ITEM 1. BUSINESS _______ ________
GENERAL _______
LSB Industries, Inc. (the "Company") was formed in 1968 as an Oklahoma corporation, and in 1977 became a Delaware corporation. The Company is a diversified holding company which is engaged, through its subsidiaries, in (i) the manufacture and sale of chemical products for the explosives, agricultural and industrial acids markets (the "Chemical Business"), (ii) the manufacture and sale of a broad range of air handling and heat pump products for use in commercial and residential air conditioning systems (the "Environmental Control Business"), and (iii) the manufacture or purchase and sale of certain automotive and industrial products, including automotive bearings and other automotive replacement parts (the "Automotive Products Business") and the purchase and sale of machine tools (the "Industrial Products Business").
SEGMENT INFORMATION AND FOREIGN AND DOMESTIC OPERATIONS AND EXPORT SALES ________________________________________________________________________
Schedules of the amounts of sales, operating profit and loss, and identifiable assets attributable to each of the Company's lines of business and of the amount of export sales of the Company in the aggregate and by major geographic area for each of the Company's last three fiscal years appear in Note 15 of the Notes to Consolidated Financial Statements included elsewhere in this report.
A discussion of any risks attendant as a result of a foreign operation or the importing of products from foreign countries appears below in the discussion of each of the Company's business segments.
CHEMICAL BUSINESS _________________
GENERAL: _______
The Chemical Business manufactures and sells the following types of chemical products to the mining, agricultural and other industries: sulfuric acid, concentrated nitric acid, prilled ammonium nitrate fertilizer and ammonium nitrate-based blasting products. In addition, the Chemical Business markets emulsions that it purchases from others for resale to the mining industry.
The Chemical Business' principal manufacturing facility is located in El Dorado, Arkansas ("El Dorado Facility") and its other manufacturing facilities are located in Hallowell, Kansas, Wilmington, North Carolina, four locations in Australia, and one location in New Zealand.
For 1996, approximately 26% of the sales of the Chemical Business consisted of sales of fertilizer and related chemical products for agricultural purposes, which represented approximately 14% of the Company's 1996 consolidated sales, and 61% consisted of sales of ammonium nitrate and other chemical-based blasting products for the mining industry, which represented approximately 33% of the Company's 1996 consolidated sales. The Chemical Business accounted for approximately 54% and 51% of the Company's 1996 and 1995 consolidated sales, respectively.
SEASONALITY: ___________
The Company believes that the only seasonal products of the Chemical Business are fertilizer and related chemical products sold to the agricultural industry. The selling seasons for those products generally occur during the spring and fall planting seasons, i.e., from March through June and from September through November, which causes the Company to increase its inventory prior to the beginning of each season. Sales to this Business' markets depend upon weather conditions and other circumstances beyond the control of the Company.
RAW MATERIALS: _______________
Ammonia represents an essential component in the production of most of the products of the Chemical Business, and the selling price of those products generally fluctuates with the price of ammonia over time. The Company has contracts with two suppliers of ammonia pursuant to which the suppliers have agreed to supply the ammonia requirements of the Chemical Business on terms the Company considers favorable. One contract is for a period of two (2) years. One contract is for a period of 120 days, and the parties are in the process of executing a long-term contract.
Substantial world-wide per ton price increases for ammonia were incurred during 1995 and 1996 by most, if not all, users of ammonia that are not also manufacturers of ammonia. Throughout 1995 and 1996, the Company's Chemical Business has been able to increase its sales prices to cover a portion of the price increases relating to the cost of ammonia that were incurred. However, the Company's Chemical Business has not been able to recover all of these cost increases by way of price increases during 1995 and 1996 on its products due to market conditions. As a result, such inability to increase prices to cover all price increases for ammonia for the Chemical Business' products had a negative impact on the Company's 1995 and 1996 earnings. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of negative impact on the Chemical Business as a result of high ammonia prices.
The Company believes that it could obtain ammonia from other sources in the event of a termination of the above referenced contracts, but such may not be obtainable on as favorable terms as presently available to the Chemical Business under its present agreements.
MARKETING AND DISTRIBUTION: __________________________
The Chemical Business sells and markets its products to wholesalers and directly through its own sales force using 32 distribution centers operated by the Chemical Business. See "Properties". The Chemical Business sells low density prilled ammonium nitrate-based explosives primarily to the surface coal mining industry through six (6) Company-owned distribution centers, most of which are located in close proximity to the customers' surface mines in the coal producing states of Kentucky, Indiana, and Missouri, and through four (4) company-owned distribution centers in Australia and one (1) location in New Zealand located in the proximity of the mines. In addition, sales of explosives are made on a wholesale basis to independent wholesalers and other explosives companies.
The Chemical Business sells high density prilled ammonium nitrate for use in agricultural markets in geographical areas within a freight-logical distance from its El Dorado, Arkansas, manufacturing plant, primarily Texas, Oklahoma, Arkansas, and Louisiana. The products are sold through 21 distribution centers, with 15 centers located in Northern and Eastern Texas, one center located in Oklahoma, two centers located in Missouri, and three centers located in Tennessee. The Chemical Business also sells its agricultural products directly to wholesale customers.
The Chemical Business sells its industrial acids, consisting primarily of high grade concentrated nitric acid and sulfuric acid, primarily to the food, paper, chemical, and electronics industries. Concentrated nitric acid is a special grade of nitric acid used in the manufacture of pharmaceuticals, explosives, and other chemical products.
CUSTOMERS: _________
The Chemical Business does not depend on any single customer or a few customers. However, the Company does have a multi-year contract expiring in December 1998, to supply a customer with nitric acid from ammonia provided by such customer. The loss of that contract could have a material adverse effect on the Chemical Business.
PATENTS: ________
The Company believes that the Chemical Business does not depend upon any patent or license; however, the Chemical Business does own certain patents that it considers important in connection with the manufacture of certain blasting agents and high explosives. These patents expire from 1997 through 1999.
REGULATORY MATTERS: __________________
Each of the Chemical Business' domestic blasting product distribution centers are licensed by the Bureau of Alcohol, Tobacco and Firearms in order to manufacture and distribute blasting products and is subject to comparable requirements in its Australian operations. The Chemical Business also must comply with substantial governmental regulations dealing with environmental matters. See "Business - Environmental Compliance" for a discussion as to an environmental issue regarding the Company's El Dorado, Arkansas, manufacturing facility.
COMPETITION: _____________
The Chemical Business competes with other chemical companies, in its markets, many of whom have greater financial resources than the Company. The Company believes that the Chemical Business is competitive as to price, service, warranty, and product performance. The Company believes that the Chemical Business' contracts with its suppliers of ammonia, which the Company believes allows the Chemical Business to purchase ammonia at favorable prices compared to the world market price of ammonia, allows the Chemical Business the ability to favorably compete with its competitors as to price. The Company believes that the Chemical Business is a leader in the Texas ammonium nitrate market and the leading producer of concentrated nitric acid in the United States for third party sales.
RECENT CONSTRUCTION: ____________________
During 1994, 1995 and 1996 the Chemical Business spent approximately $26.8 million to install an additional concentrated nitric acid plant ("DSN Plant") at its manufacturing facility located at El Dorado, Arkansas. The DSN Plant began limited operations in 1995 and such limited operations have continued through March 1997 due to certain mechanical problems at the DSN Plant. As of the date of this report, the DSN Plant is operating at approximately 80% of its design capacity.
RECENT DEVELOPMENT: __________________
The Chemical Business has substantially finalized negotiations with the Bayer Corporation ("Bayer") for the Chemical Business to build and operate on a long-term basis a nitric acid plant located on property owned by Bayer in Baytown, Texas. If the transaction is completed, the Chemical Business would provide nitric acid from such plant to Bayer's Baytown, Texas, plant. Execution of the agreement between the Chemical Business and Bayer is subject to the Company finalizing the financing to construct the nitric acid plant and the final terms upon which the Chemical Business would lease such nitric acid plant. The Company has an agreement in principle with a lender to provide financing which is subject to a number of conditions. Such nitric acid plant would be owned by a party that is not an affiliate of the Company and would be leased to the Chemical Business for a period expected to equal ten years under an operating lease. It is currently expected that the cost to construct the nitric acid plant would be approximately $60.0 million. Under the terms of the proposed agreement with Bayer, such nitric acid plant is to be constructed and become operational within 18 months from execution of the definitive agreement. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
ENVIRONMENTAL CONTROL BUSINESS ______________________________
GENERAL: _______
The Company's Environmental Control Business manufactures and sells a broad range of fan coil, air handling, air conditioning, heating, water source heat pump, geothermal water source heat pump, and dehumidification products targeted to both commercial and residential new building construction and renovation, as well as industrial applications. The fan coil products consist of in-room terminal air distribution equipment utilizing air forced over a fin tube heat exchanger which, when connected to centralized equipment manufactured by other companies, creates a centralized air conditioning and heating system that permits individual room temperature control. The heat pump products manufactured by the Environmental Control Business consist of heat-recovery, water-to-air heat pumps that include a self-contained refrigeration circuit and blower, which allow the unit to heat or cool the space it serves when supplied with recirculating water at mild temperatures. The Environmental Control Business accounted for approximately 29% and 31% of the Company's 1996 and 1995 consolidated sales, respectively.
PRODUCTION AND BACKLOG: ______________________
Most of the Environmental Control Business' production of the above- described products occurs on a specific order basis. The Company manufactures the units in many sizes, as required by the purchaser, to fit the space and capacity requirements of hotels, motels, schools, hospitals, apartment buildings, office buildings, and other commercial or residential structures. As of December 31, 1996, the backlog of confirmed orders for the Environmental Control Business was approximately $14.9 million, as compared to approximately $12.1 million as of December 31, 1995. A customer generally has the right to cancel an order prior to the order being released to production. Past experience indicates that customers generally do not cancel orders after the Company receives them. As of February 28, 1997, the Environmental Control Business had released approximately $12.6 million of the December 31, 1996 backlog to production. All of the December 31, 1996 backlog is expected to be filled by December 31, 1997.
DISTRIBUTION: ____________
The Environmental Control Business sells its products to mechanical contractors, original equipment manufacturers and distributors. The Company's sales to mechanical contractors primarily occur through independent manufacturer's representatives, who also represent complimentary product lines not manufactured by the Company. The Environmental Control Business' sales to residential mechanical contractors are through distributors or sold directly by the Environmental Control Business to the contractors. Original equipment manufacturers generally consist of other air conditioning and heating equipment manufacturers who resell under their own brand name the products purchased from the Environmental Control Business as a separate item in competition with the Company or as part of a package with other air conditioning-heating equipment products to form a total air conditioning system which they then sell to mechanical contractors, distributors or end- users. Sales to original equipment manufacturers accounted for approximately 28% of the sales of the Environmental Control Business in 1996 and approximately 8% of the Company's 1996 consolidated sales.
MARKET: _______
The Environmental Control Business depends primarily on the commercial construction industry, including new construction and the remodeling and renovation of older buildings. In recent years this Business has introduced geothermal products designed for residential markets for both new and replacement markets.
RAW MATERIALS: _____________
Numerous domestic and foreign sources exist for the materials used by the Environmental Control Business, which materials include aluminum, copper, steel, electric motors, and compressors. The Company does not expect to have any difficulties in obtaining any necessary materials for the Environmental Control Business.
COMPETITION: ___________
The Environmental Control Business competes with approximately eight companies, several of whom are also customers of the Company. Some of the competitors have greater financial resources than the Company. The Company believes that the Environmental Control Business manufactures a broader line of fan coil and water source heat pump products than any other manufacturer in the United States, and, that it is competitive as to price, service, warranty, and product performance.
JOINT VENTURES AND OPTIONS TO PURCHASE: ______________________________________
The Company has obtained an option to acquire 80% of the issued and outstanding stock of an Entity ("Entity") that performs energy savings contracts, primarily on U.S. government facilities (the "Option"). For the Option, the Company has paid $1.1 million as of the date of this report. The term of the Option expires May 4, 1997, but the Company may extend such for two (2) additional years until 1999 upon payment of $100,000 for each year the Company desires to extend such Option. As of the date of this report, the Company has not decided whether it will exercise the Option. If the Company decides to exercise the Option, the Company has agreed to pay an exercise price of $4.0 million, less the amount already paid toward the Option ("Option Price"), with a portion of the unpaid exercise price being payable in cash and the balance over a certain period of time. The grantors of the Option have entered into an employment agreement with the Entity. Under the terms of the employment agreements, each of the three grantors will receive, among other things, 12 1/2% of the net profits of the Entity for a period of three to five years following the date of exercise of the Option. If the Company decides not to exercise the Option, the grantors of the Option have agreed to repay to the Company the amounts paid by the Company in connection with the Option (less $100,000), which obligation is secured by the stock of the Entity and other affiliates of the Entity. If the Company decides not to exercise the Option, there is no assurance that the grantors of the Option will have funds necessary to repay to the Company the amount paid for the Option. The grantors of the option may, under certain conditions, require the Company to accelerate its decision as to when it exercises the Option. See "Management's Discussion and Analysis of Financial Condition and Results of Operations". For 1995 the Entity reported an unaudited net loss of approximately $.5 million. The Company believes that the Entity sustained a loss from operations for 1996, but as of the date of this report, the amount of such loss for 1996 is undeterminable.
During 1994, a subsidiary of the Company obtained an option to acquire all of the stock of a French manufacturer of air conditioning and heating equipment. The Company's subsidiary was granted the option as a result of the subsidiary loaning to the parent company of the French manufacturer approximately $2.1 million. Subsequent to the loan of $2.1 million, the Company's subsidiary has loaned to the parent of the French manufacturer an additional $1.8 million. The amount loaned is secured by the stock and assets of the French manufacturer. The Company's subsidiary may exercise its option to acquire the French manufacturer by converting approximately $150,000 of the amount loaned into equity. The option is currently exercisable and will expire June 15, 1999. As of the date of this report, the Company has not decided whether it will exercise the option.
For 1996 and 1995, the French manufacturer had revenues of $16.0 million and $15.9 million, respectively, and reported an approximate breakeven level of operations in 1996 and a net loss of $900,000 in 1995. As a result of cumulative losses by the French manufacturer, the Company has established reserves aggregating approximately $1.5 million through December 31, 1996. See "Management's Discussion and Analysis of Financial Condition and Results of Operations".
AUTOMOTIVE PRODUCTS BUSINESS ____________________________
GENERAL: _______
The Automotive Products Business is primarily engaged in the manufacture and sale of a line of anti-friction bearings, which includes straight-thrust and radial-thrust ball bearings, angular contact ball bearings, and certain other automotive replacement parts (including universal joints, motor mounts, and clutches). This Business also manufactures powertrain and drive line parts for original equipment manufacturers. These products are used in automobiles, trucks, trailers, tractors, farm and industrial machinery, and other equipment. The Automotive Products Business accounted for approximately 12% of the Company's 1996 and 1995 sales. In 1996, the Automotive Products Business manufactured approximately 44% of the products it sold and approximately 37% in 1995, and purchased the balance of its products from other sources, including foreign sources.
DISTRIBUTION AND MARKET: __________________________
The automotive, truck, and agricultural equipment replacement markets serve as the principal markets for the Automotive Products Business. This Business sells its products domestically and for export, principally through independent manufacturers' representatives who also sell other automotive products. Those manufacturers' representatives sell to retailers (including major chain stores), wholesalers, distributors, and jobbers. The Automotive Products Business also sells its products directly to original equipment manufacturers and certain major chain stores.
INVENTORY: _________
The Company generally produces or purchases the products sold by the Automotive Products Business in quantities based on a general sales forecast, rather than on specific orders from customers. The Company fills most orders for the automotive replacement market from inventory. The Company generally produces products for original equipment manufacturers after receiving an order from the manufacturer.
RAW MATERIALS: _______________
The principal materials that the Automotive Products Business needs to produce its products consist of high alloy steel tubing, steel bars, flat strip coil steel, and bearing components produced to specifications. The Company acquires those materials from a variety of domestic and foreign suppliers at competitive prices. The Company does not anticipate having any difficulty in obtaining those materials in the near future.
