FORM 10-K
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
(Mark One)
/X/ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934 (FEE REQUIRED)
For the fiscal year ended: December 31, 1998
or
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 (NO FEE REQUIRED)
For the transition period from __________ to __________
Commission File Number:
CLIMACHEM, INC.
(Exact Name of Registrant as Specified in its Charter)
Oklahoma 73-1528549
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(State of Incorporation) (I.R.S. Employer Identification No.)
16 South Pennsylvania Avenue
Oklahoma City, Oklahoma 73107
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(Address of Principal Executive Offices) (Zip Code)
Registrant's Telephone Number, Including Area Code:
(405) 235-4546
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Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the Registrant (1) has filed all
reports required by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for the shorter period that the
Registrant has had to file the reports), and (2) has been subject to the
filing requirements for the past 90 days. YES __X__ NO _____.
Indicate by check mark if disclosure of delinquent filers pursuant
to Item 405 of Regulation S-K is not contained herein, and will not be
contained, to the best of Registrant's knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form
10-K or any amendment to this Form 10-K. __________.
All outstanding shares of common stock of the registrant are held
directly or indirectly by the registrant's parent company, LSB Industries,
Inc.
FORM 10-K OF CLIMACHEM, INC.
TABLE OF CONTENTS
PART I
Page
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Item 1. Business
General 1
Segment Information and Foreign
and Domestic Operations and Export Sales 1
Chemical Business 1
Climate Control Business 7
Employees 9
Research and Development 10
Environmental Matters 10
Item 2. Properties
Chemical Business 13
Climate Control Business 13
Item 3. Legal Proceedings 14
Item 4. Submission of Matters to a Vote of
Security Holders 15
Item 4A. Executive Officers of the Company 16
PART II
Item 5. Market for Company's Common Equity
and Related Stockholder Matters
Market Information 17
Item 6. Selected Financial Data 18
Item 7. Management's Discussion and Analysis
of Financial Condition and Results of Operations
Overview 20
Results of Operations 23
Liquidity and Capital Resources 26
Year 2000 Issues 30
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
General 32
Interest Rate Risk 32
Raw Material Price Risk 35
Foreign Currency Risk 35
Item 8. Financial Statements and Supplementary Data 35
Item 9. Changes in and Disagreements with Accountants
on Accounting and Financial Disclosure 35
Special Note Regarding Forward-Looking Statements 36
PART III 39
PART IV
Item 14. Exhibits, Financial Statement Schedules and
Reports on Form 8-K 39
iii
PART I
ITEM 1. BUSINESS
GENERAL
The Company, a wholly owned subsidiary of LSB Industries, Inc.
("LSB"), is engaged, through its subsidiaries, in the manufacture and sale of
(i) chemical products for the explosives, agricultural and industrial acids
markets, and (ii) a broad range of hydronic fan coils and water source heat
pumps as well as other products used in commercial and residential air
conditioning systems.
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 11 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 Company's Chemical Business manufactures three principal product
lines that are derived from anhydrous ammonia: (1) fertilizer grade ammonium
nitrate for the agricultural industry, (2) explosive grade ammonium nitrate
for the mining industry and (3) concentrated, blended and mixed nitric acid
for industrial applications. In addition, the Company also produces sulfuric
acid for commercial applications primarily in the paper industry. The
Chemical Business' products are sold in niche markets where the Company
believes it can establish a position as a market leader. See "Special Note
Regarding Forward-Looking Statements".
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, and
four locations in Australia.
For each of the years 1998, 1997 and 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%, 16% and 17% of the Company's consolidated sales for each respective
year, and approximately 52%, 61% and 61% of the sales of the Chemical
Business consisted of sales of ammonium nitrate and other chemical-based
blasting products for the mining industry, which represented approximately
28%, 36% and 40% of the
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Company's 1998, 1997 and 1996 consolidated sales, respectively. The Chemical
Business accounted for approximately 55%, 60% and 65% of the Company's 1998,
1997 and 1996 consolidated sales, respectively.
AGRICULTURAL PRODUCTS
The Chemical Business produces ammonium nitrate, a nitrogen-based
fertilizer, at the El Dorado Facility. In 1998, the Company sold
approximately 143,000 tons of ammonium nitrate fertilizer to farmers,
fertilizer dealers and distributors located primarily in the south central
United States.
