LSB Industries, Inc.
Q3 2008 Earnings Call Transcript

Published: 24 Nov 2008

[Operator:]

Good day everyone and welcome to the LSB Industries, Incorporated Third Quarter 2008 Conference Call. At this time, I would like to inform you that this conference is being recorded and that all participants are currently in a listen-only mode. I will now turn the conference over to Ms. Carol Oden. Please go ahead, ma'am.

[Carol Oden:]

Thank you. Welcome to the LSB Industries, Inc. third quarter 2008 conference call. Today, LSB’s management participants are Jack Golsen, Chairman and Chief Executive Officer; Barry Golsen, President, and Tony Shelby, Chief Financial Officer. This conference call is being broadcast live over the Internet and is also being recorded. An archive of the webcast will be available shortly after the call on our website at www.lsb-okc.com and will be accessible for one month. After comments by management, a question-and-answer session will be held. Instructions for asking questions will be provided at that time. Information reported on this call speaks only as of today, November 6, 2008, and therefore you are advised that time-sensitive information may no longer be accurate as at the time of any replay. We do not intend to and undertake no duties to update the information contained in this conference call. Comments today may contain certain forward-looking statements. All statements other than statements of historical facts are forward-looking statements. Statements that include the words expect, intend, plan, believe, project, anticipate, estimate and similar statements of a future or forward-looking nature identify forward-looking statements, including but not limited to, starting up our Pryor, Oklahoma chemical plant, obtaining our long-term offtake agreement for the production at the Pryor plant, cost to activate the Pryor plant, production plans at the Pryor plant at approximately 120 million annual sales, we are in a strong position to finance operations, as well as growth opportunities, capital expenditures for expansion, optimistic about the long range potential for our geothermal products, demand for our acids and ammonium nitrate, emphasize cost reduction while developing products and customer mix that will allow us to operate our chemical plants at full rate, the outlook for commercial construction for this years and future years, prospects for growing the Climate Control business, outlook for a strong ag market, the general level of future activities positions LSB to improve and grow its economy, allow liquidity as a company, impact of gas hedged contracts in the fourth quarter and future quarters, effect of economic slowdown in our Climate Control business and construction industry, sections under the Economic Stability Act of 2008 and effects on our Climate Control business, long range growth of geothermal products, cost reductions, outlook for our chemical business is good, and prospects regarding our Climate Control business is good. The term EBITDA as used in this presentation is net income plus interest expense, depreciation, amortization, income taxes, and certain non-cash charges unless otherwise described. You should not rely on forward-looking statements because actual events or results may differ materially from those indicated by these forward-looking statements as a result of a number of important factors. These factors include but are not limited to decline in general economic conditions, interest rate changes, competitive pressures, changes in working capital and the risk and uncertainties discussed under the heading Special Note Regarding Forward-Looking Statements in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007. The Form 10-Q for the quarter ended September 30, 2008, and the reports we filed from time to time with the Securities and Exchange Commission. We do not intend to and anticipate no duty to update the information contained in this conference call. The term EBITDA as used in this presentation is net income plus interest expense, depreciation, amortization, income taxes, and certain non-cash charges unless otherwise described. EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative for GAAP measurement. We will post on our website a reconciliation to GAAP of any EBITDA numbers discussed during this conference call. Now, I'll turn the conference call over to Mr. Jack Golsen, the company's Board Chairman.

[Jack Golsen:]