FOREIGN RISK: ____________
By purchasing a significant portion of the bearings and other automotive replacement parts that it sells from foreign manufacturers, the Automotive Products Business must bear certain import duties and international economic risks, such as currency fluctuations and exchange controls, and other risks from political upheavals and changes in United States or other countries' trade policies. Contracts for the purchase of foreign-made bearings and other automotive replacement parts provide for payment in United States dollars. Circumstances beyond the control of the Company could eliminate or seriously curtail the supply of bearings or other automotive replacement parts from any one or all of the foreign countries involved.
COMPETITION: ___________
The Automotive Products Business engages in a highly competitive business. Competitors include other domestic and foreign bearing manufacturers, which sell in the original equipment and replacement markets. Many of those manufacturers have greater financial resources than the Company.
INDUSTRIAL PRODUCTS BUSINESS ____________________________
GENERAL: _______
The Industrial Products Business purchases and markets a proprietary line of machine tools. The current line of machine tools distributed by the Industrial Products Business includes milling, drilling, turning, and fabricating machines. The Industrial Products Business purchases most of the machine tools marketed by it from foreign companies, which manufacture the machine tools to the Company's specifications. This Business manufactures CNC bed mills and electrical control panels for machine tools. The Industrial Products Business accounted for approximately 5% of the Company's consolidated sales in each of the years 1996, 1995, and 1994.
DISTRIBUTION AND MARKET: __________________________
The Industrial Products Business distributes its machine tools in the United States, Mexico, Canada and certain other foreign markets. The Industrial Products Business also sells its machine tools through independent machine tool dealers throughout the United States and Canada, who purchase the machine tools for resale to end users. The principal markets for machine tools, other than machine tool dealers, consist of manufacturing and metal working companies, maintenance facilities, and utilities.
FOREIGN RISK: ______________
By purchasing a majority of the machine tools from foreign manufacturers, the Industrial Products Business must bear certain import duties and international economic risks, such as currency fluctuations and exchange controls, and other risks from political upheavals and changes in United States or other countries' trade policies. Contracts for the purchase of foreign-made machine tools provide for payment in United States dollars. Circumstances beyond the control of the Company could eliminate or seriously curtail the supply of machine tools from any one or all of the foreign countries involved.
COMPETITION: ___________
The Industrial Products Business competes with manufacturers, importers, and other distributors of machine tools many of whom have greater financial resources than the Company. The Company's machine tool business generally is competitive as to price, warranty, and service, and maintains personnel to install and service machine tools.
EMPLOYEES: __________
As of December 31, 1996, the Company employed 1,563 persons. As of that date, (a) the Chemical Business employed 569 persons, with 105 represented by unions under agreements expiring in August, 1998,(b) the Environmental Control Business employed 577 persons, none of whom are represented by a union, and (c) the Automotive Products Business employed 261 persons, with 14 represented by unions under an agreement that expired in August, 1990 which has not been renewed.
RESEARCH AND DEVELOPMENT: ________________________
The Company incurred approximately $532,000 in 1996, $501,000 in 1995, and $606,000 in 1994 on research and development relating to the development of new products or the improvement of existing products. All expenditures for research and development related to the development of new products and improvements are sponsored by the Company.
ENVIRONMENTAL COMPLIANCE: ________________________
The Chemical Business and its operations are subject to extensive federal, state, and local environmental laws, rules, regulations and ordinances relating to pollution, the protection of the environment or the release or disposal of materials ("Environmental Laws") and is also subject to other federal, state, and local laws regarding health and safety matters ("Health Laws"). The operation of any chemical manufacturing plant and the distribution of chemical products entail risks under the Environmental Laws and Health Laws, many of which provide for substantial fines and criminal sanctions for violations, and there can be no assurance that material costs or liabilities will not be incurred to comply with such laws or to pay fines and penalties. In addition, the Environmental Laws and Health Laws, and enforcement policies thereunder, relating to the Chemical Business could bring into question the handling, manufacture, use, emission or disposal of substances or pollutants at the facilities of the Chemical Business or the manufacture, use, or disposal or certain of its chemical products. Potentially significant expenditures could be required in order to comply with the Environmental Laws and Health Laws. The Company may be required to make additional significant site or operational modifications, potentially involving substantial expenditures and reduction or suspension of certain operations. See "Management's Discussion and Analysis of Financial Condition and Results of Operations -- Liquidity and Capital Resources". A subsidiary of the Company in the Automotive Products Business was notified in 1987 that it is a potentially responsible party as a result of having been a generator of waste disposed of at a site in Oklahoma City, Oklahoma. See "Legal Proceedings".
The Arkansas Department of Pollution Control & Ecology ("ADPC&E"), on behalf of the EPA, performed a preliminary assessment at the Chemical Business' El Dorado, Arkansas Plant site ("Site") in 1994. ADPC&E's preliminary assessment report stated, in part, that a release of certain types of contaminants is suspected to have occurred at the Site. In addition, subsequent to the preliminary assessment, the ADPC&E conducted additional inspections at the Site, which revealed certain instances of noncompliance with applicable hazardous waste management activities at the Site. In 1995, El Dorado Chemical Company ("EDC") and the ADPC&E entered into a Consent Agreement to address certain groundwater contamination and other issues at the Site. This Consent Agreement required EDC to undertake certain activities at the Site, including action to reduce contaminants in the groundwater at the Site. EDC submitted a groundwater monitoring work plan to the ADPC&E, which the ADPC&E approved, and EDC initiated such plan. EDC has installed additional monitoring wells at the Site to further test the groundwater. The results of tests of water from the new monitoring wells indicated that a risk assessment needed to be conducted on nitrates identified to be present in the shallow groundwater. The ADPC&E has approved a work plan submitted by EDC for the performance of such risk assessment. The risk assessment is currently being performed.
During 1995 and the first half of 1996, EDC entered into two additional Consent Administrative Agreements ("Agreements") with the ADPC&E to resolve certain environmental compliance and certain other issues associated with EDC's nitric acid concentrators. In the summer of 1996, EDC and the ADPC&E entered into an amendment ("Amendment") to the Agreements to resolve various compliance issues. In January 1997, EDC entered into a second amendment ("Second Amendment") to the Agreements, under which the ADPC&E acknowledged EDC's completion of certain engineering activities and assessed a penalty of $150,000 to resolve a number of permit issues relating to off-site emissions and other air permit conditions. The Second Amendment also requires EDC to modify its air permit to reflect the new pollution control and other equipment installed. EDC is currently in compliance with the Agreements, as amended.
During 1996, the Chemical Business expended approximately $6.8 million in connection with capital expenditures relating to compliance with federal, state and local Environmental Laws at its El Dorado, Arkansas, facility, including, but not limited to, compliance with the above- discussed consent agreements with the ADPC&E. The Company estimates that the Chemical Business is planning to spend approximately $1.2 million in 1997 for capital expenditures relating to environmental control facilities at its El Dorado, Arkansas, facility to comply with Environmental Laws, including, but not limited to, such consent agreements. The amount to be spent in 1997 for capital expenditures by the Chemical Business related to compliance with Environmental Laws is a forward-looking statement and the results could materially differ, if during 1997 there are additional releases or threatened releases into the environment, changes in the Environmental Laws applicable to the Chemical Business that require the Chemical Business to spend additional amounts for capital expenditures not presently anticipated by the Company or any federal or state environmental agencies or court of competent jurisdiction, requires the Chemical Business to spend more for capital expenditures in order to comply with Environmental Laws than presently contemplated by the Company.
The Chemical Business is also involved in various lawsuits pending in federal court in El Dorado, Arkansas, relating to environmental issues at the Chemical Business' El Dorado, Arkansas, facility. See Item 3. "Legal Proceedings" for a discussion of such litigation and insurance coverage relating thereto. The above discussion relating to the amount spent in 1996 and anticipated to be spent in 1997 for capital expenditures relating to compliance with federal, state, and local Environmental Laws at the Chemical Business' El Dorado, Arkansas, facility does not include fees and expenses incurred, or to be incurred, in connection with such litigation or expenditures, if any, that may be spent to comply with any order issued by the court in connection with such lawsuits.
ITEM 2.
ITEM 2. PROPERTIES ___________________
CHEMICAL BUSINESS _________________
The Chemical Business primarily conducts manufacturing operations (i) on 150 acres of a 1,400 acre tract of land located in El Dorado, Arkansas (the "Site"), (ii) on 10 acres of land in a facility of approximately 60,000 square feet located in Hallowell, Kansas ("Kansas facility") and (iii) a mixed acid plant in Wilmington, North Carolina. In addition, the Chemical Business has four manufacturing facilities in Australia and one in New Zealand that produce blasting related products.
As of December 31, 1996, the manufacturing facility at the Site was being utilized to the extent of approximately 76%, based on the continuous operation of those facilities. As of December 31, 1996, manufacturing operations at the Kansas facility were being utilized to the extent of approximately 80% based on two 8 hour shifts per day and a 5 day week.
In addition, the Chemical Business distributes its products through 32 agricultural and blasting distribution centers. The Chemical Business currently operates 21 agricultural distribution centers, with 15 of the centers located in Texas (12 of which the Company owns and 3 of which it leases); 1 center located in Oklahoma which the Company owns; 2 centers located in Missouri (1 of which the Company owns and 1 of which it leases); and 3 centers located in Tennessee (all of which the Company owns). The Chemical Business currently operates 6 domestic explosives distribution centers located in Bonne Terre, Missouri (owned); Owensboro, Combs, and Pilgrim, Kentucky (leased); Midland, Indiana (leased); and Pryor, Oklahoma (leased). The Chemical Business also has four (4) explosives distribution centers in Australia, all of which are leased, and one (1) explosive distribution center located in New Zealand, which is leased.
The Chemical Business operates its Kansas facility from buildings located on an approximate ten acre site in southeastern Kansas, and a research and testing facility comprising of a one square mile tract of land including buildings and equipment thereon also located in southeastern Kansas which it owns.
The Chemical Business' El Dorado, Arkansas facility is subject to mortgages.
ENVIRONMENTAL CONTROL BUSINESS __________________________________
The Environmental Control Business conducts its fan coil manufacturing operations in two adjacent facilities located in Oklahoma City, Oklahoma, consisting of approximately 265,000 square feet owned by the Company subject to mortgage. As of December 31, 1996, the Environmental Control Business was using the productive capacity of the above-referenced facilities to the extent of approximately 55%, based on two eight-hour shifts per day and a five-day week.
The Environmental Control Business manufactures most of its heat pump products in a leased 270,000 square foot facility in Oklahoma City, Oklahoma. The lease term began March 1, 1988 and expires February 28, 1998 with options to renew for additional five year periods, and currently provides for the payment of rent in the amount of $52,389 per month. The Company also has an option to acquire the facility at any time in return for the assumption of the then outstanding balance of the lessor's mortgage. As of December 31, 1996, the productive capacity of this manufacturing operation was being utilized to the extent of approximately 64%, based on one eight-hour shift per day and a five-day week.
All of the properties utilized by the Environmental Control Business are considered by Company management to be suitable and adequate to meet the current needs of that Business.
AUTOMOTIVE PRODUCTS BUSINESS ____________________________
The Automotive Products Business conducts its operations in plant facilities principally located in Oklahoma City, Oklahoma which are considered by Company management to be suitable and adequate to meet its needs. One of the manufacturing facilities occupies a building owned by the Company, subject to mortgages, totaling approximately 178,000 square feet. The Automotive Products Business also uses additional manufacturing facilities located in Oklahoma City, Oklahoma, owned and leased by the Company totalling approximately 158,000 square feet. During 1996, the Automotive Products Business under-utilized the productive capacity of its facilities.
International Bearings, Inc. ("IBI"), a subsidiary of the Company operating as a separate entity within the Automotive Products Division, operates from a Company-owned warehouse of approximately 45,000 square feet in an industrial park section of Memphis, Tennessee.
INDUSTRIAL PRODUCTS BUSINESS ____________________________
The Company owns several buildings, some of which are subject to mortgages, totaling approximately 360,000 square feet located in Oklahoma City, Oklahoma and Tulsa, Oklahoma, which the Industrial Products Business uses for showrooms, offices, warehouse, and manufacturing facilities. The Company also owns real property located near or adjacent to the above- referenced buildings in Oklahoma City, Oklahoma, which the Industrial Products Business uses for parking and storage. The Company also leases facilities in Middletown, New York containing approximately 25,000 square feet for manufacturing operations.
The Industrial Products Business also leases a facility from an entity owned by the immediate family of the Company's President, which facility occupies approximately seven acres in Oklahoma City, Oklahoma, with buildings having approximately 44,000 square feet. The Industrial Products Business also leases an office in Europe to coordinate its European activities.
All of the properties utilized by the Industrial Products Business are considered by Company management to be suitable and adequate to meet the needs of the Industrial Products Business.
SUBSEQUENT EVENT ________________
In February 1997, Prime Financial Corporation, a wholly-owned subsidiary of the Company, exercised its option to acquire a 22 story office building containing approximately 293,000 square feet of office space (the "Tower") in Oklahoma City, Oklahoma, by foreclosing against the balance owed the subsidiary under a note receivable recorded on the subsidiary's records at a carrying value of approximately $14.0 million. See "Management's Discussion and Analysis of Financial Condition and Results of Operations" for further discussion of the acquisition of the Tower by the subsidiary.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS __________________________
In December 1987, the United States Environmental Protection Agency ("EPA") notified L&S Bearing Company ("L&S") of potential responsibility for releases of hazardous substances at the Mosley Road Landfill in Oklahoma ("the Mosley Site"). The recipients of such notification were: a) generators of industrial waste allegedly sent to the Mosley Site (including L&S), and b) the current owner/operator of the Mosley Site, Waste Management of Oklahoma ("WMO") (collectively, "PRPs"). Between February 20, and August 24, 1976, the Mosley Site was authorized to accept industrial hazardous waste. During this time, a number of industrial waste shipments allegedly were transported from L&S to the Mosley Site. In February 1990, EPA added the Mosley Site to the National Priorities List. WMO and the US Air Force conducted the remedial investigation ("RI") and feasibility study ("FS"). It is too early to evaluate the probability of a favorable or unfavorable outcome of the matter for L&S. However, it is the PRP Group's position that WMO as the Mosley Site owner and operator should be responsible for at least half of total liability at the Mosley Site, and that 75% to 80% of the remaining liability, if allocated on a volumetric basis, should be assignable to the US Air Force. The Company is unable at this time to estimate the amount of liability, if any, since the estimated costs of clean-up of the Mosley Site are continuing to change and the percentage of the total waste which were alleged to have been contributed to the Mosley Site by L&S has not yet been determined. If an action is brought against the Company in this matter, the Company intends to vigorously defend itself and assert the above position.
Roy Carr, et al. v. El Dorado Chemical Company ("Carr Case"); Richard Detraz, et al. v. El Dorado Chemical Company ("Detraz Case"); Roy A. Carr, Sr., et al. v. El Dorado Chemical Company ("Citizen Suit"). The Carr Case, which was filed against El Dorado Chemical Company ("EDC") on June 26, 1996, the Detraz Case, which was filed against EDC on October 14, 1996, and the Citizen Suit, which was filed against EDC on October 17, 1996, are pending in the United States District Court, Western District of Arkansas, El Dorado Division. The plaintiffs in the Carr Case are comprised of eight (8) persons who reside in the area surrounding EDC's El Dorado, Arkansas facility, while the plaintiffs in the Detraz Case are comprised of sixteen (16) persons who reside in various locations throughout the El Dorado, Arkansas, metropolitan area. The plaintiffs in the Citizen Suit are substantially the same as the plaintiffs in the Carr Case. The plaintiffs in both the Carr Case and the Detraz Case allege that they have suffered an unspecified amount of damages under various toxic tort theories for bodily injury and/or property damage as a result of alleged releases of toxic substances into the environment from EDC's El Dorado, Arkansas facility (the "Site"), plus punitive damages. In addition, plaintiffs in the Detraz Case are seeking certification by the Court as representatives of a class of persons who allegedly have been affected by emissions from EDC's El Dorado, Arkansas facility, which certification EDC is contesting. The plaintiffs in the Citizen Suit have brought a citizen's suit alleging that EDC has violated the Comprehensive Environmental Response, Compensation and Liability Act ("CERCLA"), as amended by the Emergency Planning Community Right-To-Know Act ("EPCRA"), the Clean Air Act, and the Clean Water Act and permits issued to EDC under certain of these acts, and, as a result, under the terms of such acts the plaintiffs in the Citizen Suit are seeking the Court to order EDC to pay penalties for each day in which EDC violated such acts, if any, and injunctive relief requiring EDC to remediate any such alleged violations. Recently, the Court in the Citizen Suit granted EDC's motion to dismiss some of the plaintiffs' claims in the Citizen Suit, but denied EDC's motion to dismiss other claims. It is expected that the plaintiffs in the Citizen Suit will appeal the dismissal of certain of their claims by the Court. EDC intends to vigorously defend the Carr Case, Detraz Case, and the Citizen Suit.
