course with the state of Kansas of long-term surface and groundwater monitoring to track the natural decline in contamination, instead of the soil excavation proposed previously. Our subsidiary and Chevron submitted its final report on the groundwater monitoring and an addendum to the Mitigation Work Plan to the state of Kansas. The data from the monitoring program is being evaluated by the state of Kansas and the potential costs of additional monitoring or required remediation, if any, is unknown. Therefore, no liability has been established at September 30, 2009. It is reasonably possible that a change in estimate of a liability and receivable will occur in the near term relating to this matter.

B.  Other Pending, Threatened or Settled Litigation

1.  Climate Control Business

A proposed class action was filed in the Illinois state district court in September 2007 alleging 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 been fully briefed and is pending oral arguments and a decision from the court. Climate Master has filed a motion for summary judgment as to the plaintiffs’ claims, which motion has been fully briefed and is pending a decision from the court. Climate Master has removed this action to federal court. Climate Master has also filed its answer denying the plaintiffs’ claims and asserting several affirmative defenses. Climate Master’s insurers have been placed on notice of this matter. One of these insurers has denied coverage, one is out of business and has been liquidated and one insurer advised that it will monitor the litigation subject to a reservation of rights to decline coverage. Climate Master is vigorously defending itself and is
 
21 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

expensing its legal defense costs as incurred. Currently, the Company is unable to determine the amount of damages or the likelihood of any losses resulting from this claim. Therefore, no liability has been established at September 30, 2009.

2.  Chemical Business

On July 30, 2009, an agricultural distribution center located in Bryan, Texas (“Bryan Center”), owned and operated by our Chemical Business, was destroyed by fire, resulting in the cessation of operations at this center. As a result of the fire, local authorities evacuated certain areas around Bryan and College Station, Texas, and a number of individuals were treated at the local hospital emergency room and released. As a result of the fire, our Chemical Business is a party to several lawsuits (including one class action lawsuit) and has been threatened with other potential litigation. Our general liability and pollution insurance carrier, Chartis (an insurance unit of AIG), was immediately notified and is actively involved in the handling of this matter. Chartis is defending and indemnifying us and our Chemical Business in connection with claims arising from the fire under a reservation of rights. We have been advised by our insurance counsel that there is only a remote risk that Chartis would exercise the coverage defenses under its reservation of rights. We have incurred expenses up to our insurance deductible of $250,000 relating to our general liability and pollution coverage. As a result, we believe our insurance policies are adequate to cover any currently foreseeable losses and claims arising from the fire. No liability remains outstanding relating to this matter as of September 30, 2009.

3.  Other

The Jayhawk Group

In November 2006, we entered into an agreement with Jayhawk Capital Management, LLC, Jayhawk Investments, L.P., Jayhawk Institutional Partners, L.P. and Kent McCarthy, the manager and sole member of Jayhawk Capital, (collectively, the “Jayhawk Group”), in which the Jayhawk Group agreed, among other things, that if we undertook, in our sole discretion, within one year from the date of agreement a tender offer for our Series 2 $3.25 convertible, exchangeable Class C preferred stock (“Series 2 Preferred”) or to issue our common stock for a portion of our Series 2 Preferred pursuant to a private exchange, that it would tender or exchange an aggregate of no more than 180,450 shares of the 340,900 shares of the Series 2 Preferred beneficially owned by the Jayhawk Group, subject to, among other things, the entities owned and controlled by Jack E. Golsen, our Chairman and Chief Executive Officer (“Golsen”), and his immediate family, that beneficially own Series 2 Preferred only being able to exchange or tender approximately the same percentage of shares of Series 2 Preferred beneficially owned by them as the Jayhawk Group is able to tender or exchange under the terms of the agreement. In addition, under the agreement, the Jayhawk Group agreed to vote its shares of our common stock and Series 2 Preferred “for” an amendment to the Certificate of Designation covering the Series 2 Preferred to allow us:
 
22 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

·  
for a period of five years from the completion of an exchange or tender to repurchase, redeem or otherwise acquire shares of our common stock, without approval of the outstanding Series 2 Preferred irrespective that dividends are accrued and unpaid with respect to the Series 2 Preferred; or
·  
to provide that holders of Series 2 Preferred may not elect two directors to our board of directors when dividends are unpaid on the Series 2 Preferred if less than 140,000 shares of Series 2 Preferred remain outstanding.