Thank you, Carol. Good afternoon, everybody, and welcome to LSB's third quarter 2008 conference call. Today, Tony Shelby, our Chief Financial Officer and Executive Vice President will review our overall financial results. Then Barry Golsen, our President and Chief Operating Officer will discuss both the Climate Control and the chemical businesses. Following these presentations, Tony, Barry and I will be available to answer your questions. With everything that's taking place in our economy, any indications we give you about the markets we serve are subject to the return of stability in the credit and capital markets. Our businesses have continued to have good order levels and our backlogs are strong at this time. We do see indications that the general level of future activity will be less than has been in certain areas. We are convinced that even if the short or medium term general economy turns out to be negative, we are doing the right thing to position LSB to improve and grow as the economy and our markets allow. We did not anticipate the current financial crisis that our country is experiencing, but fortunately the steps that we have previously taken have resulted in us having liquidity, the need to continue with the investments required for our planned long-term growth. Our general approach is to conserve cash to use to fuel our growth plans. When you analyze the numbers behind our third quarter results as we have reported them in our new release this afternoon, they were better than they appear. In last year's third quarter, there were tax benefits. This year, our earnings are fully taxed. During last year's third quarter, we recognized income of 4.8 million from a litigation settlement and insurance recoveries. This did not recur this year. This year's third quarter was a perfect storm of detracting events. Tony will break down the details on these events for you in a few minutes. During the third quarter, our chemical's operating income was adversely affected by $10 million due to unexpected plant maintenance downtime, loss of commodity markets and hurricane related delays. When we discussed the Pryor plant with investors during the prior conference call, we mentioned that we were considering activating a portion of the Pryor Oklahoma plant subject to securing a sales agreement with a strategic customer to purchase or distribute the majority of UAN production. We believe that we will be able to reach an agreement based on our discussions with several strategic industry customers. Based on that belief and our expectation that we will receive the necessary permit, we have rehired key personnel to operate this facility and have positioned the additional necessary personnel to be hired at appropriate intervals during the preparation to startup. We have hit an administrative delay with obtaining the necessary permits to operate the Pryor plant. We expected to receive permits last month but it now looks like issuance of the final permit could be delayed up to 90 days due to administrative procedures. Therefore, we are proceeding with preparations to start the plant. Barring unforeseen delays and subject to securing a sales or distribution agreement, we expect production to be implemented by July 2009, which at today's prices, we believe will add approximately $120 million in annual sales. We can expect this sales number to fluctuate according to market conditions. We are also considering the addition of industrial products to our production at this plant and are discussing this possibility with industrial users of anhydrous ammonia, nitric acid and solutions. The above sales numbers do not include these additional products. Before turning the call over to Tony, a few points are worth mentioning. On October 28, our shares began trading on the New York Stock Exchange, we have the same stock symbol LXU. As we announced last month, we renewed long-term supply agreement with two of our large customers, Bayer MaterialScience for nitric acid and with Nelson Brothers for ammonium nitrate solutions. We welcome Northern Securities to the list of firms that follow LSB in research. And finally in the October 27 issue of Forbes Magazine, LSB was ranked number 27 among America's best small companies. Now, I will turn this call over to Tony Shelby. Tony?

[Tony Shelby:]

Thank you Jack and good afternoon. We made our earnings announcement approximately one hour ago reporting diluted earnings per share of $0.18 for the third quarter of 2008 versus $0.77 in the 2007 third quarter. The details for the third quarter of 2008 compared to third quarter 2007 were

[Barry Golsen:]