The Company and the Chemical Business maintain an Environmental Impairment Insurance Policy ("EIL Insurance") that provides coverage to the Company and the Chemical Business for certain discharges, dispersals, releases, or escapes of certain contaminants and pollutants into or upon land, the atmosphere or any water course or body of water from the Site, which has caused bodily injury, property damage, or contamination to others or to other property not on the Site. The EIL Insurance provides limits of liability for each loss up to $10.0 million and a similar $10.0 million limit for all losses due to bodily injury or property damage, except $5 million for all remediation expenses, with the maximum limit of liability for all claims under the EIL Insurance not to exceed $10.0 million for each loss or remediation expense and $10.0 million for all losses and remediation expenses. The EIL Insurance also provides a retention of the first $500,000 per loss or remediation expense that is to be paid by the Company. The Company has given notice to its insurance carrier of the above claims. The Company believes that the EIL Insurance will provide coverage for actual damages, if any, sustained by the plaintiffs, in the Carr Case and the Detraz Case, if any, up to the limits of the policy in excess of the $500,000 retention, but will not provide coverage for punitive damages or penalties. As of the date of this report, the Company is unaware whether such claims in the Carr Case and/or the Detraz Case will exceed the limits of the coverage of the EIL Insurance. Although there can be no assurances, the Company does not believe the outcome of these matters will have a material adverse effect on the Company's financial position or results of operation. Certain statements contained in this paragraph are forward- looking statements that involve a number of risks and uncertainties that could cause actual results to differ materially, such as, among other factors, the following: the EIL Insurance does not provide coverage to the Company and the Chemical Business for any material claims made by the claimants, the claimants alleged damages are not covered by the EIL Policy which a court may find the Company and/or the Chemical Business liable for, such as punitive damages, or a court finds the Company and/or the Chemical Business liable for damages to such claimants for a material amount in excess of the limits of coverage of the EIL Insurance.
Arch Mineral Corporation, et al. v. ICI Explosives USA, Inc., et al. On May 24, 1996, the plaintiffs filed this civil cause of action against EDC and five (5) other unrelated commercial explosives manufacturers alleging that the defendants allegedly violated certain federal and state antitrust laws in connection with alleged price fixing of certain explosive products. This cause of action is pending in the United States District Court, Southern District of Indiana. The plaintiffs are suing for an unspecified amount of damages, which, pursuant to statute, plaintiffs are requesting be trebled, together with costs. Based on the information presently available to EDC, EDC does not believe that EDC conspired with any party, including but not limited to, the five (5) other defendants, to fix prices in connection with the sale of commercial explosives. Discovery has only recently commenced in this matter. EDC intends to vigorously defend itself in this matter.
ASARCO v. ICI, et al. The US District Court for the Eastern District of Missouri has granted ASARCO and other plaintiffs in a lawsuit originally brought against various commercial explosives manufacturers in Missouri, and consolidated with other lawsuits in Utah, leave to add EDC as a defendant in that lawsuit. An answer or other response is due in April 1997. This lawsuit alleges a national conspiracy, as well as a regional conspiracy, directed against explosive customers in Missouri and seeks unspecified damages. EDC has been included in this lawsuit because it sold products to customers in Missouri during a time in which other defendants have admitted to participating in an antitrust conspiracy, and because it has been sued in the Arch Case discussed above. Based on the information presently available to EDC, EDC does not believe that EDC conspired with any party, to fix prices in connection with the sale of commercial explosives. EDC intends to vigorously defend itself in this matter.
Department of Justice Investigation of Explosives Industry. For several years, the explosives industry has been under an investigation by the US Department of Justice. Certain explosives companies plead guilty to antitrust violations. In connection with that investigation, EDC received and has complied with certain document subpoenas, and certain of EDC's employees have been subpoenaed to testify in connection with such investigation. As of the date of this report, EDC has not been identified as a target of this investigation.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ____________________________________________________________
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY ____________________________________________
IDENTIFICATION OF EXECUTIVE OFFICERS ____________________________________. The following table identifies the executive officers of the Company.
Position and Served as Offices with an Officer Name Age the Company from ______________ _____ ____________ _____________
Jack E. Golsen 68 Board Chairman December 1968 and President
Barry H. Golsen 46 Board Vice Chairman August 1981 and President of the Environmental Control Business
David R. Goss 56 Senior Vice March 1969 President of Operations and Director
Tony M. Shelby 55 Senior Vice March 1969 President - Chief Financial Officer, and Director
Jim D. Jones 55 Vice President - April 1977 Treasurer and Corporate Controller
David M. Shear 37 Vice President and March 1990 General Counsel
_________________________________________________________
The Company's officers serve one-year terms, renewable on an annual basis by the Board of Directors. In March 1996, the Company executed an employment agreement (the "Agreement") with Jack E. Golsen for an initial term of three years followed by two additional three year terms. The Agreement automatically renews for each successive three year term unless terminated by either the Company or Jack E. Golsen giving written notice at least one year prior to the expiration of the then three year term. All of the individuals listed above have served in substantially the same capacity with the Company and/or its subsidiaries for the last five years.
FAMILY RELATIONSHIPS. ____________________ The only family relationship that exists among the executive officers of the Company is that Jack E. Golsen is the father of Barry H. Golsen.
PART II _______
ITEM 5.
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER _________________________________________________________________________ MATTERS _______
MARKET INFORMATION __________________
The Company's Common Stock trades on the New York Stock Exchange, Inc. ("NYSE"). The following table shows, for the periods indicated, the high and low closing sales prices for the Company's Common Stock.
STOCKHOLDERS ____________
As of February 28, 1997, the Company had 1,155 record holders of its Common Stock.
DIVIDENDS _________
Holders of the Company's Common Stock are entitled to receive dividends only when, as, and if declared by the Board of Directors. No dividends may be paid on the Company's Common Stock until all required dividends are paid on the outstanding shares of the Company's Preferred Stock, or declared and amounts set apart for the current period, and, if cumulative, prior periods. The Company has issued and outstanding as of December 31, 1996, 915,000 shares of $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2 ("Series 2 Preferred"), 1,539 shares of a series of Convertible Non Cumulative Preferred Stock ("Non Cumulative Preferred Stock") and 20,000 shares of Series B 12% Convertible, Cumulative Preferred Stock ("Series B Preferred"). Each share of Preferred Stock is entitled to receive an annual dividend, if, as, and when declared by the Board of Directors, payable as follows: (i) Series 2 Preferred at the rate of $3.25 a share payable quarterly in arrears on March 15, June 15, September 15, and December 15, which dividend is cumulative, (ii) Non Cumulative Preferred Stock at the rate of $10 a share payable April 1, and (iii) Series B Preferred at the rate of $12.00 a share payable January 1, which dividend is cumulative. The Company has a policy as to the payment of annual cash dividends on its outstanding Common Stock of $.06 per share, payable at $.03 per share semiannually, subject to change or termination by the Board of Directors at any time. The Company paid a cash dividend of $.03 a share on its outstanding Common Stock on July 1, 1996, and January 1, 1997; however, there are no assurances that this policy will not be terminated or changed by the Board of Directors. See Notes 7,9 and 11 of Notes to Consolidated Financial Statements.
Under the terms of a loan agreement between the Company and its lender, the Company may, so long as no event of default has occurred and is continuing under the loan agreement, make currently scheduled dividends and pay dividends on its outstanding Preferred Stock and pay annual dividends on its Common Stock equal to $.06 per share. See Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations" for a discussion of the financial covenants which the Company's failure to maintain could result in an event of default. In addition, the loan agreement with the lender includes as an event of default an ownership change if any Person (except Jack E. Golsen or members of his Immediate Family [as defined below] and any entity controlled by Jack E. Golsen or members of his Immediate Family together with such Person's affiliates and associates), is or becomes the beneficial owner, directly or indirectly, of more than fifty percent (50%) of the outstanding Common Stock of LSB. The term "Immediate Family" of any Person means the spouse, siblings, children, mothers and mothers-in-law, fathers and fathers- in-law, sons and daughters-in-law, daughters and sons-in-law, nieces, nephews, brothers and sisters-in-law, and sisters and brothers-in-law.
The Company is a holding company and, accordingly, its ability to pay dividends on its Preferred Stock and its Common Stock is dependent in large part on its ability to obtain funds from its subsidiaries. The ability of EDC, Slurry Explosive Corporation ("SEC"), Northwest Financial Corporation ("NFC"), and DSN Corporation ("DSN") to pay dividends to the Company, to fund the payment of dividends by the Company, or for other purposes, is restricted by certain agreements to which they are parties.
Under the terms of a term loan agreement between EDC, EDC's wholly-owned subsidiary, SEC, both within the Company's Chemical Business, NFC, a wholly- owned subsidiary of the Company, and certain lenders, and between DSN, another subsidiary of the Company within the Chemical Business, and a lender, (i) EDC cannot transfer funds to the Company in the form of cash dividends or other distributions or advances, except (a) for the amount of taxes that the borrowers would be required to pay if they were not consolidated with the Company and (ii) an amount not to exceed fifty percent (50%) of the borrowers' net income for the immediately preceding fiscal year and (iii) DSN is prohibited from paying any dividends or making any distributions to the Company. See Note 7 of Notes to Consolidated Financial Statements and Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations".
On February 17, 1989, the Company's Board of Directors declared a dividend to its stockholders of record on February 27, 1989, of one Preferred Stock purchase right on each of the Company's outstanding shares of Common Stock. The rights expire on February 27, 1999. The Company issued the rights, among other reasons, in order to assure that all of the Company's stockholders receive fair and equal treatment in the event of any proposed takeover of the Company and to guard against partial tender abusive tactics to gain control of the Company. The rights will become exercisable only if a person or group acquires beneficial ownership of 30% or more of the Company's Common Stock or announces a tender or exchange offer the consummation of which would result in the ownership by a person or group of 30% or more of the Common Stock, except any acquisition by Jack E. Golsen, Chairman of the Board and President of the Company, and certain other related persons or entities.
Each right (other than the rights, owned by the acquiring person or members of a group that causes the rights to become exercisable, which became void) will entitle the stockholder to buy one one-hundredth of a share of a new series of participating Preferred Stock at an exercise price of $14.00 per share. Each one one-hundredth of a share of the new Preferred Stock purchasable upon the exercise of a right has economic terms designed to approximate the value of one share of the Company's Common Stock. If another person or group acquires the Company in a merger or other business combination transaction, each right will entitle its holder (other than rights owned by that person or group, which become void) to purchase at the right's then current exercise price, a number of the acquiring company's common shares which at the time of such transaction would have a market value two times the exercise price of the right. In addition, if a person or group (with certain exceptions) acquires 30% or more of the Company's outstanding Common Stock, each right will entitle its holder, (other than the rights owned by the acquiring person or members of the group that results in the rights becoming exercisable, which become void), to purchase at the right's then current exercise price, a number of shares of the Company's Common Stock having a market value of twice the right's exercise price in lieu of the new Preferred Stock.
Following the acquisition by a person or group of beneficial ownership of 30% or more of the Company's outstanding Common Stock (with certain exceptions) and prior to an acquisition of 50% or more of the Company's Common Stock by the person or group, the Board of Directors may exchange the rights (other than rights owned by the acquiring person or members of the group that results in the rights becoming exercisable, which become void), in whole or in part, for shares of the Company's Common Stock. That exchange would occur at an exchange ratio of one share of Common Stock, or one one-hundredth of a share of the new series of participating Preferred Stock, per right.
Prior to the acquisition by a person or group of beneficial ownership of 30% or more of the Company's Common Stock (with certain exceptions) the Company may redeem the rights for one cent per right at the option of the Company's Board of Directors. The Company's Board of Directors also has the authority to reduce the 30% thresholds to not less than 10%.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED) ____________________________________________
ITEM 7.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND _______ _______________________________________________________________ RESULTS OF OPERATIONS _____________________
The following Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with a review of the Company's December 31, 1996 Consolidated Financial Statements, Item 6 "SELECTED FINANCIAL DATA" and Item 1 "BUSINESS" included elsewhere in this report.
OVERVIEW _________
The Company is pursuing a strategy of focusing on its more profitable businesses and concentrating on businesses and product lines in niche markets where the Company has established or can establish a position as a market leader. In addition, the Company is seeking to improve its liquidity and profits through liquidation of selected assets that are on its balance sheet and on which it is not realizing an acceptable return nor does it have the potential to do so.
In this connection, the Company has been concentrating on reshaping the Automotive Products Business by the liquidation of certain of their assets that don't have the potential to earn an acceptable return and focusing on product lines that management believes have strategic advantages within select niche markets. The Company has also recruited new key management people in the Automotive Products Business including marketing, materials control, manufacturing, and financial. The Company continues to explore its alternatives to accomplish these goals.
In addition, the Company has been liquidating certain slow moving inventory in the Industrial Products Business in the ordinary course of business. It is the present intention of the Company to limit this Business to lines of machine tools which should result in an acceptable return on capital employed.
Certain statements contained in this Overview are forward-looking statements, and the results thereof could differ materially from such statements if the Company is unable to liquidate such assets in a reasonable period or on reasonable terms, and if able to liquidate such assets, it may not be able to improve profits in the Automotive Products Business or have an acceptable return on capital employed in these Businesses if general economic conditions deteriorate drastically from the environment these Businesses currently operate in or these Businesses are unable to meet competitive pressures in the market place which restrict these Businesses from manufacturing or purchasing and selling their products at acceptable prices.
The following table contains certain of the information from Note 15 of Notes to the Company's Consolidated Financial Statements about the Company's operations in different industry segments for each of the three years in the period ended December 31, 1996.
(1) Gross profit by industry segment represents net sales less cost of sales. (2) Operating profit by industry segment represents revenues less operating expenses before deducting general corporate expenses, interest expense, and income taxes. As indicated in the above table the operating profit (as defined) declined from $13.1 million in 1995 to $9.5 million in 1996, while sales increased approximately 15% during the same period. The decline in operating profit resulted in a loss from continuing operations before income taxes for 1996 of $3.7 million. This decline in operating profit is primarily due to lower earnings in the Chemical Business as a result of increased ammonia costs and underabsorbed overhead related to modifications at the Company's El Dorado, Arkansas chemical plant complex and to the lower margins in the Automotive Products Business and foreign sales income recognized in 1995 and not repeated in 1996 in the Industrial Products Business as discussed in Note 6 to Notes to Consolidated Financial Statements.
CHEMICAL BUSINESS
The Chemical Business manufacturers and sells prilled ammonium nitrate products and high grade specialty acids to the explosives, agricultural, and industrial acids markets, and markets and licenses a number of proprietary explosives products. The Company has grown this Business through the expansion of its principal manufacturing facility in El Dorado, Arkansas, the construction of a mixed acid plant in Wilmington, North Carolina, and the acquisition of new agricultural distribution centers in key geographical markets which are freight logical to its principal plant. During the years 1996, 1995, and 1994, capital expenditures in this Business were $19.1 million, $18.0 million, and $15.5 million, respectively. During the period from December 1994 through December 1996 the net investment in assets of the Chemical Business was increased from $95.0 million to $132.4 million primarily due to the construction of additional capacity to benefit future periods.
The operating profit in the Chemical Business is down from $12.8 million in 1994 and $13.4 million in 1995 to $11.0 million in 1996. During 1996, the Chemical Business incurred significant amounts of unplanned downtime at the El Dorado, Arkansas Plant site due to mechanical problems and planned downtime for improvements being made to the plants. The downtime resulted in increases in manufacturing overhead and lower absorption of such costs. The unabsorbed overhead combined with unexpected increases in the cost of the primary raw material, ammonia, led to higher cost of sales as a percent of sales and lower gross profit margins.