During 2007, we made a tender offer for our outstanding Series 2 Preferred at the rate of 7.4 shares of our common stock for each share of Series 2 Preferred so tendered. In July 2007, we redeemed the balance of our outstanding shares of Series 2 Preferred. Pursuant to its terms, the Series 2 Preferred was convertible into 4.329 shares of our common stock for each share of Series 2 Preferred. As a result of the redemption, the Jayhawk Group converted the balance of its Series 2 Preferred pursuant to the terms of the Series 2 Preferred in lieu of having its shares redeemed.

During November 2008, the Jayhawk Group filed suit against us and Golsen in a lawsuit styled Jayhawk Capital Management, LLC, et al. v. LSB Industries, Inc., et al., in the United States District Court for the District of Kansas at Kansas City. During March 2009, the Jayhawk Group amended its complaint alleging that the Jayhawk Group should have been able to tender all of its Series 2 Preferred pursuant to the tender offer, notwithstanding the above-described agreement, based on the following claims against us and Golsen:

·  
fraudulent inducement and fraud,
·  
violation of 10(b) of the Exchange Act and Rule 10b-5,
·  
violation of 17-12A501 of the Kansas Uniform Securities Act, and
·  
breach of contract.

The Jayhawk Group seeks damages in an unspecified amount based on the additional number of common shares it allegedly would have received on conversion of all of its Series 2 Preferred through the February 2007 tender offer, plus punitive damages. In addition, the amended complaint seeks damages in the amount of approximately $4,000,000 for accrued and unpaid dividends it purports are owed as a result of Jayhawk’s July 2007 conversion of its remaining shares of Series 2 Preferred. In May 2008, the General Counsel for the Jayhawk Group offered to settle its claims against us and Golsen in return for a payment of $100,000, representing the approximate legal fees it had incurred investigating the claims at that time. Through counsel, we verbally agreed to the settlement offer and confirmed the agreement by e-mail. Afterward, the Jayhawk Group’s General Counsel purported to withdraw the settlement offer, and asserted that Jayhawk is not bound by any settlement agreement. We contend that the settlement agreement is binding on the Jayhawk Group. Both Golsen and we have filed motions to dismiss the plaintiff’s complaint in the federal court, and such motions to dismiss are pending. We intend to contest the lawsuit vigorously, and will assert that Jayhawk is bound by an agreement to settle the claims for $100,000. Our insurer, a subsidiary of AIG, has agreed to defend this lawsuit on our behalf and on behalf of Golsen and to indemnify under a reservation of rights to deny liability under certain
 
23 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 12: Contingencies (continued)

conditions. We have incurred expenses associated with this matter up to our insurance deductible of $250,000. We believe our insurance coverage is adequate to cover any currently foreseeable losses associated with the Jayhawk claims. As a result, no liability remains outstanding relating to this matter as of September 30, 2009.

Other Claims and Legal Actions

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.

Note 13: Derivatives, Hedges and Financial Instruments Derivatives are recognized in the balance sheet and are measured at fair value. Changes in fair value of derivatives are recorded in results of operations unless the normal purchase or sale exceptions apply or hedge accounting is elected.

We have three types of contracts that are accounted for on a fair value basis, which are interest rate contracts, commodities futures/forward contracts (“commodities contracts”) and foreign exchange contracts as discussed below. All of these contracts are used as economic hedges for risk management purposes but are not designated as hedging instruments. The valuation of these contracts was determined based on quoted market prices or, in instances where market quotes are not available, other valuation techniques or models used to estimate fair values. The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts. The valuations of contracts classified as Level 2 are based on quoted prices for similar contracts and valuation inputs other than quoted prices that are observable for these contracts. At December 31, 2008, the valuations of contracts classified as Level 3 were based on the average ask/bid prices obtained from a broker relating to a low volume market.

Interest Rate Contracts

As part of our interest rate risk management, we periodically purchase and/or enter into various interest rate contracts. These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. In March 2005, we purchased two interest rate cap contracts for a cost of $590,000, which matured in March 2009. In April 2008, we entered into an interest rate swap at no cost, which sets a fixed three-month LIBOR rate of 3.24% on $25 million and matures in April 2012. In September 2008, we acquired an interest rate swap at a cost basis of $354,000, which sets a fixed three-month LIBOR rate of 3.595% on $25 million and matures in April 2012. Although no purchases requiring cash occurred during the nine and three months ended September 30, 2009 and 2008, the cash flows relating to the purchase of interest rate contracts are included in cash flows from continuing investing activities. In addition, the cash flows associated with the interest rate swap payments are included in cash flows from continuing operating activities.
 