Thanks, Tony. First let's discuss the Climate Control business. As Tony mentioned, our Climate Control business sale during the third quarter were higher than the same period last year by 10%. Total heat pump sales were up 21%. Fan coil sales were down 5% and other sales were down 6%. As discussed in prior conference calls, our shipments in the first half of 2007 were unusually high because we were in the process of working off excessively high backlogs. Despite these high sales levels in 2007, our year-to-date sales this year were still higher than last year by 4%. New product orders during the third quarter were $101 million, 53% year-over-year increase, 34% increase over the second quarter, and the highest bookings quarter in history of our Climate Control business. Year-to-date as of 9/30, our order in take was 247 million, up 31% over the first nine months of 2007. This trend has continued. In October we received new product orders totaling 27.5 million. We ended the quarter with a backlog of product orders of 86 million, up from 54 million at year end. I am glad to report that as of the end of the third quarter, we continue to maintain leading market shares with geothermal and water source heat pumps and for hydraulic fan coils. Our gross margin during the third quarter this year was 29.9% approximately the same at 29.7% for the same period last year. With regard to raw materials, primarily copper, steel and aluminum, since our last conference call, we've seen considerable volatility. Prices increased through the third quarter. Recently, raw material prices have declined. We continue to watch commodities very closely and to hedge when appropriate. Even though our gross profit increased by 2.5 million, our operating profit showed only marginal improvement over the third quarter of 2007. This was due to higher variable sales cost associated with sales volume increases, higher legal and insurance costs and higher personnel cost associated primarily with intensified sales and marketing efforts. A key question that we are asked frequently is, what's the outlook for construction both commercial and residential? Due to the trauma caused by the worst financial crisis in decades, which is still unresolved at this time, the availability of credit to our customers going forward is still a question. So, with the assumption that credit availability will stabilize, I will attempt, let me repeat and emphasize, attempt, to discuss the current outlook. The vast majority of our Climate Control business sales are to commercial and institutional new construction renovation and replacement. Year-to-date through 6/30, commercial and institutional sales accounted for approximately 84% of our total Climate Control business sales. 74% of our total Climate Control business sales were used in offices, hotels, educational facilities, healthcare and retirement facilities, manufacturing and process plants, apartments and condominiums. McGraw-Hill's current outlook as we reported in the 2008 Ware edition of their construction market forecasting service is that contract awards for these building types in the aggregate will increase by 0.8% in 2008 and will decrease by 9.9% in 2009 followed by increases of 5.3% and 14.3% in 2010 and 2011. These numbers represent an upward revision for 2008 since the last conference call, a downward revision for 2009 and 2010 and an upward revision for 2011. I would like to emphasize again that McGraw-Hill's forecast is predicated on the credit market stabilizing in the near future. Input from our sales force is that the current pipeline is strong but that certain markets have been hit hard. There is hesitancy by some customers to proceed with new projects and some projects have been put on hold. The market that seemed to be the hardest hit are New York City; banking and financial industry and office buildings, Las Vegas; large casino hotels and condos, and Florida, primarily condominium. Because it’s an area of interest to many of you, I would like to discuss our residential geothermal sales. It's stating the obvious to describe the dismal situation the single family residential construction market is in. The current McGraw- Hill forecast is for a 36% decline in 2008. This is following a cumulative decline of almost 40% during 2006 and 2007. It’s important to focus on the fact that in 2007, our sales into the single family residential market, which for us is all geothermal heat pumps represented only 11% of total Climate Control business sales. Year-to-date through 9/30 our residential geothermal business was 16% of climate control business sales. Despite the lagging residential market in general, our third quarter residential geothermal sales increased 149% over the third quarter of 2007. Even more encouraging were bookings for these products. During the third quarter, they were up 261% over the same period last year. Year-to-date, as of 9/30, our residential geothermal bookings are up 150% over the first nine months of last year. To put it another way, both our single family residential geothermal third quarter sales and year-to-date bookings were two and a half times greater than the same periods last year and our third quarter bookings were over three and a half times greater than the third quarter of last year, all in the face of a housing market that in general has been decimated. Also relating to geothermal, the Economic Stability Act 2008 also known as the $700 billion bailout package included tax incentives in the form of tax credits that should encourage the purchase of residential and non-residential geothermal heat pumps. The provisions of the bill applicable to geothermal heat pumps are up to $2000 of Federal tax credits persistent for private residential systems and Federal tax credits equal to 10% of the total system cost for non-residential systems with no persistent limit for the non-residential part. Both of these tax credits will remain in effect for eight years and it can offset both regular and alternative minimum tax liabilities. In addition, the bill also provides that any property, which is described as energy property, which includes geothermal heat pumps is depreciable over five yeas. In addition, many states have incentives at this time and we're hopeful that spurred by the new federal legislation, other states will get on board and the states that currently have incentives will increase them. We believe that our geothermal products are an important part of the solution to environmental and energy issues facing our country, and we remain very optimistic about the long range growth potential for these products. While our historic business model has not been predicated on any tax incentives, we certainly plan to take advantage of this to the extent possible to promote sales of our geothermal products. To that end, we're in the process of substantially intensifying our sales and marketing programs for geothermal products and are also preparing our manufacturing facilities to handle any increased volume that may result from these efforts. We have made significant staff additions in field sales, dedicated support staff and marketing. In the past two years, we've doubled our manufacturing floor space and added equipment, and we are in the planning stages for another significant plant addition. We've also increased the capacity of our coil manufacturing facility which supports this product. Turning to our Chemical business, as Tony reported, this business got off to a great start in the first half of the year but it hit road bumps in the third quarter. During the third quarter, total sales of our chemical products were up 80% over the third quarter of 2007. The increased sales were driven by substantially higher raw material costs that translated into higher sales prices. Gross profits and operating income were down. Gross profit decreased from $11.7 million in 2007 to $5.3 million in 2008, and operating decreased from 11.5 million to 1.9 million. Backing off the impact of the 4.8 million of unusual gains in the third quarter of 2007 that Tony discussed earlier, the balance of this decrease can be attributed to the unplanned maintenance downtime at the Cherokee Facility and to the unrealized non-cash loss on natural gas contracts. Both of these items were discussed by Tony earlier. Without these unusual items, operating income would have improved. The unplanned maintenance downtime at Cherokee was unusual in duration and also impacted our most profitable product at that time. All of the supply against demand fundamentals continued to be in our favor during the third quarter. However, we are in a very volatile market as the following information will indicate. During the third quarter, our shipped tonnage of urea ammonium nitrate or UAN was 20% higher than the third quarter of 2007 while our revenues from these sales increased 82%. The published sales prices per ton during the third quarter of 2008 ranged from 418 to $520 per ton, up from 270 to $300 per ton a year ago. However, it is now below $300 a ton. At the same time, the cost of natural gas, the primary feedstock for producing UAN at our Cherokee Facility increased from a range of $5.33 to $7.19 per MMBtu in the third quarter of 2007 to a range of $6.98 to $13.16 this year. Currently, the spot market natural gas price is approximately $6.90 in the 12 months strip, which changes daily, it was quoted today at approximately $7.35 per MMBtu. Whereas ammonium nitrate sales lagged in both the first and second quarters due to weather conditions primarily, high prices of urea pushed the market towards UAN in the third quarter. During the third quarter of 2008, we sold 23% more tons of UAN than in the third quarter of 2007. However, our revenues for this product were up 90%, reflecting an increase – reflecting increased sales price per ton. The price of anhydrous ammonia, the raw material feedstock for our El Dorado Facility escalated significantly during the first nine months of the year after being relatively stable during 2007. Published prices at the Tampa price point increased from an average of the mid 400 per metric ton in January to a range of $585 to $930 per metric ton during the third quarter. Since that time, ammonia has tumbled and today's price is approximately $575 per metric ton and is predicted to go lower. The majority of El Dorado sales are to customers who accept the cost of ammonia as a passthrough. Global grain stocks including corn and wheat are at historic low levels and are driving the demand for nitrogen fertilizers. These favorable supply demand fundamentals were the catalyst for significantly higher fertilizer selling prices and better margins in 2007 and this trend continued into 2008. However, recently, we have seen a sudden price drop for most commodities and the price of fertilizer in the market has also declined. Fortunately, the price of both the feedstocks we use, anhydrous ammonia at El Dorado and natural gas at Cherokee have also declined and we're able to produce our agricultural fertilizer products at possible level at current market prices. On both the Ag and industrial sides of our chemical business, many of our customers are in an inventory correction mode. This is also affecting current short-term demand. Based on the general economic conditions, we're anticipating some softening in the demand for our industrial products. We believe that many of our customers are in a wait and see mode with regard to their production level. However, we believe that in the long run, there will be steady demand for both our industrial acids and our industrial grade ammonium nitrate used for surface mining. Summing up, the third quarter Climate Control sales were up but the bottom line only showed marginal improvement, primarily due to our investments in growing the business. We also incurred higher variable selling expenses, leave costs in healthcare expenses. New orders were very strong during the third quarter continuing the trend from the first half of the year. The current outlook for 2008 commercial construction is slightly better than a quarter ago. However, the future of credit availability to our customers is unknown and could virtually affect commercial construction. We're particularly glad to see strong shipments and new orders of our geothermal products, which have so far bucked the trend of both general residential construction and the markets for conventional residential heating and cooling systems. We believe the recently enacted federal tax incentives will help our geothermal sales. We're very excited about our prospects for growing all of LSB's Climate Control business and particularly our geothermal heat pumps over the long-term. Turning to Chemical, sales were up but profits were down, primarily as a result of the unusual items that we've discussed. We believe the long-term outlook for our ag market is good because of the continuing demand for product costs that will be strong. Current sales prices and feedstock costs are lower than in the recent past; however, the current sales price results in a positive cash margin. Our industrial chemical business demand has been steady so far with the outlook remaining good but we anticipate softening due to the general economic conditions. This business should remain profitable as long as we run our plants at economic levels as it is sold on a cost plus basis. We recently renewed our agreements with Bayer MaterialScience and Nelson Brothers and finally we should make a decision whether to proceed with the startup of Pryor plant in the next 90 to 120 days. We will now take your questions.