The Chemical Business purchases approximately 250,000 tons per year of anhydrous ammonia. The cost of ammonia consumed by the Chemical Business in 1996 was $167 per ton compared to $162 in 1995 and $157 in 1994. In November and December 1996, ammonia prices took an unexpected increase to an average of $200 per ton compared to an average of $152 in November and December 1995. This spike had a disruptive effect on the fourth quarter results of operations. The increased cost of purchased ammonia in 1996 was partially passed on to customers in the form of higher prices, but the entire cost increase could not be offset by higher sales prices resulting in lower gross profit margins.
Ammonia prices continued to increase in 1997 averaging $217 per ton in January and $212 in February. In March, the price of ammonia began to come down, but not in time to significantly reduce the cost of sales percent in the first quarter of 1997. The price for the Chemical Business' purchased ammonia has declined to $165 per ton as of the date of this report.
The Chemical Business has substantially finalized negotiations with Bayer for the Chemical Business to build and operate on a long-term basis a nitric acid plant located on property owned by Bayer in Baytown, Texas. If the transaction is completed, the Chemical Business would provide nitric acid from such plant to Bayer's Baytown, Texas plant. Execution of the agreement between the Chemical Business and Bayer is subject to the Company finalizing the financing to construct the nitric acid plant and the final terms upon which the Chemical Business would lease such nitric acid plant. The Company has an agreement in principle with a lender to provide financing. Such nitric acid plant would be owned by a party that is not an affiliate of the Company and would be leased to the Chemical Business for a period expected to equal ten years under an operating lease. It is expected that the cost to construct the nitric acid plant would be approximately $60.0 million. Under the terms of the proposed agreement, such nitric acid plant can be constructed and become operational within 18 months from execution of the definitive agreement.
ENVIRONMENTAL CONTROL
The Environmental Control Business manufactures and sells a broad range of fan coil, air handling, air conditioning, heating, water source heat pumps, and dehumidification products targeted to both commercial and residential new building construction and renovation.
The Environmental Business focuses on product lines in the specific niche markets of fan coils and water source heat pumps and has established a significant market share in these specific markets.
As indicated in the above table, the Environmental Control Business reported improved sales (an increase of 6%) and improved operating profit for 1996 as compared to 1995. From December 1994 through December 1996 the net investment in assets of the Environmental Control Business was increased from $40.7 million to $50.6 million. During this two year period, additions to property, plant, and equipment were $2.0 million and depreciation was approximately $3.1 million.
AUTOMOTIVE AND INDUSTRIAL PRODUCTS BUSINESSES
The Automotive Products Business sells its products into the automotive, truck, and agricultural equipment replacement markets. Certain of the products are sold directly to original equipment manufacturers and certain major chain stores. The Industrial Products Business markets a proprietary line of machine tools most of which are purchased from foreign companies, which manufacture the machine tools to Company specifications. As indicated in the above table, during 1994, 1995, and 1996, respectively, these Businesses recorded combined sales of $43.5 million, $46.6 million and $51.7 million, respectively, and reported operating losses (as defined above) of $5.6 million, $4.9 million, and $6.8 million in 1994 and 1995, and 1996 respectively. The net investment in assets of these Businesses was $56.8 million, $61.2 million and $56.8 million at year end 1994, 1995, and 1996, respectively. The investment in these Businesses had become excessive due to a build in inventory beyond current demand. However, the investment is beginning to come back down due to a stringent inventory reduction program put into place in 1995.
RESULTS OF OPERATIONS _____________________
YEAR ENDED DECEMBER 31, 1996 COMPARED TO YEAR ENDED DECEMBER 31, 1995
REVENUES
Total revenues for 1996 and 1995 were $314.1 million and $274.1 million, respectively (an increase of $40.0 million or 14.6%). Sales increased $39.8 million or 14.9%.
NET SALES
Consolidated net sales for 1996 were $307.2 million, compared to $267.4 million for 1995, an increase of $39.8 million or 14.9%. This sales increase resulted principally from: (i) increased sales in the Environmental Control Business of $5.4 million, primarily due to improved market conditions; (ii) increased sales in the Chemical Business of $29.3 million which were primarily attributable to increased sales of $16.0 million at Total Energy Systems ("TES"), the Company's subsidiary located in Australia and New Zealand, which have resulted from an expanded customer base, to higher costs being passed through to customers and higher sales of agricultural products; (iii) increased sales of $.4 million in the Industrial Products Business; and (iv) increased sales of $4.7 million in the Automotive Products Business due to the addition of certain new product lines that the Company believes the Automotive Products Business has a strategic advantage in.
GROSS PROFIT
Gross profit decreased $.3 million and was 18.5% of net sales for 1996, compared to 21.3% of net sales for 1995. The gross profit percentage declined in the Automotive Products, Chemical, and Environmental Control Businesses. The gross profit of the Chemical Business was adversely affected due to the continued high cost of anhyrdrous ammonia as discussed above and higher production costs due to unabsorbed overhead costs resulting from excessive downtime at the Chemical Business' El Dorado, Arkansas plant complex related to modifications made to install air emissions abatement equipment and resolve problems associated with mechanical failures at the DSN Plant. The Environmental Control Business' gross profit percentage decreased due to production inefficiencies and decreased absorption of costs due to lower production volumes in certain product lines of this Business. The primary reason for the decline in gross profit percentage in the Automotive Products Business was a less favorable customer mix i.e. decreased sales to higher margin retail customers, and increased sales to Original Equipment Manufacturers (OEM) customers which are lower margin customers.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses ("SG&A"), as a percent of net sales, were 18.7% in 1996 and 21.4% in 1995. Consolidated SG&A expenses were approximately the same in 1996 as 1995 and consolidated net sales increased by 14.9% resulting in a lower percentage of SG&A to sales. Increased SG&A of the Chemical Business consistent with sales increases were offset by reductions in SG&A in the Environmental Control Business and general corporate expenses.
INTEREST EXPENSE
Interest expense for the Company, excluding capitalized interest, was $10.0 million during 1996, compared to $10.1 million during 1995. During 1996, $2.4 million of interest expense was capitalized in connection with construction of the DSN Plant, compared to $1.4 million in 1995. The increase of $.9 million before the effect of capitalization primarily resulted from increased borrowings and higher interest rates. The increased borrowings were necessary to support capital expenditures, higher accounts receivable balances and to meet the operational requirements of the Company. See "Liquidity and Capital Resources" of this Management's Discussion and Analysis.
NET INCOME (LOSS)
The Company had a net loss of $3.8 million in 1996 compared to a net loss of $3.7 million in 1995. Although 1996 consolidated net sales increased, the consolidated gross profit did not increase and the net loss was approximately the same in 1996 as 1995.
RESULTS OF OPERATIONS _____________________
YEAR ENDED DECEMBER 31, 1995 COMPARED TO YEAR ENDED DECEMBER 31, 1994
REVENUES
Total revenues for 1995 and 1994 were $274.1 million and $250.0 million, respectively (an increase of $24.1 million or 9.7%). Sales increased $22.4 million or 9.1%. Other income included in total revenues was $6.7 million, an increase of $1.8 million from 1994, which resulted primarily from proceeds received on the settlement of loans which were acquired in connection with the sale of Equity Bank. See "Liquidity and Capital Resources" of this Management's Discussion and Analysis.
NET SALES
Consolidated net sales for 1995 were $267.4 million, compared to $245.0 million for 1994, an increase of $22.4 million or 9.1%. This sales increase resulted principally from: (i) increased sales in the Environmental Control Business of $13.9 million, primarily due to improved market conditions and increased production in the fan coil segment of this Business and to increased sales in geothermal water source heat pumps related to certain governmental projects; (ii) increased sales in the Chemical Business of $5.3 million which were primarily attributable to higher ammonia costs being passed through to customers, and increased sales of $2.5 million at TES, the Company's subsidiary located in Australia, which have resulted from an expanded customer base; (iii) increased sales of $2.2 million in the Industrial Products Business primarily due to finalization of a sale to a foreign customer and increases in sales of machine tools; and (iv) increased sales of $1.0 million in the Automotive Products Business due to the addition of new product lines.
GROSS PROFIT
Gross profit increased $4.0 million and was 21.3% of net sales for 1995, compared to 21.7% of net sales for 1994. The gross profit percentage remained consistent, with only slight changes, in the Chemical and Environmental Control Businesses. The gross profit of the Chemical Business was adversely affected due to the continued high cost of anhyrdrous ammonia as discussed above. The Industrial Products Business' gross profit percentage increased due to higher prices. The primary reason for the consolidated decline in gross profit percentage was due to customer mix in the Automotive Products Business, i.e. decreased sales to higher margin retail customers, and increased sales to Original Equipment Manufacturers (OEM) customers which are lower margin customers.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative ("SG&A") expenses, as a percent of et sales, were 21.4% in 1995 and 20.7% in 1994. SG&A remained consistent from 1994 to 1995 as a percentage of sales in the Chemical, Environmental Control, and Automotive Products Businesses. The increase in SG&A, as a percent of sales on a consolidated basis, was primarily attributable to: (1) an increase in the Company's cost of providing employee healthcare benefits of $.7 million; and, (2) increased legal expenses of $.6 million primarily attributable to litigation in connection with an insurance claim for damages to machine tools during transport in a prior year.
INTEREST EXPENSE
Interest expense for the Company, excluding capitalized interest, was $10.1 million during 1995, compared to $6.9 million during 1994. During 1995, $1.4 million interest expense was capitalized in connection with construction of the DSN Plant compared to $.5 million in 1994. The increase primarily resulted from increased borrowings. The increased borrowings were necessary to support capital expenditures, higher inventory levels, higher accounts receivable balances and to meet the operational requirements of the Company. See "Liquidity and Capital Resources" of this Management's Discussion and Analysis.
NET INCOME (LOSS)
The Company had a net loss of $3.7 million in 1995 compared to net income of $24.5 million in 1994. The 1994 net income includes approximately $23.5 million relating to a gain on the sale of a certain business and income from discontinued operations. Excluding this non-recurring activity, the 1994 net income was $1.0 million. The decreased profitability in 1995 of $4.7 million was primarily attributable to increased SG&A, as discussed above, and increased interest expense of $3.2 million due to higher average balances of outstanding debt. These increased expenses were offset in part by increased income of $1.0 million from collection of loans receivables in excess of net carrying values. Such loans were purchased at a discount in connection with the Equity Bank transaction.
LIQUIDITY AND CAPITAL RESOURCES ______________________________
CASH FLOW FROM OPERATIONS
Net cash provided by operations for the year ended 1996 was $13.3 million, after $9.8 million for noncash depreciation and amortization, $3.7 million in provisions for possible losses on accounts and notes receivable, and $1.6 million in gains from real estate and other assets and including the following changes in assets and liabilities: (i) accounts receivable increases of $8.3 million; (ii) inventory increases of $1.7 million; (iii) increases in supplies and prepaid items of $1.5 million; and (iv) increases in accounts payable and accrued liabilities of $16.7 million. The increase in accounts receivable is due to increased sales in all businesses, especially in the Environmental Control Business and the Chemical Business' Australian subsidiary (see Results of Operations for discussion of increase in sales). The increase in inventory was due primarily to an increase of $3.6 million at the Chemical Business' Australian subsidiary resulting from growth of that operation and increases in the Environmental Control Business to support sales increases. These increases were offset by inventory reductions in the Automotive and Industrial Products Businesses resulting from liquidation of excess inventory. The increase in supplies and prepaid items resulted primarily from an increase in manufacturing supplies in the Chemical Business. The increase in accounts payable and accrued liabilities resulted primarily from higher business volume and an increase in capital construction projects in 1996.
CASH FLOW FROM INVESTING AND FINANCING ACTIVITIES
Cash used by investing activities for the year ended December 31, 1996 was $21.0 million primarily for capital expenditures in the Chemical Business to complete construction of a strong nitric acid plant and for installation of certain air emissions abatement equipment, and expenditures in the Automotive Products Business related to the relocation of a u-joint manufacturing facility moved from Indiana to Oklahoma. The balance of capital expenditures were for normal additions in the Chemical, Environmental Control, and Automotive Products Businesses. The increase in other assets is due primarily to increased loans to potential acquisition candidates. Cash provided by financing activities included long-term borrowings of $25.0 million reduced by payments on long-term debt of $12.0 million, and (i) net paydown on revolving credit facilities of $1.3 million, (ii) dividends of $4.0 million and (iii) increases in other assets of $2.3 million.
During 1996, the Company declared and paid the following aggregate dividends: (i) $12.00 per share on each of the outstanding shares of its Series B 12% Cumulative Convertible Preferred Stock; (ii) $3.25 per share on each outstanding share of its $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2; (iii) $10.00 per share on each outstanding share of its Convertible Noncumulative Preferred Stock; and (iv) $.06 per share on its outstanding shares of Common Stock. The Company expects to continue the payment of such dividends in the future in accordance with the policy adopted by the Board of Directors and the terms inherent to the Company's various Preferred Stocks.
SOURCE OF FUNDS
The Company is a diversified holding Company and its liquidity is dependent, in large part, on the operations of its subsidiaries and credit agreements with lenders.
On February 13, 1997 the Company's wholly-owned subsidiaries, EDC, SEC, and NFC (collectively "Borrowers") completed a $50.0 million long-term financing agreement ("Financing") with an institutional lender. Approximately $19.3 million in proceeds from the Financing were used to repay other outstanding term debt, and the remaining $30.7 million in proceeds was used to pay down the Company's revolving credit facilities and thereby create additional borrowing availability for future working capital and other corporate needs. The Financing is secured by a first mortgage lien on the Chemical Business' property, plant, and equipment located in El Dorado, Arkansas and owned by the Borrowers, except rolling stock and excluding the DSN Plant which is security under a separate loan agreement. The $50.0 million Financing consists of $25.0 million of fixed rate notes bearing interest at 10.57% per annum and $25.0 million of floating rate notes bearing interest at LIBOR plus 4.2% (initially 9.76%). Repayment of the notes is due in quarterly installments of $833,332 plus interest commencing on July 1,1997 through April 2004 at which time the balance is due. The Financing requires the Borrowers to maintain certain financial ratios and contains other financial covenants, including the ratio of funded debt to total capitalization, current ratio, and fixed charge coverage ratio, in addition to net worth and working capital requirements. The Financing also contains certain restrictions on transactions with affiliates. The Financing limits the amount of dividends or distributions on its shares to an amount equal to payments for federal income taxes determined as if the Borrowers filed returns on a separate company basis and dividends up to 50% of the Borrowers' prior year net income. See Note 7 to Notes to Consolidated Financial Statements.
The Company and certain of its subsidiaries are parties to a working capital line of credit evidenced by six separate loan agreements ("Agreements") with an unrelated lender ("Lender") collateralized by receivables, inventory, and proprietary rights of the Company and the subsidiaries that are parties to the Agreements and the stock of certain of the subsidiaries that are borrowers under the Agreements. The Agreements, as amended, provide for revolving credit facilities ("Revolver") for total direct borrowings up to $63.0 million, including the issuance of letters of credit. The Revolver provides for advances at varying percentages of eligible inventory and trade receivables. The Agreements, as amended, provide for interest at the reference rate as defined (which approximates the national prime rate) plus 2%, or the Eurodollar rate plus 4.375%. At December 31, 1996 the effective interest rate was 9.4%. The initial term of the Agreements is through December 12, 1997, and is renewable thereafter for successive thirteen month terms. The Lender has agreed to amend the initial term maturity date to April 1, 1998. At December 31, 1996, the available borrowings, based on eligible collateral approximated $3.3 million. Borrowings under the Revolver outstanding at December 31, 1996, were $57.2 million. As discussed above, on February 13, 1997, certain of the Company's subsidiaries completed a $50.0 million long-term Financing, from which $30.7 million in proceeds were used to pay down the Revolver. Had this transaction taken place on December 31, 1996, outstanding borrowing under the revolver would have been $26.5 million and available borrowings would have approximated $34.0 million. The Agreements, as amended, require the Company to maintain certain financial ratios and contain other financial covenants, including tangible net worth requirements and capital expenditure limitations. The annual interest on the outstanding debt under the Revolver at December 31, 1996 at the rates then in effect would approximate $5.4 million.