24 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 13: Derivatives, Hedges and Financial Instruments (continued)

Commodities Contracts

Raw materials for use in our manufacturing processes include copper used by our Climate Control Business and anhydrous ammonia and natural gas used by our Chemical Business. As part of our raw material price risk management, we periodically enter into futures/forward contracts for these materials, which contracts are generally accounted for on a mark-to-market basis. At September 30, 2009, our futures/forward copper contracts were for 750,000 pounds of copper through December 2009 at a weighted-average cost of $1.93 per pound. Also our futures/forward natural gas contracts were for approximately 221,000 MMBtu of natural gas through December 2009 at a weighted-average cost of $10.52 per MMBtu. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

Foreign Exchange Contracts

One of our business operations purchases industrial machinery and related components from vendors outside of the United States. As part of our foreign currency risk management, we periodically enter into foreign exchange contracts, which set the U.S. Dollar/Euro exchange rates. These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. At September 30, 2009, we had no outstanding foreign exchange contracts. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

The following details our assets and liabilities that are measured at fair value on a recurring basis at September 30, 2009 and December 31, 2008:

 
Fair Value Measurements at
 September 30, 2009 Using

 
 
 
 
Description
 
 
Total Fair
Value at
September 30,
2009
 
Quoted Prices
 in Active
Markets for Identical Assets (Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
 
Significant Unobservable Inputs
(Level 3)
 
 
Total Fair
Value at
December 31,
2008
 
(In Thousands)
Assets – Supplies, prepaid items and other:
                             
Commodities contracts
$
666
 
$
666
 
$
-
 
$
-
 
$
-
 
Foreign exchange contracts
 
-
   
-
   
-
   
-
   
35
 
Total
$
666
 
$
666
 
$
-
 
$
-
 
$
35
 
                               
Liabilities – Current and noncurrent accrued and other liabilities:
                             
Commodities contracts
$
1,268
 
$
137
 
$
1,131
 
$
-
 
$
5,910
 
Interest rate contracts
 
2,123
   
-
   
2,123
   
-
   
2,437
 
Total
$
3,391
 
$
137
 
$
3,254
 
$
-
 
$
8,347
 
 
 
25 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 13: Derivatives, Hedges and Financial Instruments (continued)
 
The following is a reconciliation of the beginning and ending balances for liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine months ended September 30, 2009 (not applicable for the nine months ended September 30, 2008 and the three months ended September 30, 2009 and 2008):

 
Commodities Contracts
 
(In Thousands)
Beginning balance
  $ (1,388 )
Total realized and unrealized gain included in earnings
    493  
Purchases, issuances, and settlements
    895  
Transfers in and/or out of Level 3
    -  
Ending balance
  $ -  

Realized and unrealized gains (losses) included in earnings and the income statement classifications are as follows:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Total gains (losses) included in earnings:
                             
Cost of sales – Commodities contracts
$
(1,598
)
 
$
(3,766
)
 
$
(450
)
 
$
(8,254
)
Cost of sales – Foreign exchange contracts
 
(31
)
   
(172
)
   
-
     
(137
)
Interest expense – Interest rate contracts
 
(530
)
   
209
     
(688
)
   
(499
)
 
$
(2,159
)
 
$
(3,729
)
 
$
(1,138
)
 
$
(8,890
)

Change in unrealized gains and losses relating to contracts still held at period end:
                           
Cost of sales – Commodities contracts
$
236
 
$
(4,931
)
 
$
385
   
$
(5,391
)
Cost of sales – Foreign exchange contracts
 
-
   
(129
)
   
-
     
(123
)
Interest expense – Interest rate contracts
 
314
   
275
     
(335
)
   
(361
)
 
$
550
 
$
(4,785
)
 
$
50
   
$
(5,875
)

The following discussion of fair values is not indicative of the overall fair value of our assets and liabilities since it does not include all assets, including intangibles.

Our long-term debt agreements are the only financial instruments with fair values significantly different from their carrying amounts. At September 30, 2009 and December 31, 2008, the fair value for variable debt, excluding the Secured Term Loan, was believed to approximate their carrying value. At September 30, 2009 and December 31, 2008, the estimated fair value of the
 
26 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 13: Derivatives, Hedges and Financial Instruments (continued)

Secured Term Loan is based on defined LIBOR rates plus 8.75% and 10%, respectively, utilizing information obtained from the lender. The fair values of fixed rate borrowings, other than the 2007 Debentures, are estimated using a discounted cash flow analysis that applies interest rates currently being offered on borrowings of similar amounts and terms to those currently outstanding while also taking into consideration our current credit worthiness. At September 30, 2009 and December 31, 2008, the estimated fair value of the 2007 Debentures is based on quoted prices obtained from a broker for these debentures. The estimated fair value and carrying value of our long-term debt are as follows:

 
September 30, 2009
 
December 31, 2008
 
Estimated Fair Value
 
Carrying
Value
 
Estimated
Fair Value
 
Carrying
Value
 
(In Thousands)
Variable Rate:
                     
Secured Term Loan
$ 23,076     $ 50,000     $ 20,939     $ 50,000  
Working Capital Revolver Loan
  -       -       -       -  
Other bank debt and financing
  2,581       2,581       8       8  
                               
Fixed Rate:
                             
5.5% Convertible Senior Subordinated Notes
  28,880       30,400       27,338       40,500  
Other bank debt and equipment financing
  20,949       20,547       14,949       14,652  
  $ 75,486     $ 103,528     $ 63,234     $ 105,160  

Note 14: Income Per Common Share  Net income applicable to common stock is computed by adjusting net income by the amount of preferred stock dividends. Basic income per common share is based upon net income applicable to common stock and the weighted-average number of common shares outstanding during each period.

Diluted income per share is based on net income applicable to common stock plus preferred stock dividends on preferred stock assumed to be converted, if dilutive, and interest expense including amortization of debt issuance cost, net of income taxes, on convertible debt assumed to be converted, if dilutive, and the weighted-average number of common shares and dilutive common equivalent shares outstanding, and the assumed conversion of dilutive convertible securities outstanding.
 
27 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
 
Note 14: Income Per Common Share (continued)

The following is a summary of certain transactions which affected basic income per share or diluted income per share, if dilutive:

During the nine months ended September 30, 2009,

·  
we issued 408,500 shares of our common stock as the result of the exercise of stock options,
·  
we acquired $10,100,000 aggregate principal amount of our 2007 Debentures; and
·  
we paid cash dividends on our Series B 12% cumulative, convertible preferred stock (“Series B Preferred”), Series D 6% cumulative, convertible Class C preferred stock (“Series D Preferred”) and noncumulative redeemable preferred stock (“Noncumulative Preferred”) totaling approximately $240,000, $60,000 and $6,000, respectively.

During the nine months ended September 30, 2008,

·  
we acquired 200,000 shares of our common stock;
·  
we issued 430,304 shares of our common stock as the result of the exercise of stock options;
·  
we paid cash dividends on our Series B Preferred, Series D Preferred and Noncumulative Preferred totaling approximately $240,000, $60,000 and $6,000, respectively.

At September 30, 2009, there were no dividends in arrears.
 
28 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 14: Income Per Common Share (continued)

The following table sets forth the computation of basic and diluted net income per common share:

(Dollars In Thousands, Except Per Share Amounts)

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
Numerator:
                             
Net income
$
21,546
   
$
32,975
   
$
1,073
   
$
4,161
 
Dividends on Series B Preferred
 
(240
)
   
(240
)
   
-
     
-
 
Dividends on Series D Preferred
 
(60
)
   
(60
)
   
-
     
-
 
Dividends on Noncumulative Preferred
 
(6
)
   
(6
)
   
-
     
-
 
Total dividends on preferred stocks
 
(306
)
   
(306
)
   
-
     
-
 
Numerator for basic net income per common share - net income applicable to common stock
 
21,240
     
32,669
     
1,073
     
4,161
 
Dividends on preferred stocks assumed to be converted, if dilutive
 
306
     
306
     
-
     
-
 
Interest expense including amortization of debt issuance costs, net of income taxes, on convertible debt assumed to be converted, if dilutive
 
 
914
     
 
1,805
     
 
-
     
 
-
 
Numerator for diluted net income per common share
$
22,460
   
$
34,780
   
$
1,073
   
$
4,161
 
                               
Denominator:
                             
Denominator for basic net income per common share - weighted-average shares
 
21,279,030
     
21,155,724
     
21,486,688
     
21,237,268
 
Effect of dilutive securities:
                             
Convertible notes payable
 
1,110,560
     
2,188,000
     
4,000
     
4,000
 
Convertible preferred stocks
 
938,006
     
938,999
     
937,106
     
939,286
 
Stock options
 
295,539
     
600,917
     
205,149
     
473,882
 
Dilutive potential common shares
 
2,344,105
     
3,727,916
     
1,146,255
     
1,417,168
 
Denominator for diluted net income per common share - adjusted weighted-average shares and assumed conversions
 