[Operator:]

(Operator instructions). And your first question will come from the line of Eric Prouty with Canaccord Adams.

[Eric Prouty:]

Great. Thanks a lot. And Jack, Barry and Tony, congratulations, good quarter on a tough environment. I guess on the geothermal and Climate Control business in particular, obviously with the real rapid growth in geothermal, we have a mix shift going on, could you maybe get into a little bit of detail about how that revenue mix shift over time might impact both the gross margin and operating margin, both geothermal as a whole grows, and then as residential within the geothermal mix grows at even faster clip than the commercial?

[Jack Golsen:]

Well, these are all products that have good healthy gross margins. And as we grow the business, I think in general no matter how we grow the business, we're going to see some operating leverage and leverage on the bottom line and overhead absorption is what I'm really talking about. And so, as we grow, we expect this to just enhance the overall profitability of the business.

[Eric Prouty:]

Right. So, no significant differential in gross margin between the geothermal products and say the coil product, any other retract products?

[Jack Golsen:]

No they are all in the same range. What you have in our business, I'm going to leave you with the impression that all the products we sell have exactly the same gross profits. I might over explain here but I want to be explicit. In everyone of our products, there's a range of profitability depending on the distribution channel we sell through, the size of the job, the competitive nature of the market at the time. So, there is a range. But generally speaking, we don't see a significant difference in the gross profit levels but what we just see is continued growth of the business and the benefits we get from that growth.