In addition to the Agreements discussed above, the Company had the following term loans in place as of December 31, 1996:
(1) As of December 31, 1996, the Company's wholly-owned subsidiaries, El Dorado Chemical Company and Slurry Explosive Corporation (collectively "Chemical"), were parties to a loan agreement ("Loan Agreement") with two institutional lenders ("Lenders"). This Loan Agreement provided for a loan ("Term Loan") having a balance at December 31, 1996 of $7.4 million. The Term Loan was repaid in February 1997 with proceeds from the $50.0 million Financing discussed above.
(2) As of December 31, 1996, Chemical was a party to a financing agreement ("Financing Agreement") with a leasing subsidiary of a national bank (the "Bank"). The financing provided for a loan having a balance at December 31, 1996 of $12.0 million. On February 13, 1997, outstanding borrowings under the Financing Agreement were repaid with proceeds from the $50.0 million Financing discussed above.
(3) The Company' s wholly-owned subsidiary, DSN, is a party to several loan agreements with a financing company (the "Financing Company") for three (3) projects. These loan agreements are for a $16.5 million term loan (the "DSN Permanent Loan"), which was used to construct, equip, re- erect, and refurbish the DSN Plant being placed into service by the Chemical Business at its El Dorado, Arkansas facility; a loan for approximately $1.2 million to purchase additional railcars to support the DSN Plant (the "Railcar Loan"); and a loan for approximately $1.1 million to finance the construction of a mixed acid plant (the "Mixed Acid Plant") in North Carolina (the "Mixed Acid Loan"). At December 31, 1996, DSN had outstanding borrowings of $13.9 million under the DSN Permanent Loan, $.9 million under the Mixed Acid Loan, and $1.0 million under the Railcar Loan. The loans have repayment schedules of eighty- four (84) consecutive monthly installments of principal and interest. The interest rate on each of the loans is fixed and range from 8.24% to 8.86%. Annual interest, for the three notes as a whole, at December 31, 1996 at the agreed to interest rates would approximate $1.4 million. The loans are secured by the various DSN and Mixed Acid Plants property and equipment, and all railcars purchased under the Railcar Loan. The loan agreements require the Company to maintain certain financial ratios, including tangible net worth requirements. As of the date of this report, the Company is in compliance with all financial covenants or if not in compliance, has obtained appropriate waivers from the Financing Company.
(4) As of December 31, 1996, a subsidiary of the Company ("Prime") was a party to an agreement ("Agreement") with Boatmen's Bank, N.A. ("Bank"). The Agreement, as modified, requires interest per annum at a rate equal to three quarters of one percent (.75%) above the prime rate in effect from day to day as published in the Wall Street Journal. The outstanding principal balance of the note is payable in sixty (60) monthly payments of principal and interest commencing on June 30, 1996. Payment of the note is secured by a first and priority lien and security interest in and to Prime's right, title, and interest in the loan receivable relating to the real property and office building located in Oklahoma City, Oklahoma (the "Tower"), the Management Agreement relating to the Tower. In February 1997, the Company exercised its option to purchase the Tower by foreclosing against the loan receivable and paying approximately $140,000 in related costs.
Future cash requirements include working capital requirements for anticipated sales increases in all Businesses, and funding for future capital expenditures, primarily in the Chemical Business and the Environmental Control Business. Funding for the higher accounts receivable resulting from anticipated sales increases will be provided by cash flow generated by the Company and the revolving credit facilities discussed elsewhere in this report. Inventory requirements for the higher anticipated sales activity should be met by scheduled reductions in the inventories of the Industrial Products Business and in the inventories of the Automotive Products Business, which increased its inventories in 1995 beyond required levels. In 1997, the Company has planned capital expenditures of approximately $6.0 million, primarily in the Chemical and Environmental Control Businesses.
As discussed elsewhere in this report in the "Results of Operations", as a result of mechanical problems and planned downtime for improvements being made to the plants at the facility, the Chemical Business has experienced unabsorbed overhead costs at its El Dorado, Arkansas facility. The unabsorbed overhead costs adversely impacted the Chemical Business' gross profit and the Company's consolidated income before income taxes for the year ended December 31, 1996.
Management believes that cash flows from operations, the Company's revolving credit facilities, and other sources, including the $50.0 million Financing completed in February 1997, will be adequate to meet its presently anticipated capital expenditure, working capital, debt service, and dividend requirements. This is a forward-looking statement that involves a number of risks and uncertainties that could cause actual results to differ materially, such as, a material reduction in revenues, continuing to incur losses, inability to collect a material amount of receivables, required capital expenditures in excess of those presently anticipated, or other future events, not presently predictable, which individually or in the aggregate could impair the Company's ability to obtain funds to meet its requirements. The Company currently has no material commitment for capital expenditures, except as discussed under "Overview", "Chemical Business" of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" regarding the negotiations to build a new nitric acid plant.
FOREIGN SUBSIDIARY FINANCING
The Company has guaranteed a revolving credit working capital facility (the "Facility") between TES and Bank of New Zealand. The Facility allows for borrowings based on specific percentages of qualified eligible assets. The Facility was amended on December 19, 1996 to allow for borrowings up to an aggregate of $8.5 million Australian. This amendment also requires a reduction of $.5 million to the amount of $8.0 million on or before February 28 1997, then a further reduction of $1.0 million to the amount of $7.0 million on or before March 31, 1997. Based on the effective exchange rate at December 31, 1996, the amount of $6.7 million. (approximately US $4.6 million borrowed at December 31, 1996). Such debt is secured by substantially all the assets of TES, plus an unlimited guarantee and indemnity from the Company. The interest rate on this debt is the Bank of New Zealand Corporate Lending Rate plus 0.5% (approximately 10.0% at December 31, 1996). The next annual review is due on September 30, 1997. TES is in technical non-compliance with a certain financial covenant contained in the loan agreement involving the Facility. However, this covenant was not met at the time of closing and the Bank of New Zealand agrees that the covenant is something to work towards in the future and has continued to allow TES to borrow under the Facility. The outstanding borrowing under the facility at December 31, 1996 has been classified as due within one year in the accompanying Consolidated Financial Statements.
JOINT VENTURES AND OPTIONS TO PURCHASE
During 1994 the Company, through a subsidiary, loaned $2.1 million to a French manufacturer of HVAC equipment whose product line is compatible with that of the Company's Environmental Control Business in the USA. Under the loan agreement, the Company has the option to exchange its rights under the loan for 100% of the borrower's outstanding common stock. The Company obtained a security interest in the stock of the French manufacturer to secure its loan. During fiscal year 1995 and January 1996 the Company advanced an additional $800,000 to the French manufacturer bringing the total of the loan at December 31, 1996 to $2.9 million. At this time the decision has not been made to exercise such option and the $2.9 million loan net of a $1.5 million valuation reserve is carried on the books as a note receivable in other assets. Subsequent to December 31, 1996, the Company advanced an additional $1.0 million to the French manufacturer for the purchase of additional plant facilities.
During the second quarter of 1995, the Company executed a stock option agreement to acquire eighty percent (80%) of the stock of a specialty sales organization ("Optioned Company") to enhance the marketing of the Company's air conditioning products. The stock option has a four (4) year term, and a total option granting price of $1.0 million payable in installments including an option fee of $500,000 paid upon signing of the option agreement and annual $100,000 payments for yearly extensions of the stock option thereafter for up to three (3) years. Upon exercise of the stock option by the Company, or upon the occurrence of certain performance criteria which would give the grantors of the stock option the right to accelerate the date on which the Company must elect whether to exercise, the Company shall pay certain cash and issue promissory notes for the balance of the exercise price of the subject shares. The total exercise price of the subject shares is $4.0 million, less the amounts paid for the granting and any extensions of the stock option.
A subsidiary of the Company invested approximately $2.8 million to purchase a fifty percent (50%) equity interest in an energy conservation joint venture (the "Project"). The Project had been awarded a contract to retrofit residential housing units at a US Army base. The completed contract was for installation of energy-efficient equipment (including air conditioning and heating equipment), which would reduce utility consumption. For the installation and management, the Project will receive an average of seventy- seven percent (77%) of all energy and maintenance savings during the twenty (20) year contract term. The Project spent approximately $17.5 million to retrofit the residential housing units at the US Army base. The Project has received a loan from a lender to finance approximately $14.0 million of the cost of the Project. The Company is not guaranteeing any of the lending obligations of the Project.
DEBT GUARANTEE
As disclosed in Note 12 of the Notes to Consolidated Financial Statements a subsidiary of the Company and one of its subsidiaries have guaranteed approximately $2.6 million of indebtedness of a start up aviation company in exchange for an ownership interest. The debt guarantee relates to two note instruments. One note for which the subsidiary had guaranteed up to $600,000 had a principal balance of $125,000 at December 31, 1996 and was paid in full subsequent to December 31, 1996. The other note in the amount of $2.0 million requires monthly principal payments of $11,111 plus interest beginning in October 1998 through August 8, 1999, at which time all outstanding principal and accrued interest are due. In the event of default of the $2.0 million note, the Company is required to assume payments on the note with the term extended until August 2004. Both notes are current as to principal and interest.
In 1996, the aviation company received a cash infusion of $4.0 million from an unrelated third party investor for a 41.6% ownership interest in the aviation company. The investor also retained an option to purchase additional stock of the aviation company in exchange for $4.0 million.
AVAILABILITY OF COMPANY'S LOSS CARRYOVERS
The Company anticipates that its cash flow in future years will benefit from its ability to use net operating loss ("NOL") carryovers from prior periods to reduce the federal income tax payments which it would otherwise be required to make with respect to income generated in such future years; however, such benefit will be limited by the Company's reduced NOL for alternative minimum tax purposes which is approximately $10.0 million at December 31, 1996. As of December 31, 1996, the Company had available NOL carryovers of approximately $45.0 million, based on its federal income tax returns as filed with the Internal Revenue Service for taxable years through 1995, and on the Company's estimates for 1996. These NOL carryovers will expire beginning in the year 1999.
The above paragraph contains certain forward-looking statements. The amount of these carryovers has not been audited or approved by the Internal Revenue Service and, accordingly, no assurance can be given that such carryovers will not be reduced as a result of audits in the future. In addition, the ability of the Company to utilize these carryovers in the future will be subject to a variety of limitations applicable to corporate taxpayers generally under both the Internal Revenue Code of 1986, as amended, and the Treasury Regulations. These include, in particular, limitations imposed by Code Section 382 and the consolidated return regulations.
CONTINGENCIES
As discussed in Item 3 and in Note 12 of Notes to Consolidated Financial Statements, the Company has several contingencies that could impact its liquidity in the event that the Company is unsuccessful in defending against the claimants. Although management does not anticipate that these claims will result in substantial adverse impacts on its liquidity, it is not possible to determine the outcome.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA ______ ___________________________________________
The Company has included the financial statements and supplementary financial information required by this item immediately following Part IV of this report and hereby incorporates by reference the relevant portions of those statements and information into this Item 8.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND _________________________________________________________________________ FINANCIAL DISCLOSURE ____________________
No disagreements between the Company and its accountants have occurred within the 24-month period prior to the date of the Company's most recent financial statements.
PART III _________
The Company hereby incorporates by reference the information required by Part III of this report except for the information of the Company's executive officers included under Part 4A of Part I of this report, from the definitive proxy statement that the Company may file with the Securities and Exchange Commission on or before April 30, 1997, in connection with the Company's 1997 annual meeting of stockholders.
PART IV _______
ITEM 14.
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K __________________________________________________________________________
(a)(1) FINANCIAL STATEMENTS. The following consolidated financial ____________________ statements of the Company appear immediately following this Part IV: Pages _______________
Report of Independent Auditors
Consolidated Balance Sheets at December 31, 1996 and 1995 to
Consolidated Statements of Operations for each of the three years in the period ended December 31, 1996
Consolidated Statements of Stockholders' Equity for each of the three years in the period ended December 31, 1996 to
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 1996 to
Notes to Consolidated Financial Statements to
Quarterly Financial Data (Unaudited)
(a)(2) FINANCIAL STATEMENT SCHEDULE. The Company has included the ____________________________ following schedule in this report:
II - Valuation and Qualifying Accounts
The Company has omitted all other schedules because the conditions requiring their filing do not exist or because the required information appears in the Company's Consolidated Financial Statements, including the notes to those statements.
(a)(3) EXHIBITS. The Company has filed the following exhibits with ________ this report:
2.1. Stock Option Agreement dated as of May 4, 1995, optionee, LSB Holdings, Inc., an Oklahoma Corporation, an option to purchase, which the Company incorporates by reference from Exhibit 2.1 to the Company's Form 10-K for fiscal year ended December 31, 1995.
2.2. Stock Purchase Agreement and Stock Pledge Agreement between Dr. Hauri AG, a Swiss Corporation, and LSB Chemical Corp., which the Company hereby incorporates by reference from Exhibit 2.2 to the Company's Form 10-K for fiscal year ended December 31, 1994.
3.1. Restated Certificate of Incorporation, the Certificate of Designation dated February 17, 1989, and certificate of Elimination dated April 30, 1993, which the Company hereby incorporates by reference from Exhibit 4.1 to the Company's Registration Statement, No. 33-61640; Certificate of Designation for the Company's $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2, which is incorporated by reference from Exhibit 4.6 to the Company's Registration Statement, No. 33-61640.
3.2. Bylaws, as amended, which the Company hereby incorporates by reference from Exhibit 3.02 to the Company's form 10-K for fiscal year ended December 31, 1990.
4.1. Specimen Certificate for the Company's Non-cumulative Preferred Stock, having a par value of $100 per share, which the Company hereby incorporates by reference from Exhibit 4.1 to the Company's Form 10-Q for the quarter ended June 30, 1983.
4.2. Specimen Certificate for the Company's Series B Preferred Stock, having a par value of $100 per share, which the Company hereby incorporates by reference from Exhibit 4.27 to the Company's Registration Statement No. 33-9848.
4.3. Specimen Certificate for the Company's Series 2 Preferred, which the Company hereby incorporates by reference from Exhibit 4.5 to the Company's Registration Statement No. 33-61640.
4.4. Specimen Certificate for the Company's Common Stock, which the Company incorporates by reference from Exhibit 4.4 to the Company's Registration Statement No. 33-61640.
4.5. Rights Agreement, dated as of February 17, 1989, between the Company and The Liberty National Bank and Trust Company of Oklahoma City, which the Company hereby incorporates by reference from Exhibit 2.1 to the Company's Form 8-A Registration Statement dated February 22, 1989.
4.6. First Amendment to Preferred Share Purchase Rights Plan, dated as of May 24, 1994, between the Company and Liberty National Bank and Trust Company of Oklahoma City, which the Company hereby incorporates by reference from Exhibit 4.2 to the Company's Form 10-Q for the fiscal quarter ended March 31, 1995.
4.7. Loan and Security Agreement, dated December 12, 1994, between the Company and BankAmerica Business Credit, Inc., which the Company hereby incorporates by reference from Exhibit 4.12 to the Company's Form 10-K for the fiscal year ended December 31, 1994. The Loan and Security Agreement contains a list of schedules and exhibits omitted from the filed exhibit and the Company agrees to furnish supplementally a copy of any of the omitted schedules and exhibits to the Commission upon request.
4.8. Loan and Security Agreement dated December 12, 1994, between El Dorado Chemical Company and Slurry Explosive Corporation, as borrowers, and BankAmerica Business Credit, Inc., as lender, which the Company hereby incorporates by reference from Exhibit 4.13 to the Company's Form 10-K for the fiscal year ended December 31, 1994. The Loan and Security Agreement contains a list of schedules and exhibits omitted from the filed exhibit and the Company agrees to furnish supplementally a copy of any of the omitted schedules and exhibits to the Commission upon request. Substantially identical Loan and Security Agreements, dated December 12, 1994, have been entered into by each of L&S Bearing Co., International Environmental Corporation, Climate Master, Inc., and Summit Machine Tool Manufacturing, Corp. with BankAmerica Business Credit, Inc. and are hereby omitted and such will be provided to the Commission upon the Commission's request.
4.9. First Amendment dated August 17, 1995, to the Loan and Security Agreement dated December 12, 1994, between the Company and BankAmerica Business Credit, Inc. Substantially identical First Amendments dated August 17, 1995, to the Loan and Security Agreements dated December 12, 1994, were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing, Corp., and El Dorado Chemical Company and Slurry Explosive Corporation with BankAmerica Business Credit, Inc. and are hereby omitted and such will be provided upon the Commission's request.