 
23,623,135
     
 
24,883,640
     
 
22,632,943
     
 
22,654,436
 
                               
Basic net income per common share
$
1.00
   
$
1.54
   
$
.05
   
$
.20
 
                               
Diluted net income per common share
$
.95
   
$
1.40
   
$
.05
   
$
.18
 
 
 
29 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 14: Income Per Common Share (continued)

The following weighted-average shares of securities were not included in the computation of diluted net income per common share as their effect would have been antidilutive:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
Stock options
  406,685       425,000       383,152       425,000  
Convertible notes payable
  -       -       1,106,560       2,184,000  
    406,685       425,000       1,489,712       2,609,000  
 
Note 15:  Income Taxes Provisions for income taxes are as follows:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Current:
Federal
$
4,245
 
$
13,641
   
$
(2,245
)
 
$
2,121
 
State
 
492
   
1,752
     
(280
)
   
28
 
Total current provisions
$
4,737
 
$
15,393
   
$
(2,525
)
 
$
2,149
 
 
Deferred:
Federal
$
8,680
 
$
3,927
   
$
3,710
   
$
388
 
State
 
693
   
497
     
125
     
(149
)
Total deferred provisions
 
9,373
   
4,424
     
3,835
     
239
 
Provisions for income taxes
$
14,110
 
$
19,817
   
$
1,310
   
$
2,388
 

For the nine and three months ended September 30, 2009 and 2008, the current provision for federal income taxes shown above includes regular federal income tax after the consideration of permanent and temporary differences between income for GAAP and tax purposes. For the nine and three months ended September 30, 2009 and 2008, the current provision for state income taxes shown above includes regular state income tax and provisions for uncertain state income tax positions. At December 31, 2008, we had state net operating loss (“NOL”) carryforwards totaling approximately $35,000,000, which begin expiring in 2009.

Our annual estimated effective tax rate for 2009 is reduced by permanent tax differences, including the domestic manufacturer’s deduction and other permanent items.

The tax provision for the three months ended September 30, 2009 was $1,310,000 or 55% of pretax income. This tax provision was disproportionately high as a percentage of pretax income primarily due to the impact of filing the federal income tax return during the third quarter of 2009 and the related adjustments necessary to reconcile the completed and filed return with the
 
30 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 15:  Income Taxes (continued)

2008 estimated tax provision. Additionally, as a result of lower projected taxable income for 2009, we will be limited in the amount of the domestic manufacturer’s deduction that can be utilized. We previously estimated that we would have received the full benefit of this deduction, which resulted in a lower expected effective tax rate.

Our accounting for income taxes includes utilizing the accounting principle that the realization of an uncertain income tax position must be “more likely than not” (i.e., greater than 50% likelihood) that the position will be sustained upon examination by taxing authorities before it can be recognized in the financial statements.

We believe that we do not have any material uncertain tax positions other than the failure to file state income tax returns in some jurisdictions where we or some of our subsidiaries may have a filing responsibility (i.e, nexus). We had approximately $664,000 and $898,000 accrued for uncertain tax liabilities at September 30, 2009 and December 31, 2008, respectively, which are included in current and noncurrent accrued and other liabilities.

We and certain of our subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The federal tax returns for 1994 through 2004 remain subject to examination for the purpose of determining the amount of remaining tax NOL and other carryforwards. With few exceptions, the 2006-2008 years remain open for all purposes of examination by the IRS and other major tax jurisdictions.
 
31 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 16: Other Expense, Other Income and Non-Operating Other Income, net

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Other expense:
                             
Losses on sales and disposals of property and equipment
$
340
   
$
130
   
$
120
   
$
48
 
Litigation settlements and potential  settlements
 
75
     
367
     
-
     
-
 
Income tax related penalties
 
31
     
176
     
4
     
175
 
Impairment of long-lived assets (1)
 
-
     
192
     
-
     
-
 
Other miscellaneous expense (2)
 
15
     
81
     
3
     
66
 
Total other expense
$
461
   
$
946
   
$
127
   
$
289
 
                               
Other income:
                             
Litigation judgment, settlements and potential settlements (3)
 
$
 
50
   
 
$
 
8,235
   
 
$
 
-
   
 
$
 
-
 
Other miscellaneous income (2)
 
172
     
182
     
32
     
88
 
Total other income
$
222
   
$
8,417
   
$
32
   
$
88
 
                               
Non-operating other income, net:
                             
Interest income
$
138
   
$
1,188
   
$
60
   
$
289
 
Miscellaneous income (2)
 
1
     
10
     
1
     
(1
)
Miscellaneous expense (2)
 
(67
)
   
(73
)
   
(23
)
   
(25
)
Total non-operating other income, net
$
72
   
$
1,125
   
$
38
   
$
263
 

(1)  
Based on an unsuccessful effort to sell certain corporate assets in an auction, we recognized an impairment of long-lived assets.