4.10. Second Amendment dated December 1, 1995, to the Loan and Security Agreement dated December 12, 1994, between the Company and BankAmerica Business Credit, Inc. Substantially identical Second Amendments dated December 1, 1995, to the Loan and Security Agreements dated December 12, 1994, were entered into by each of L&S Bearing, Climate Master, Inc., and Summit Machine Tool Manufacturing, Corp. with BankAmerica Business Credit, Inc. and are hereby omitted and such will be provided upon the Commission's request.
4.11. Second Amendment dated December 1, 1995, to the Loan and Security Agreement dated December 12, 1994, between El Dorado Chemical Company and Slurry Explosives Corporation, and BankAmerica Business Credit, Inc., which the Company hereby incorporates by reference from Exhibit 4.18 to the Company's Form 10-K for the fiscal year ended December 31, 1995.
4.12. Second Amendment dated December 1, 1995, to the Loan and Security Agreement dated December 12, 1994, between International Environmental Corporation, and BankAmerica Business Credit, Inc., which the Company hereby incorporates by reference from Exhibit 4.19 to the Company's Form 10-K for the fiscal year ended December 31, 1995.
4.13. Third Amendment to Loan and Security Agreement between the Company and BankAmerica Business Credit, Inc. Substantially identical Third Amendments were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing Corp., and El Dorado Chemical Company and are hereby omitted, and such will be provided to the Commission upon request.
4.14. Fourth Amendment to Loan and Security Agreement between the Company and BankAmerica Business Credit, Inc. Substantially identical Fourth Amendments were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing Corp., and El Dorado Chemical Company and are hereby omitted, and such will be provided to the Commission upon request.
4.15. Fifth Amendment to Loan and Security Agreement between the Company and BankAmerica Business Credit, Inc. Substantially identical Fifth Amendments were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing Corp., and El Dorado Chemical Company and are hereby omitted, and such will be provided to the Commission upon request.
4.16. Sixth Amendment to Loan and Security Agreement between the Company and BankAmerica Business Credit, Inc. Substantially identical Sixth Amendments were entered into by each of L&S Bearing, International Environmental Corporation, Climate Master, Inc., Summit Machine Tool Manufacturing Corp., and El Dorado Chemical Company and are hereby omitted, and such will be provided to the Commission upon request.
4.17. Loan Agreement dated as of May 4, 1995, by and among Prime Financial Corporation, as borrower, LSB Industries, Inc., Summit Machine Tool Manufacturing Corp., L&S Bearing Co., International Environmental Corporation, El Dorado Chemical Company, and Climate Master, Inc., as the guarantors, and Bank IV Oklahoma, N.A., which the Company hereby incorporates by reference from Exhibit 4.1 to the Company's Form 10-Q for the fiscal quarter ended March 31, 1995.
4.18 Note Purchase Agreement, dated February 13, 1997 between El Dorado Chemical Company, Northwest Financial Corporation, and Slurry Explosive Corporation as Borrowers, and John Hancock Mutual Life Insurance Company.
4.19. Intercreditor Agreement dated February 13, 1997 by and between BankAmerica Business Credit, Inc. and John Hancock Mutual Life Insurance Company with respect to certain financing arrangements with El Dorado Chemical Company, Slurry Explosive Corporation, and Northwest Financial Corporation.
10.1. Form of Death Benefit Plan Agreement between the Company and the employees covered under the plan, which the Company hereby incorporates by reference from Exhibit 10(c)(1) to the Company's Form 10-K for the year ended December 31, 1980.
10.2. The Company's 1981 Incentive Stock Option Plan, as amended, and 1986 Incentive Stock Option Plan, which the Company hereby incorporates by reference from Exhibits 10.1 and 10.2 to the Company's Registration Statement No. 33-8302.
10.3. Form of Incentive Stock Option Agreement between the Company and employees as to the Company's 1981 Incentive Stock Option Plan, which the Company hereby incorporates by reference from Exhibit 10.10 to the Company's Form 10-K for the fiscal year ended December 31, 1984.
10.4. Form of Incentive Stock Option Agreement between the Company and employees as to the Company's 1986 Incentive Stock Option Plan, which the Company hereby incorporates by reference from Exhibit 10.6 to the Company's Registration Statement No. 33-9848.
10.5. The 1987 Amendments to the Company's 1981 Incentive Stock Option Plan and 1986 Incentive Stock Option Plan, which the Company hereby incorporates by reference from Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1986.
10.6. The Company's 1993 Stock Option and Incentive Plan which the Company hereby incorporates by reference from Exhibit 10.6 to the Company's Form 10-K for the fiscal year ended December 31, 1993.
10.7. The Company's 1993 Non-employee Director Stock Option Plan which the Company hereby incorporates by reference from Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1993.
10.8. Union Contracts, dated August 5, 1995, between EDC and the Oil, Chemical and Atomic Workers, the International Association of Machinists and Aerospace Workers, and the United Steel Workers of America, dated November 1, 1995 which the Company hereby incorporates by reference from Exhibit 10.7 to the Company's Form 10-K for the fiscal year ended December 31, 1995.
10.9. Lease Agreement, dated March 26, 1982, between Mac Venture, Ltd. and Hercules Energy Mfg. Corporation, which the Company hereby incorporates by reference from Exhibit 10.32 to the Company's Form 10-K for the fiscal year ended December 31, 1981.
10.10. Agreement for Purchase and Sale of Anhydrous Ammonia, dated as of January 1, 1997, between El Dorado Chemical Company and Farmland Industries, Inc.
10.11. Limited Partnership Agreement dated as of May 4, 1995, between the general partner, and LSB Holdings, Inc., an Oklahoma Corporation, as limited partner which the Company hereby incorporates by reference from Exhibit 10.11 to the Company's Form 10-K for the fiscal year ended December 31, 1995.
10.12. Lease Agreement dated November 12, 1987, between Climate Master, Inc. and West Point Company and amendments thereto, which the Company hereby incorporates by reference from Exhibits 10.32, 10.36, and 10.37, to the Company's Form 10-K for fiscal year ended December 31, 1988.
10.13. Severance Agreement, dated January 17, 1989, between the Company and Jack E. Golsen, which the Company hereby incorporates by reference from Exhibit 10.48 to the Company's Form 10-K for fiscal year ended December 31, 1988. The Company also entered into identical agreements with Tony M. Shelby, David R. Goss, Barry H. Golsen, David M. Shear, and Jim D. Jones and the Company will provide copies thereof to the Commission upon request.
10.14. Third Amendment to Lease Agreement, dated as of December 31, 1987, between Mac Venture, Ltd. and Hercules Energy Mfg. Corporation, which the Company hereby incorporates by reference from Exhibit 10.49 to the Company's Form 10-K for fiscal year ended December 31, 1988.
10.15. Employment Agreement and Amendment to Severance Agreement dated January 17, 1989 between the Company and Jack E. Golsen, dated March 21, 1996 which the Company hereby incorporates by reference from Exhibit 10.15 to the Company's Form 10-K for fiscal year ended December 31, 1995.
10.16. Option to Purchase Real Estate, dated January 4, 1989, between Northwest Financial Corporation and Northwest Tower Limited Partnership, which the Company hereby incorporates by reference from Exhibit 10.50 to the Company's Form 10-K for fiscal year ended December 31, 1988.
10.17. Right of First Refusal, dated November 4, 1992, between the Company, Climate Master, Inc., and Carrier Corporation, which the Company hereby incorporates by reference from Exhibit 28.4 to the Company's Registration Statement No. 33-55608.
10.18. Fixed Assets Purchase Parts Purchase and Asset Consignment Agreement, dated November 4, 1992, between Climate Master, Inc. and Carrier Corporation, which the Company hereby incorporates by reference from Exhibit 28.5 to the Company's Registration Statement No. 33-55608.
10.19. Processing Agreement, dated January 1, 1994, between Monsanto Company and El Dorado Chemical Company, which the Company hereby incorporates by reference from Exhibit 10.22 to the Company's Form 10-K for the fiscal year ended December 31, 1994.
10.20. Non-Qualified Stock Option Agreement, dated June 1, 1992, between the Company and Robert C. Brown, M.D. which the Company hereby incorporates by reference from Exhibit 10.38 to the Company's Form 10-K for fiscal year ended December 31, 1992. The Company entered into substantially identical agreements with Bernard G. Ille, Jerome D. Shaffer and C.L.Thurman, and the Company will provide copies thereof to the Commission upon request.
10.21. Loan and Security Agreement dated October 31, 1994 between DSN Corporation and the CIT Group which the Company hereby incorporates by reference from Exhibit 10.1 to the Company's Form 10-Q for the fiscal quarter ended September 30, 1994.
10.22. Loan and Security Agreement dated April 5, 1995 between DSN Corporation and the CIT Group, which the Company hereby incorporates by reference from Exhibit 10.25 to the Company's Form 10-K for the fiscal year ended December 31, 1994.
10.23. First Amendment to Non-Qualified Stock Option Agreement, dated March 2, 1994, and Second Amendment to Stock Option Agreement, dated April 3, 1995, each between the Company and Jack E. Golsen, which the Company hereby incorporates by reference from Exhibit 10.1 to the Company's Form 10-Q for the fiscal quarter ended March 31, 1995.
10.24 Agreement for purchase and sale of ammonia dated December 31, 1996 between El Dorado Chemical Company and Koch Nitrogen Company.
11.1. Statement re: Computation of Per Share Earnings
21.1. Subsidiaries of the Company
23.1. Consent of Independent Auditors
27.1. Financial Data Schedule
(b) REPORTS ON FORM 8-K. The Company did not file any reports on Form ___________________ 8-K during the fourth quarter of 1996.
SIGNATURES __________
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Company has caused the undersigned, duly-authorized, to sign this report on its behalf of this 11th day of April, 1997. LSB INDUSTRIES, INC.
By: /s/ Jack E. Golsen _______________________________ Jack E. Golsen Chairman of the Board and President (Principal Executive Officer)
By: /s/ Tony M. Shelby ______________________________ Tony M. Shelby Senior Vice President of Finance (Principal Financial Officer)
By: /s/ Jim D. Jones _______________________________ Jim D. Jones Vice President, Controller and Treasurer (Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the undersigned have signed this report on behalf of the Company, in the capacities and on the dates indicated.
Dated: April 11, 1997 By: /s/ Jack E. Golsen ________________________________ Jack E. Golsen, Director
Dated: April 11, 1997 By: /s/ Tony M. Shelby ________________________________ Tony M. Shelby, Director
Dated: April 11, 1997 By: /s/ David R. Goss _______________________________ David R. Goss, Director
Dated: April 11, 1997 By: /s/ Barry H. Golsen _______________________________ Barry H. Golsen, Director
Dated: April 11, 1997 By: /s/ Robert C. Brown _______________________________ Robert C. Brown, Director
Dated: April 11, 1997 By: /s/ Bernard G. Ille _______________________________ Bernard G. Ille, Director
Dated: April 11, 1997 By: /s/ Jerome D. Shaffer ________________________________ Jerome D. Shaffer, Director
Dated: April 11, 1997 By: /s/ Raymond B. Ackerman ______________________________ Raymond B. Ackerman, Director
Dated: April 11, 1997 By: /s/ Horace Rhodes _______________________________ Horace Rhodes, Director
Report of Independent Auditors
The Board of Directors and Stockholders LSB Industries, Inc.
We have audited the accompanying consolidated balance sheets of LSB Industries, Inc. as of December 31, 1996 and 1995, and the related consolidated statements of operations, stockholders' equity and cash flows for each of the three years in the period ended December 31, 1996. Our audits also included the financial statement schedule listed in the Index at Item 14(a)(2). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and the schedule based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of LSB Industries, Inc. at December 31, 1996 and 1995, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1996, in conformity with generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.
ERNST & YOUNG LLP
Oklahoma City, Oklahoma March 7, 1997
LSB Industries, Inc.
Consolidated Balance Sheets
(Continued on following page)
LSB Industries, Inc.
Consolidated Balance Sheets (continued)
See accompanying notes.
LSB Industries, Inc.
Consolidated Statements of Operations
See accompanying notes.
LSB Industries, Inc.
Consolidated Statements of Stockholders' Equity
(Continued on following page)
LSB Industries, Inc.
Consolidated Statements of Stockholders' Equity (continued)
See accompanying notes.
LSB Industries, Inc.
Consolidated Statements of Cash Flows
(Continued on following page)
LSB Industries, Inc.
Consolidated Statements of Cash Flows (continued)
See accompanying notes.
LSB Industries, Inc.
Notes to Consolidated Financial Statements
December 31, 1996, 1995 and 1994
1. BASIS OF PRESENTATION
The accompanying consolidated financial statements include the accounts of LSB Industries, Inc. (the "Company") and its subsidiaries. On May 25, 1994, the financial services subsidiary, Equity Bank for Savings, F.A. ("Equity Bank"), was sold and, thus, the consolidated statement of operations for 1994 presents the operations of Equity Bank as discontinued operations.
2. ACCOUNTING POLICIES
USE OF ESTIMATES
The preparation of consolidated financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
STATEMENTS OF CASH FLOWS
For purposes of reporting cash flows, cash and cash equivalents include cash, overnight funds and interest bearing deposits with maturities when purchased by the Company of 90 days or less.
Supplemental cash flow information includes:
LOANS RECEIVABLE
Loans receivable are stated at unpaid principal balances, less any allowance for loan losses (none in 1996, 1995 or 1994). Management's periodic evaluation of the adequacy of the allowance is
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
based on past loan loss experience, known and inherent risks in the portfolio, adverse situations that may affect the borrower's ability to repay, the estimated value of the underlying collateral, and current economic conditions.
In February 1997, the Company foreclosed on a loan receivable with a carrying amount of $14.0 million and exercised its option to acquire the related office building located in Oklahoma City, known as "The Tower." The estimated fair value of The Tower at the date of acquisition exceeds the Company's carrying amount at December 31, 1996 plus the exercise payment.
INVENTORIES
Purchased machinery and equipment are carried at specific cost plus duty, freight and other charges, not in excess of net realizable value. All other inventory is priced at the lower of cost or market, with cost being determined using the first-in, first-out (FIFO) basis, except for certain heat pump products with a value of $8,595,000 at December 31, 1996 ($5,981,000 at December 31, 1995), which are priced at the lower of cost or market, with cost being determined using the last-in, first-out (LIFO) basis. The difference between the LIFO basis and current cost is not material at December 31, 1996 or 1995.
DEPRECIATION
For financial reporting purposes, depreciation, depletion and amortization is primarily computed using the straight-line method over the estimated useful lives of the assets.
CAPITALIZATION OF INTEREST
Interest costs of $2,405,000, $1,357,000 and $491,000 related to the construction of a new nitric acid plant were capitalized in 1996, 1995 and 1994, respectively, and will be amortized over the related plant's estimated useful life.
EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED
The excess of purchase price over net assets acquired totals $3,941,000 and $4,361,000, net of accumulated amortization, of $3,400,000 and $2,980,000 at December 31, 1996 and 1995, respectively, is included in other assets and is being amortized by the straight-line method over periods of 10 to 22 years. The carrying value of the excess of purchase price over net assets acquired is reviewed (using estimated future net cash flows, including proceeds from disposal) if the facts and circumstances indicate that it may be impaired. No impairment provisions were required in 1996, 1995 or 1994.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
2. ACCOUNTING POLICIES (CONTINUED)
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in connection with product research and development are expensed as incurred. Such costs amounted to $532,000 in 1996, $501,000 in 1995 and $606,000 in 1994.
ADVERTISING COSTS
Costs incurred in connection with advertising and promotion of the Company's products are expensed as incurred. Such costs amounted to $1,814,000 in 1996, $1,658,000 in 1995 and $1,321,000 in 1994.
NET INCOME (LOSS) APPLICABLE TO COMMON STOCK
Net income (loss) applicable to common stock is computed by adjusting net income or loss by the amount of preferred stock dividends.
EARNINGS (LOSS) PER SHARE
Primary earnings (loss) per common share are based upon the weighted average number of common shares and dilutive common equivalent shares outstanding during each period after giving appropriate effect to preferred stock dividends.
Fully diluted earnings (loss) per share are based on the weighted average number of common shares and dilutive common equivalent shares outstanding and the assumed conversion of dilutive convertible securities outstanding, if any, after appropriate adjustment for interest and related income tax effects on convertible notes payable, as applicable.
Average common shares outstanding used in computing earnings per share are as follows:
3. DISCONTINUED OPERATIONS--FINANCIAL SERVICES
On May 25, 1994, pursuant to a Stock Purchase Agreement, dated as of February 9, 1994 (the "Acquisition Agreement"), the Company sold for $91.1 million its wholly-owned subsidiary, Equity Bank, which constituted the Financial Services Business of the Company, to Fourth
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
3. DISCONTINUED OPERATIONS--FINANCIAL SERVICES (CONTINUED)
Financial Corporation (the "Purchaser"). The Purchaser acquired all of the outstanding shares of capital stock of Equity Bank. Equity Bank's revenues for the period from January 1, 1994 to May 25, 1994 were $16.5 million.
4. INVENTORIES
Inventories at December 31, 1996 and 1995 consist of:
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, at cost, consist of:
6. FOREIGN SALES CONTRACT
In connection with a 1992 equipment sales contract with a foreign customer, a subsidiary of the Company agreed to a contract amendment in May 1995 that enabled collection of outstanding billings on the contract and required the customer deliver bearing products to the subsidiary, at a future date, without charge to the subsidiary. The amendment also included a purchase commitment by the subsidiary to purchase $30 million of bearing products from the customer over a five-year period. During 1995, the subsidiary purchased approximately $3.1 million of product in connection with such requirement.
In January 1996, the subsidiary negotiated another amendment to the agreement with the foreign customer, modifying the subsidiary's firm commitment to purchase $30 million of bearing products over the five-year period in exchange for waiver of the foreign customer's commitment to provide bearing products without charge to the subsidiary at a future date. Under this amendment, the Company will not be required to purchase more bearing products each year than it can sell in its normal course of business.
Accordingly, as a result of the elimination of the subsidiary's future bearing product commitment, the Company recognized the remaining $1.8 million of contract revenue in the fourth quarter of 1995 which had been previously deferred pending completion of the subsidiary's firm purchase commitment.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT
Long-term debt consists of the following:
(A) In December 1994, the Company, certain subsidiaries of the Company (the "Borrowing Group") and a bank entered into a series of six asset-based revolving credit facilities aggregating up to $65 million based upon defined eligible assets. The agreement provides for an initial term of three years; however, the agreement will automatically renew for successive 13-month terms, unless terminated by either party by notice from either party 60 days prior to maturity. Subsequent to December 31, 1996, the Company obtained a commitment from the bank to renew the credit
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT (CONTINUED)
facilities through April 1, 1998. Accordingly, all amounts outstanding at December 31, 1996 have been classified as long-term debt due after one year in the accompanying 1996 consolidated balance sheet. The revolving loans are available based on varying percentages of eligible accounts receivable and inventory and also provide for the issuance of letters of credit of up to $11 million, subject to certain restrictions. The agreement provides for loans at the reference rate as defined (which approximates the national prime rate) plus 2%, or the Eurodollar rate plus 4.375%, with interest due monthly. The agreement is secured by substantially all of the Company's receivables, inventory, proprietary rights, and proceeds thereof and the stock of certain participating subsidiaries. The agreement contains financial covenants, including limitations on dividends, investments and capital expenditures, and requires maintenance of tangible net worth, as defined (escalating from $64.5 million in 1996 to $80.4 million in 1998), and debt ratios whereby the Borrowing Groups' debt shall not exceed 2.39 times the Company's adjusted tangible net worth. See (E) below.
(B) This agreement between a subsidiary of the Company and two institutional lenders provided for two series of term loans and a revolving credit facility. The balance outstanding at December 31, 1996 was paid in February 1997. See Note (E).
(C) This agreement, as amended, between a subsidiary of the Company and an institutional lender provided for a loan in the aggregate amount of $16.5 million, the proceeds of which were used in the construction of a nitric acid plant, requiring 84 equal monthly payments of principal plus interest, with interest at a fixed rate of 8.86%. This agreement is secured by the plant, equipment and machinery, and proprietary rights associated with the plant which has an approximate carrying value of $28.9 million.
This agreement contains various financial and restrictive covenants, including a requirement to maintain tangible net worth, as defined, of $66 million, escalating to $76 million by December 31, 1997.
(D) In May 1995, a subsidiary of the Company entered into a term loan agreement with a bank in the amount of $9 million. The agreement was amended in May 1996 to increase the loan to $13 million. The loan, which matures in May 2001, is payable in 60 monthly payments of principal and
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
7. LONG-TERM DEBT (CONTINUED)
interest, commencing on June 30, 1996. The monthly principal and interest payment is based on a 240-month period ("Amortization Period") at a rate of interest equal to .75% in excess of the prime rate of a certain bank. On September 30, 1996, and on the last day of each calendar quarter thereafter, the monthly principal and interest payment is adjusted to an amount which will fully amortize the outstanding principal balance over the remaining part of the Amortization Period. When the loan matures in May 2001, all outstanding principal and all unpaid interest on the loan shall become immediately due. The loan is secured by The Tower, subsequent to its acquisition in February 1997 as discussed in Note 2.
(E) On February 13, 1997, certain subsidiaries of the Company entered into a $50 million financing arrangement with John Hancock Mutual Life Insurance Company (the "New Note Agreement"). Approximately $19.3 million of the proceeds from the New Note Agreement were used to retire the principal balances outstanding on the term and revolving credit facility discussed in (B) above and the secured loan due in monthly installments through 2003. The remaining proceeds of the New Note Agreement (approximately $30.7 million) were used to pay down the revolving credit facility described in (A). In connection with the new financing, $9.5 million of debt previously due within one year has been classified as due after one year reflecting the payment terms of the New Note Agreement.
The New Note Agreement consists of: (i) $25 million of fixed rate notes bearing interest at 10.57% per annum and (ii) $25 million of floating rate notes bearing interest at LIBOR plus 4.2%. Repayment of the notes is due in quarterly installments of $833,332 plus interest through April 2004 commencing on July 1, 1997. The notes are secured by real and personal property of the subsidiaries. The New Note Agreement contains several financial covenants related to the borrowing subsidiaries. These financial covenants, as defined, include the maintenance of a debt to capitalization ratio, combined net worth, combined working capital, current ratio and fixed charge coverage ratio. The New Note Agreement also restricts payments that can be made by the borrowing subsidiaries to the Company or its subsidiaries.
Maturities of long-term debt, after consideration of the New Note Agreement discussed in (E) above, for each of the five years after December 31, 1996 are: 1997--$13,007; 1998--$36,745; 1999--$10,428; 2000--$10,456; 2001--$21,771 and thereafter--$39,877.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES
The provision (benefit) for income taxes from continuing operations consists of the following for the year indicated:
The approximate tax effects of each type of temporary difference and carryforward that are used in computing deferred tax assets and liabilities and the valuation allowance related to deferred tax assets at December 31, 1996 and 1995 are as follows:
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
8. INCOME TAXES (CONTINUED)
The Company is able to realize deferred tax assets up to an amount equal to the future reversals of existing taxable temporary differences. The majority of the taxable temporary differences will turn around in the loss carryforward period as the differences are depreciated or amortized. Other differences will turn around as the assets are disposed in the normal course of business.
The differences between the amount of the provision for income taxes and the amount which would result from the application of the federal statutory rate to "Income (loss) from continuing operations before provision (benefit) for income taxes" for each of the three years in the period ended December 31, 1996 are detailed below:
At December 31, 1996, the Company has regular-tax net operating loss ("NOL") carryforwards of approximately $45 million (approximately $10 million alternative minimum tax NOLs). Such amounts of regular-tax NOL expire beginning in 1999. The Company also has investment tax credit carryforwards of approximately $356,000 which begin expiring in 1997.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY
STOCK OPTIONS
The Company has elected to follow Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations in accounting for its employee stock options because, as discussed below, the alternative fair value accounting provided for under FASB Statement No. 123, "Accounting for Stock-Based Compensation," requires use of option valuation models that were not developed for use in valuing employee stock options. Under APB 25, because the exercise price of the Company's employee stock options equals the market price of the underlying stock on the date of grant, no compensation expense is generally recognized.
Pro forma information regarding net income and earnings per share is required by Statement 123, which also requires that the information be determined as if the Company has accounted for its employee stock options granted subsequent to December 31, 1994 under the fair value method of that Statement. The fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following weighted average assumptions for 1996 and 1995, respectively: risk-free interest rates of 6.0% and 6.4%; an dividend yield of 1.38% and 1.04%; volatility factors of the expected market price of the Company's common stock of .41 and .41; and a weighted average expected life of the option of 6.8 and 7.3 years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company's employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
For purposes of pro forma disclosures, the estimated fair value of the qualified and non-qualified options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
Because Statement 123 is applicable only to options granted subsequent to December 31, 1994, its pro forma effect will not be fully reflected until 1997.
QUALIFIED STOCK OPTION PLANS
In November 1981, the Company adopted the 1981 Incentive Stock Option Plan (1,350,000 shares), in March 1986, the Company adopted the 1986 Incentive Stock Option Plan (1,500,000 shares) and, in September 1993, the Company adopted the 1993 Stock Option and Incentive Plan (850,000 shares). Under these plans, the Company is authorized to grant options to purchase up to 3,700,000 shares of the Company's common stock to key employees of the Company and its subsidiaries. The 1981 and 1986 Incentive Stock Option Plans have expired and, accordingly, no additional options may be granted from these plans. Options granted prior to the expiration of these plans continue to remain valid thereafter in accordance with their terms. At December 31, 1996, there are 331,140 of options outstanding related to these two plans. At December 31, 1996, there are 845,500 options outstanding related to the 1993 Incentive Stock Option Plan which continues to be effective. These options become exercisable 20% after one year from date of grant, 40% after two years, 70% after three years, 100% after four years and lapse at the end of ten years. The exercise price of options to be granted under this plan is equal to the fair market value of the Company's common stock at the date of grant. For participants who own 10% or more of the Company's common stock at the date of grant, the option price is 110% of the fair market value at the date of grant and the options lapse after five years from the date of grant.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
Activity in the Company's qualified stock option plans during each of the three years in the period ended December 31, 1996 is as follows:
Outstanding options to acquire 1,026,640 shares of stock at December 31, 1996 had exercise prices ranging from $1.13 to $4.88 per share and had a weighted average remaining contractual life of 8.1 years. The balance of options outstanding at December 31, 1996 had exercise prices ranging from $5.36 to $9.00 per share and a weighted average remaining contractual life of 8.1 years.
NON-QUALIFIED STOCK OPTION PLANS
The Company's Board of Directors approved the grant of non-qualified stock options to the Company's outside directors, President and a key employee of one of the Company's subsidiaries, as detailed below. The option price was based on the market value of the Company's common stock at the date of grant and these options are exercisable at any time after the date of grant (except for the 1994 extension discussed below) and expire five years from such date; however, the options granted to the key employee have a vesting schedule which has been completed and do not expire until ten years from the date of grant. In June 1994, the Board of Directors extended the expiration date on the grant of options for 165,000 shares to the Company's Chairman for an additional five years. The option price and terms of the option were unchanged except that, in consideration of the extension of time to exercise, the Chairman agreed to a
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
revised vesting schedule for exercise of 20% of the option shares in each of the years 1995, 1996 and 1997 and 40% of the option shares in 1998.
In September 1993, the Company adopted the 1993 Nonemployee Director Stock Option Plan (the "Outside Director Plan"). The Outside Director Plan authorizes the grant of non-qualified stock options to each member of the Company's Board of Directors who is not an officer or employee of the Company or its subsidiaries. The maximum number of shares of common stock of the Company that may be issued under the Outside Director Plan is 150,000 shares (subject to adjustment as provided in the Outside Director Plan).
The Company shall automatically grant to each outside director an option to acquire 5,000 shares of the Company's common stock on April 30 following the end of each of the Company's fiscal years in which the Company realizes net income of $9.2 million or more for such fiscal year. The exercise price for an option granted under this plan shall be the fair market value of the shares of common stock at the time the option is granted. Each option granted under this plan to the extent not exercised shall terminate upon the earlier of the termination as a member of the Company's Board of Directors or the fifth anniversary of the date such option was granted. During each 1995 and 1994, there were 25,000 options granted at $5.375 and $9.00 per share, respectively, under the Outside Director Plan (40,000 options outstanding at December 31, 1996).
Activity in the Company's non-qualified stock option plans during each of the three years in the period ended December 31, 1996 is as follows:
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
9. STOCKHOLDERS' EQUITY (CONTINUED)
Outstanding options to acquire 225,000 shares of stock at December 31, 1996 had exercise prices ranging from $1.38 to $3.13 per share and had a weighted average remaining contractual life of 2.2 years. The balance of options outstanding at December 31, 1996 had exercise prices ranging from $5.38 to $9.00 per share and a weighted average remaining contractual life of 2.8 years.
PREFERRED SHARE PURCHASE RIGHTS
In February 1989, the Company's Board of Directors declared a dividend distribution of one Preferred Share Purchase Right (the "Preferred Right") for each outstanding share of the Company's common stock. The Preferred Rights are designed to ensure that all of the Company's stockholders receive fair and equal treatment in the event of a proposed takeover or abusive tender offer.
The Preferred Rights are generally exercisable when a person or group, other than the Company's Chairman and his affiliates, acquire beneficial ownership of 30% or more of the Company's common stock (such a person or group will be referred to as the "Acquirer"). Each Preferred Right (excluding Preferred Rights owned by the Acquirer) entitles stockholders to buy one one-hundredth (1/100) of a share of a new series of participating preferred stock at an exercise price of $14. Following the acquisition by the Acquirer of beneficial ownership of 30% or more of the Company's common stock, and prior to the acquisition of 50% or more of the Company's common stock by the Acquirer, the Company's Board of Directors may exchange all or a portion of the Preferred Rights (other than Preferred Rights owned by the Acquirer) for the Company's common stock at the rate of one share of common stock per Preferred Right. Following acquisition by the Acquirer of 30% or more of the Company's common stock, each Preferred Right (other than the Preferred Rights owned by the Acquirer) will entitle its holder to purchase a number of the Company's common shares having a market value of two times the Preferred Right's exercise price.
If the Company is acquired, each Preferred Right (other than the Preferred Rights owned by the Acquirer) will entitle its holder to purchase a number of the Acquirer's common shares having a market value at the time of two times the Preferred Right's exercise price.
Prior to the acquisition by the Acquirer of beneficial ownership of 30% or more of the Company's stock, the Company's Board of Directors may redeem the Preferred Rights for $.01 per Preferred Right.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
10. REDEEMABLE PREFERRED STOCK
Each share of the noncumulative redeemable preferred stock, $100 par value, is convertible into 40 shares of the Company's common stock at any time at the option of the holder; entitles the holder to one vote and is redeemable at par. The redeemable preferred stock provides for a noncumulative annual dividend of 10%, payable when and as declared. Dividend payments were current at December 31, 1996 and 1995.
11. NON-REDEEMABLE PREFERRED STOCK
The 20,000 shares of Series B cumulative, convertible preferred stock, $100 par value, are convertible, in whole or in part, into 666,666 shares of the Company's common stock (33.3333 shares of common stock for each share of preferred stock) at any time at the option of the holder and entitles the holder to one vote per share. The Series B preferred stock provides for annual cumulative dividends of 12% from date of issue, payable when and as declared. Dividend payments were current at December 31, 1996 and 1995.
The Class C preferred stock, designated as a $3.25 convertible exchangeable Class C preferred stock, Series 2, has no par value ("Series 2 Preferred"). The Series 2 Preferred has a liquidation preference of $50.00 per share plus accrued and unpaid dividends and is convertible at the option of the holder at any time, unless previously redeemed, into common stock of the Company at an initial conversion price of $11.55 per share (equivalent to a conversion rate of approximately 4.3 shares of common stock for each share of Series 2 Preferred), subject to adjustment under certain conditions. Upon the mailing of notice of certain corporate actions, holders will have special conversion rights for a 45-day period.