(2)  
Amounts represent numerous unrelated transactions, none of which are individually significant requiring separate disclosure.

(3)  
For the nine months ended September 30, 2008, income from litigation judgment and settlements included approximately $7.6 million, net of attorneys’ fees, relating to a litigation judgment involving a subsidiary within our Chemical Business. On June 6, 2008, we received proceeds of approximately $11.2 million for this litigation judgment, which includes interest of approximately $1.4 million and from which we paid attorneys’ fees of approximately $3.6 million. The payment of attorneys’ fees of 31.67% of our recovery was contingent upon the cash receipt of the litigation judgment. Cash flows relating to this litigation judgment are included in cash flows from continuing operating activities, except for the portion of the judgment associated with the recovery of damages relating to property, plant and equipment and its pro-rata portion of the attorneys’
 
 
32 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 16: Other Expense, Other Income and Non-Operating Other Income, net (continued)

fees. These cash flows are included in cash flows from continuing investing activities. In addition during the nine months ended September 30, 2008, a settlement was reached for $0.4 million for the recovery of certain environmental-related costs incurred in previous periods relating to property used by Corporate and other business operations.

Note 17: Business Interruption and Property Insurance Claims  Our accounting policy for insurance claims is 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 or realizable and earned.

On February 5, 2009, a small nitric acid plant located at the Cherokee Facility suffered damage due to a fire. The fire was immediately extinguished and there were no injuries. The extent of the damage to the nitric acid plant has been determined; however, the final repair option has not yet been determined. The nitric acid plant that suffered the fire, with a current 182 ton per day capacity, is the smaller of the two nitric acid plants at the Cherokee Facility. The Cherokee Facility continues production with the larger of the nitric acid plants. Our insurance provides for replacement cost coverage relating to property damage with a $1,000,000 property loss deductible. Because our replacement cost coverage for property damages is estimated to exceed our property loss deductible and the net book value of the damaged property, we have not recognized a loss relating to property damage from this fire but we have recorded a property insurance claim receivable of $1,175,000 relating to this event at September 30, 2009.

As discussed in Note 12 - Contingencies, on July 30, 2009, one of our fifteen agricultural distribution centers operated by our Chemical Business was destroyed by fire, resulting in the cessation of operations at this center, which is located in Bryan, Texas (“Bryan Center”). The Bryan Center stored and sold agricultural chemical products, including fertilizer grade ammonium nitrate, potash and certain other fertilizer products. Our Chemical Business currently intends to rebuild the Bryan Center. Our insurance provides for business interruption coverage and for replacement cost coverage relating to property damage with a total $100,000 loss deductible. As of September 30, 2009, a recovery, if any, from our business interruption coverage has not been recognized. Because our replacement cost coverage for property damages is estimated to exceed our property loss deductible and the net book value of the damaged property, we have not recognized a loss relating to property damage from this fire but we have recorded an insurance claim receivable of $539,000 consisting primarily of our property insurance claim at September 30, 2009.
 
33 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 18: Segment Information

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Net sales:
                             
Climate Control
$
206,443
   
$
230,303
   
$
67,413
   
$
83,354
 
Chemical
 
204,089
     
329,271
     
59,718
     
124,483
 
Other
 
6,006
     
9,853
     
647
     
3,083
 
 
$
416,538
   
$
569,427
   
$
127,778
   
$
210,920
 
                               
Gross profit: (1)
                             
Climate Control (2)
$
72,172
   
$
72,346
   
$
24,746
   
$
24,892
 
Chemical (3) (4)
 
35,091
     
37,181
     
5,662
     
5,329
 
Other
 
1,945
     
3,140
     
245
     
948
 
 
$
109,208
   
$
112,667
   
$
30,653
   
$
31,169
 
                               
Operating income (loss): (5)
                             
Climate Control (2)
$
32,146
   
$
31,017
   
$
10,942
   
$
9,835
 
Chemical (3) (4) (6) (7)
 
15,491
     
34,487
     
(3,344
)
   
1,860
 
General corporate expenses and other business operations, net (8)
 
(9,405
)
   
(8,158
)
   
(3,328
)
   
(3,005
)
   
38,232
     
57,346
     
4,270
     
8,690
 
                               
Interest expense
 
(5,139
)
   
(6,363
)
   