The Series 2 Preferred is redeemable subsequent to June 15, 1996. The Series 2 Preferred will be redeemable at the option of the Company, in whole or in part, at $52.28 per share if redeemed on or after June 15, 1996, and thereafter at prices decreasing ratably annually to $50.00 per share on or after June 15, 2003, plus accrued and unpaid dividends to the redemption date. Dividends on the Series 2 Preferred are cumulative and are payable quarterly in arrears. Dividend payments were current at December 31, 1996 and 1995.
The Series 2 Preferred also is exchangeable in whole, but not in part, at the option of the Company on any dividend payment date beginning June 15, 1996, for the Company's 6.50% Convertible Subordinated Debentures due 2018 (the "Debentures") at the rate of $50.00 principal amount of Debentures for each share of Series 2 Preferred. Interest on the Debentures, if issued, will be payable semiannually in arrears. The Debentures will, if issued, contain
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
11. NON-REDEEMABLE PREFERRED STOCK (CONTINUED)
conversion and optional redemption provisions similar to those of the Series 2 Preferred and will be subject to a mandatory annual sinking fund redemption of five percent of the amount of Debentures initially issued, commencing June 15, 2003 (or the June 15 following their issuance, if later).
At December 31, 1996, the Company is authorized to issue an additional 248,461 shares of $100 par value preferred stock and an additional 5,000,000 shares of no par value preferred stock. Upon issuance, the Board of Directors of the Company is to determine the specific terms and conditions of such preferred stock.
12. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases certain property, plant and equipment under noncancelable operating leases. Future minimum payments on operating leases with initial or remaining terms of one year or more at December 31, 1996 are as follows:
Rent expense under all operating lease agreements, including month-to-month leases, was $4,337,000 in 1996, $3,400,000 in 1995 and $3,149,000 in 1994. Renewal options are available under certain of the lease agreements for various periods at approximately the existing annual rental amounts. Rent expense paid to related parties was $90,000 in 1996, 1995 and 1994.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
DEBT GUARANTEE
The Company has guaranteed approximately $2.6 million of indebtedness of a start-up aviation company, Kestrel Aircraft Company, in exchange for a 25.6% ownership interest, to which no value has been assigned as of December 31, 1996. The Company has advanced the aviation company $241,000 as of December 31, 1996 (none in 1995) and is accruing losses of the aviation company based on its ownership percentage. As a result, the Company has recorded losses of $1,216,000 ($626,000 in 1996, $590,000 in 1995 and none in 1994) related to the debt guarantee. The debt guarantee relates to a $2 million term note and a $2 million revolving credit facility. The $2 million term note requires interest only payments through September 1998; thereafter, it requires monthly principal payments of $11,111 plus interest beginning in October 1998 until it matures on August 8, 1999, at which time all outstanding principal and unpaid interest are due. In the event of default of this note, the Company is required to assume payments on the note with the term extended until August 2004. The $2 million revolving credit facility, on which a subsidiary of the Company has guaranteed up to $600,000 of indebtedness, had been paid down to $125,000 at December 31, 1996 and was paid in full subsequent to year end, although the full line of credit remains available.
The aviation company expects to complete the Federal Aviation Authority certification process by the end of 1997, at which time commercial production may begin. The aviation company will require a significant amount of additional funding in 1997 to complete the certification process and to establish commercial production facilities.
In 1996, the aviation company received $5.0 million from an unrelated third party investor for a 41.6% ownership interest in the aviation company. The investor also retained an option to purchase additional stock of the aviation company in exchange for $4 million. The Company believes these events reduce its likelihood of performing under the debt guarantee; however, if the aviation company is not successful in completing the certification process and obtaining additional external funding, the Company is likely to become responsible for the $2.6 million indebtedness guarantee and may not be able to recover amounts advanced.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
LEGAL MATTERS
Following is a summary of certain legal actions involving the Company:
A. In 1987, the U.S. Government notified one of the Company's subsidiaries, along with numerous other companies, of potential responsibility for clean- up of a waste disposal site in Oklahoma. No legal action has yet been filed. The amount of the Company's cost associated with the clean-up of the site is unknown due to continuing changes in (i) the estimated total cost of clean-up of the site and (ii) the percentage of the total waste which was alleged to have been contributed to the site by the Company, accordingly, no provision for any liability which may result has been made in the accompanying financial statements. The subsidiary's insurance carriers have been notified of this matter; however, the amount of possible coverage, if any, is not yet determinable.
B. The State of Arkansas performed a preliminary assessment of the Chemical Business' primary manufacturing facility (the "Site") and advised the Company that the Site has had certain releases of contaminants. On July 18, 1994, the Company received a report from the State of Arkansas which contained findings of violations of certain environmental laws and requested the Company to conduct further investigations to better determine the compliance status of the Company and releases of contaminants at the Site. On May 2, 1995, the Company signed a Consent Administrative Agreement ("Agreement") with the State of Arkansas. The Agreement provides for the Company to remediate and close a certain landfill, monitor groundwater for certain contaminants and depending on the results of the monitoring program to submit a remediation plan, upgrade certain equipment to reduce wastewater effluent, and pay a civil penalty of $25,000.
Subsequent to the signing of the Agreement on May 2, 1995, the Company completed its remediation and closure activities and had the "Closure Certification Report" approved by the State of Arkansas. The Company also submitted a "Groundwater Monitoring Work Plan" to the State of Arkansas which has been approved and the initial phase of field work has been completed. A work plan for the second phase of the monitoring has also been submitted and approved by the State of Arkansas.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
On February 12, 1996, the Company entered into another Consent Administrative Agreement ("Original Agreement") to resolve certain compliance issues associated with nitric acid concentrations. The Company has installed additional pollution control equipment to reduce opacity and constituent emissions which impact opacity. The Company was assessed $50,000 in civil penalties associated with the Original Agreement. In the Summer of 1996 and then on January 28, 1997, the Company executed amendments to the Original Agreement ("Amended Agreement") which amended the Original Agreement. The January 28, 1997 Amended Agreement acknowledges compliance with the requirements of the prior Amended Agreement and imposed a $150,000 civil penalty. As of December 31, 1996, the Company has paid $13,000 of the above penalties and, subsequent to 1996, the Company paid an additional $127,000 of penalties. The Company is planning to undertake one or more supplemental environmental projects in lieu of paying the remaining penalty due. Based on information presently available, the Company does not believe that compliance with these agreements should have a material adverse effect on the Company or the Company's financial condition or results of operations.
C. In 1996, a lawsuit was filed against the Company's Chemical Business by a group of residents of El Dorado, Arkansas, asserting a citizens' suit against the Chemical Business as a result of certain alleged violations of the Clean Air Act, the Clean Water Act, the Chemical Business' air and water permits and certain other environmental laws, rules and regulations. The citizens' suit requests the court to order the Chemical Business to cure such alleged violations, if any, plus penalties as provided under the applicable statutes. The Company's Chemical Business will assert all defenses available to it and will vigorously defend itself.
In July 1996, several of the same individuals who are plaintiffs in the citizens' suit referenced above filed a toxic tort lawsuit against the Company's Chemical Business alleging that they suffered certain injuries and damages as a result of alleged releases of toxic substances from the Chemical Business' El Dorado, Arkansas manufacturing facility. In October 1996, another toxic tort lawsuit was filed against the Company's Chemical Business. This subsequent action asserts similar damage theories as the previously discussed lawsuit, except this action attempts to have a class certified to represent substantially all allegedly affected persons.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
12. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In October 1996, individuals who reside in various locations throughout the El Dorado, Arkansas metropolitan area filed a class action toxic tort lawsuit against the Chemical Business alleging that, due to releases of certain allegedly toxic substances by the Chemical Business' El Dorado, Arkansas facility, certain property damage and bodily injury resulted to residents of El Dorado, Arkansas. The plaintiffs are attempting to have themselves certified by the court as representatives of persons who allegedly have been affected by emissions from the Chemical Business' El Dorado, Arkansas facility. The plaintiffs are suing for an unspecified amount of actual and punitive damages.
The Company's insurance carriers have been notified of these matters.
The Company, including its subsidiaries, is a party to various other claims, legal actions, and complaints arising in the ordinary course of business. In the opinion of management after consultation with counsel, all claims, legal actions (including those described above) and complaints are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that unfavorable disposition would not have a material effect on the financial position of the Company, but could have a material impact to the net income (loss) of a particular quarter or year, if resolved unfavorably.
OTHER
In 1989 and 1991, the Company entered into severance agreements with certain of its executive officers that become effective after the occurrence of a change in control, as defined, if the Company terminates the officer's employment or if the officer terminates employment with the Company for good reason, as defined. These agreements require the Company to pay the executive officers an amount equal to 2.9 times their average annual base compensation, as defined, upon such termination.
The Company has retained certain risks associated with its operations, choosing to self-insure up to various specified amounts under its automobile, workers' compensation, health and general liability programs. The Company reviews such programs on at least an annual basis to balance the cost/benefit between its coverage and retained exposure.
13. EMPLOYEE BENEFIT PLANS
The Company sponsors a retirement plan under Section 401(k) of the Internal Revenue Code under which participation is available to substantially all full-time employees. The Company does not contribute to this plan, although it does pay for all costs associated with administering the plan.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
14. FAIR VALUE OF FINANCIAL INSTRUMENTS
The following discussion of fair values is not indicative of the overall fair value of the Company's balance sheet since the provisions of the SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," do not apply to all assets, including intangibles.
The following methods and assumptions were used by the Company in estimating its fair value of financial instruments:
LOANS RECEIVABLE: For variable-rate loans with no significant change in credit risk since loan origination, fair values approximate carrying amounts. Fair values for fixed-rate loans are estimated using discounted cash flow analyses, using interest rates which would currently be offered for loans with similar terms to borrowers of similar credit quality and for the same remaining maturities (interest rates range from 5.0% to 11.0% at December 31, 1996). The fair values of loans which are collateral dependent for realization are estimated using the fair value of the underlying collateral.
As of December 31, 1996 and 1995, the net book value of loans receivable was $15.0 million and $15.7 million and fair values of loans receivable were approximately $18.9 million and $18.2 million, respectively (assuming an estimated fair value of the underlying collateral for collateral dependent loans of $18.0 million and $16.5 million in 1996 and 1995, respectively).
BORROWED FUNDS: Fair values for fixed rate borrowings 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. Carrying values for variable rate borrowings approximate their fair value. As of December 31, 1996 and 1995, carrying values of variable rate and fixed-rate long-term debt which aggregated $132.3 million and $118.3 million, respectively, approximated their estimated fair value.
As of December 31, 1996, the carrying values of cash and cash equivalents, accounts receivable, accounts payable, and accrued liabilities approximated their estimated fair value.
15. SEGMENT INFORMATION
The Company and its subsidiaries operate principally in four industries.
CHEMICAL
This segment manufactures and sells chemical products for mining, agricultural, electronic, paper and other industries. Production from the Company's primary
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. SEGMENT INFORMATION (CONTINUED)
manufacturing facility in El Dorado, Arkansas, comprises approximately 72% of the chemical segment's sales. Sales to customers of this segment primarily include coal mining companies throughout the United States and farmers in Texas, Missouri and Tennessee.
The Chemical Business is subject to various federal, state and local environmental regulations. Although the Company has designed policies and procedures to help reduce or minimize the likelihood of significant chemical accidents and/or environmental contamination, there can be no assurances that the Company will not sustain a significant future operating loss related thereto.
The Chemical Business is currently constructing a concentrated nitric acid plant (carrying value of $28.9 million at December 31, 1996) which has a stated production capacity of 285 tons per day. The Company has incurred significant delays and costs in attempting to achieve the plant's stated capacity. The Company anticipates maintaining an economically feasible rate of production. If such rate of production is not maintained, the Company may sustain significant future operating losses related thereto.
Further, the Company purchases substantial quantities of anhydrous ammonia for use in manufacturing its products. The pricing volatility of such raw material directly affects the operating profitability of the chemical segment.
ENVIRONMENTAL CONTROL
This business segment manufactures and sells, primarily from its various facilities in Oklahoma City, a variety of air handling and water source heat pump products for use in commercial and residential air conditioning and heating systems. The Company's various facilities in Oklahoma City comprise substantially all of the environment control operations. Sales to customers of this segment primarily include original equipment manufacturers, contractors and independent sales representatives located throughout the world, are generally secured by a mechanic's lien, except for sales to original equipment manufacturers.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. SEGMENT INFORMATION (CONTINUED)
INDUSTRIAL PRODUCTS
This segment manufactures and purchases machine tools and purchases industrial supplies for sale to machine tool dealers and end users throughout the world. Sales of industrial supplies are generally unsecured, whereas the Company generally retains a security interest in machine tools sold until payment is received.
The industrial products segment attempts to maintain a full line of certain product lines, which necessitates maintaining certain products in excess of management's successive year expected sales levels. Inasmuch as these products are not susceptible to rapid technological changes, management believes no loss will be incurred on disposition.
AUTOMOTIVE PRODUCTS
This segment manufactures and sells anti-friction bearings and other products for automotive applications to wholesalers, retailers and original equipment manufacturers located throughout the world. Net sales from the Company's primary facility in Oklahoma City comprises approximately 87% of the automotive products segment sales.
At December 31, 1996, the automotive segment has $23.6 million of inventory, a portion of which is in excess of current requirements based on recent sales levels. Management has developed a program to reduce this inventory to desired levels over the near term and believes no significant loss will be incurred on disposition.
Credit, which is generally unsecured, is extended to customers based on an evaluation of the customer's financial condition and other factors. Credit losses are provided for in the financial statements based on historical experience and periodic assessment of outstanding accounts receivable, particularly those accounts which are past due. The Company's periodic assessment of accounts and credit loss provisions are based on the Company's best estimate of amounts which are not recoverable. Concentrations of credit risk with respect to trade receivables are limited due to the large number of customers comprising the Company's customer bases, and their dispersion across many different industries and geographic areas.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. Segment Information (continued)
Information about the Company's operations in different industry segments for each of the three years in the period ended December 31, 1996 is detailed below.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. Segment Information (continued)
Revenues by industry segment include revenues from unaffiliated customers, as reported in the consolidated financial statements. Intersegment revenues, which are accounted for at transfer prices ranging from the cost of producing or acquiring the product or service to normal prices to unaffiliated customers, are not significant.
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. Segment Information (continued)
Gross profit by industry segment represents net sales less cost of sales. Operating profit by industry segment represents revenues less operating expenses. In computing operating profit, none of the following items have been added or deducted: general corporate expenses, income taxes or interest expense.
Identifiable assets by industry segment are those assets used in the operations in each industry. Corporate assets are those principally owned by the parent company or by subsidiaries not involved in the four identified industries.
Information about the Company's domestic and foreign operations for each of the three years in the period ended December 31, 1996 is detailed below:
LSB Industries, Inc.
Notes to Consolidated Financial Statements (continued)
15. Segment Information (continued)
Revenues from unaffiliated customers include foreign export sales as follows:
LSB Industries, Inc.
Supplementary Financial Data
Quarterly Financial Data (Unaudited)
(In Thousands, Except Per Share Amounts)
(A) In the fourth quarter of 1996, the Company recorded adjustments to the cost of the DSN plant for depreciation, interest capitalization, excess cost accruals and advances on an insurance settlement. These adjustments increased gross profit on net sales by approximately $3.7 million for the three months ended December 31, 1996.
In the fourth quarter of 1996, the Company also sustained a loss of $1.0 million related to writing-off a note receivable from a customer in the Chemical Business.
LSB Industries, Inc.
Schedule II - Valuation and Qualifying Accounts
Years ended December 31, 1996, 1995 and 1994
(Dollars in Thousands)
(1) Deducted in the balance sheet from the related assets to which the reserve applies.
Other valuation and qualifying accounts are detailed in the Company's notes to consolidated financial statements.
Exhibit 23.1
Consent of Independent Auditors
We consent to the incorporation by reference in the Registration Statement (Form S-8, No. 33-8302) pertaining to the 1981 and 1986 Incentive Stock Option Plans of LSB Industries, Inc. and the Registration Statement (Form S-3, No. 33-69800) and related Prospectus of LSB Industries, Inc. of our report dated March 7, 1997, with respect to the consolidated financial statements and schedule of LSB Industries, Inc. included in the Annual Report (Form 10-K) for the year ended December 31, 1996.
ERNST & YOUNG LLP
Oklahoma City, Oklahoma April 10, 1997