(2,200
)
   
(2,643
)
Gains on extinguishment of debt
 
1,796
     
-
     
53
     
-
 
Non-operating other income (expense), net:
                         
Climate Control
 
-
     
1
     
-
     
-
 
Chemical
 
26
     
64
     
20
     
-
 
Corporate and other business operations
 
46
     
1,060
     
18
     
263
 
Provisions for income taxes
 
(14,110
)
   
(19,817
)
   
(1,310
)
   
(2,388
)
Equity in earnings of affiliate-Climate Control
 
740
     
697
     
252
     
235
 
Income from continuing operations
$
21,591
   
$
32,988
   
$
1,103
   
$
4,157
 

(1)
Gross profit by industry segment represents net sales less cost of sales. Gross profit classified as “Other” relates to the sales of industrial machinery and related components.

(2)
During the nine and three months ended September 30, 2009, we recognized gains totaling $1,193,000 and $404,000, respectively, on our futures contracts for copper. During the nine and three months ended September 30, 2008, we recognized gains (losses) on our copper futures contracts totaling $2,202,000 and $(483,000), respectively. During the three months ended September 30, 2009, our engineering and construction business recognized
 
 
34 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 18: Segment Information (continued)

 
additional gross profit of $552,000 relating to customer change orders. The impact of these transactions is included in gross profit and operating income.

(3)
During the nine and three months ended September 30, 2009, we recognized losses totaling $2,791,000 and $854,000, respectively, on our futures/forward contracts for natural gas and ammonia compared to $5,968,000 and $7,771,000 for each of the same periods in 2008, respectively. In addition, during the three months ended September 30, 2008, our Chemical Business recognized unrealized gains of $447,000 associated with natural gas forward contracts, which were deferred at June 30, 2008 due to uncertainties involving a sales contract with a customer. During the nine and three months ended September 30, 2009, we recognized losses on outstanding firm sales commitments of $1,310,000 and $1,229,000, respectively, which amounts include $992,000 relating to the Pryor Facility discussed below in footnote 7. The impact of these transactions is included in gross profit and operating income (loss) for each respective period.

(4)
As the result of entering into sales commitments with higher firm sales prices during 2008, we recognized sales with a gross profit of $5,143,000 and $1,585,000 higher than our comparable product sales made at lower market prices available during the nine and three months ended September 30, 2009, respectively. In addition, during the nine months ended September 30, 2009, we recognized recoveries of precious metals totaling $2,456,000 compared to $1,343,000 for the same period in 2008. During the nine and three months ended September 30, 2009, we incurred expenses of $2,682,000 and $2,079,000, respectively, relating to planned major maintenance activities compared to $1,494,000 and $881,000 for each of the same periods in 2008, respectively. Also during the nine and three months ended September 30, 2008, the Cherokee Facility incurred costs of approximately $5,100,000 as the result of unplanned downtime during the third quarter of 2008. These costs include estimates of lost fixed overhead absorption, repair cost, and losses incurred to purchase anhydrous ammonia to replace lost production in order to meet firm sales commitments. The impact of these transactions is included in gross profit and operating income (loss) for each respective period.

(5)
Our chief operating decision makers use operating income by industry segment for purposes of making decisions which include resource allocations and performance evaluations. Operating income by industry segment represents gross profit by industry segment less selling, general and administration expense (“SG&A”) incurred by each industry segment plus other income and other expense earned/incurred by each industry segment before general corporate expenses and other business operations, net. General corporate expenses and other business operations, net, consist of unallocated portions of gross profit, SG&A, other income and other expense.

(6)
For the nine month periods ended September 30, 2008, we recognized other income of $7,560,000, net of attorneys’ fees, relating to a litigation judgment.
 
 
35 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 18: Segment Information (continued)

(7)
During the nine and three months ended September 30, 2009, we incurred expenses of $12,271,000 and $7,058,000, respectively, (including the $992,000 loss on firm sales commitments discussed above in footnote 3) associated with the start up of our previously idled chemical facility located in Pryor, Oklahoma (the “Pryor Facility”) that we are in the process of activating. For the nine and three months ended September 30, 2008, we incurred expenses of $1,344,000 and $425,000, respectively, associated with maintaining the Pryor Facility. These expenses are primarily included in SG&A for each respective period.

(8)
The amounts included in general corporate expenses and other business operations, net are not allocated to our Climate Control and Chemical Businesses since these items are not included in the operating results reviewed by our chief operating decision makers for purposes of making decisions as discussed above. A detail of these amounts are as follows:

 
Nine Months Ended
September 30,
 
Three Months Ended
September 30,
 
2009
 
2008
 
2009
 
2008
 
(In Thousands)
Gross profit-Other
$
1,945
   
$
3,140
   
$
245
   
$
948
 
Selling, general and administrative:
                             
Personnel
 
(6,202
)
   
(5,810
)
   
(1,876
)
   
(1,740
)
Professional fees
 
(2,775
)
   
(3,349
)
   
(957
)
   
(1,362
)
Office overhead
 
(490
)
   
(499
)
   
(145
)
   
(122
)
Maintenance and repairs
 
(182
)
   
(115
)
   
(8
)
   
(30
)
Property, franchise and other taxes
 
(245
)
   
(299
)
   
(85
)
   
(83
)
Advertising
 
(199
)
   
(204
)
   
(67
)
   
(67
)
All other
 
(1,186
)
   
(1,082
)
   
(453
)
   
(405
)
Total selling, general and administrative
 
(11,279
)
   
(11,358
)
   
(3,591
)
   
(3,809
)
                               
Other income
 
156
     
736
     
23
     
32
 
Other expense
 
(227
)
   
(676
)
   
(5
)
   
(176
)
Total general corporate expenses and other business operations, net
$
(9,405
)
 
$
(8,158
)
 
$
(3,328
)
 
$
(3,005
)
 
 
36 

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)
Note 18: Segment Information (continued)

Information about our total assets by industry segment is as follows:

 
September 30,
2009
 
December 31,
2008
 
(In Thousands)
Climate Control
 
$
108,770
   
$
117,260
 
Chemical
   
141,507
     
145,518
 
Corporate assets and other
   
90,750
     
72,989
 
Total assets
 
$
341,027
   
$
335,767
 

Note 19: Related Party Transactions

Golsen Group

In March 2008 and March 2009, we paid, in each respective period, dividends totaling $240,000 and $60,000 on our Series B Preferred and our Series D Preferred, respectively, all of the outstanding shares of which are owned by the Golsen Group.

During 2008, the Golsen Group acquired from an unrelated third party $5,000,000 of the 2007 Debentures. As a result, during the nine months ended September 30, 2009, we incurred interest expense of $206,250 relating to the debentures held by the Golsen Group, of which $68,750 remains accrued at September 30, 2009. We also paid interest of $137,500 that was accrued at December 31, 2008.
 
37 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations (“MD&A”) should be read in conjunction with our September 30, 2009 condensed consolidated financial statements. Certain statements contained in this MD&A may be deemed forward-looking statements. See "Special Note Regarding Forward-Looking Statements".

Overview

General

We are a manufacturing, marketing and engineering company, operating through our subsidiaries. Our wholly-owned subsidiary, ThermaClime, through its subsidiaries, owns a substantial portion of our following core businesses:

·  
Climate Control Business manufactures and sells 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 related products used to control the environment in commercial and residential new building construction, renovation of existing buildings and replacement of existing systems. For the first nine months of 2009, approximately 50% of our consolidated net sales relates to the Climate Control Business.
·  
Chemical Business manufactures and sells nitrogen based chemical products produced from three plants located in Arkansas, Alabama and Texas for the industrial, mining and agricultural markets. Our products include industrial and fertilizer grade ammonium nitrate (“AN”), urea ammonium nitrate (“UAN”), nitric acid in various concentrations, nitrogen solutions and various other products. For the first nine months of 2009, approximately 49% of our consolidated net sales relates to the Chemical Business.

Certain of our other subsidiaries outside of ThermaClime own facilities and operations, including the Pryor Facility, within our above described core businesses.

Our project to begin production of ammonia and UAN at our previously idled Pryor Facility located in Pryor, Oklahoma is still underway despite certain delays being experienced. The start-up delays, which includes extended lead times to refurbish certain major equipment items that were identified during the initial start-up production phase, resulted in significant increases in our previous estimates of the third quarter start-up costs. We previously  indicated that the Pryor Facility would probably be producing UAN in September and that the remaining start-up costs were estimated to be approximately $4.0 million. In October 2009, we reported that we were experiencing delays and based upon the estimated time to make required plant adjustments, we anticipated that production would begin in November barring unforeseen circumstances. Due to the delayed start-up, the expenses for the third quarter increased to $7.1 million, including an unrealized embedded loss of $1.0 million on firm sales commitments at September 30, 2009, as the result of increases in natural gas costs and due to product we expected to produce but will be unable to produce at the Pryor Facility because of the unforeseen delays. The embedded loss is a