Ammonium nitrate is one of several forms of nitrogen-based
fertilizers which include anhydrous ammonia and urea. Although, to some
extent, the various forms of nitrogen-based fertilizers are interchangeable,
each has its own characteristics which produce agronomic preferences among
end users. Farmers decide which type of nitrogen-based fertilizer to apply
based on the crop planted, soil and weather conditions, regional farming
practices and relative nitrogen fertilizer prices.
The Chemical Business is a major manufacturer of fertilizer grade
ammonium nitrate, which it markets primarily in Texas, Arkansas and the
surrounding regions. This market, which is in close proximity to its El
Dorado Facility, includes a high concentration of pasture land and row crops
which favor ammonium nitrate over other nitrogen-based fertilizers. The
Company has developed the leading market position in Texas by emphasizing
high quality products, customer service and technical advice. Using a
proprietary prilling process, the Company produces a high performance
ammonium nitrate fertilizer that, because of its uniform size, is easier to
apply than many competing nitrogen-based fertilizer products. The Company
believes that its "E-2" brand ammonium nitrate fertilizer is recognized as a
premium product within its primary market. In addition, the Company has
developed long term relationships with end users through its network of 22
owned and operated wholesale and retail distribution centers.
In 1998, the Chemical Business has been adversely affected by the
extreme drought conditions in the mid-south market during the primary
fertilizer season, followed by excess wet conditions and floods in the fall
season, resulting in substantially lower volume and lower sales prices for
certain of its products sold in its agricultural markets. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Special Note Regarding Forward-Looking Statements".
EXPLOSIVES
The Chemical Business manufactures low density ammonium
nitrate-based explosives including bulk explosives used in surface mining. In
addition, the Company manufactures and sells a branded line of packaged
explosives used in construction, quarrying and other applications,
particularly where controlled explosive charges are required. The Company's
bulk explosives are marketed primarily through five Company-owned
distribution centers, three of which are located in close proximity to the
customers' surface mines in the coal producing states of Kentucky, Missouri,
and West Virginia. Additionally, the Company,
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through its Australian subsidiary, manufactures and distributes bulk and
packaged explosives in Australia. The Company emphasizes value-added customer
services and specialized product applications for its bulk explosives. Most
of the sales of bulk explosives are to customers who work closely with the
Company's technical representatives in meeting their specific product needs.
In addition, the Company sells bulk explosives to independent wholesalers and
to other explosives companies. Packaged explosives are used for application
requiring controlled explosive charges and typically command a premium price
and produce higher margins. The Company believes its Slurry packaged
explosive products are among the most widely recognized in the industry.
Slurry packaged explosive products are sold nationally and internationally to
other explosive companies and end-users.
The Company has received an offer in 1999, the terms of which it is
presently negotiating with the company that made the offer, to sell the
Australian subsidiary; however, there are no assurances that the Company will
sell the Australian subsidiary.
INDUSTRIAL ACIDS
The Chemical Business manufactures and sells industrial acids,
primarily to the food, paper, chemical and electronics industries. The
Company is the leading supplier to third parties of concentrated nitric acid
which is a special grade of nitric acid used in the manufacture of plastics,
pharmaceuticals, herbicides, explosives, and other chemical products. In
addition, the Company produces and sells regular, blended and mixed nitric
acid and a variety of grades of sulfuric acid. The Company competes on the
basis of price and service, including on-time reliability and distribution
capabilities. The Company operates the largest fleet of tankcars in the
concentrated nitric acid industry which provides it with a significant
competitive advantage in terms of distribution costs and capabilities. In
addition, the company provides inventory management as part of the
value-added services it offers to its customers.
The Company has identified concentrated nitric acid as a strategic
product line for its Chemical Business due to attractive levels of
profitability, increased diversity of end markets and the ability to compete
on a value added service basis. To support further growth in its nitric acid
business, the Company constructed the DSN Plant located at the El Dorado
Facility. The DSN Plant uses a newer and more efficient process to produce
concentrated nitric acid directly from anhydrous ammonia, in contrast to the
conventional process which requires the input of regular nitric acid, an
intermediate step to produce concentrated nitric acid.
DSN PLANT
During the four years commencing January 1, 1994, the Chemical
Business spent approximately $32.0 million to construct and install the DSN
Plant. The DSN Plant began limited operations in 1995, and such limited
operations continued due to certain mechanical and design problems associated
with the plant's construction and installation. As a result of such problems,
production at the DSN Plant was limited to approximately 170 and 223 tons per
day for the years
3
ended December 31, 1997 and 1998, respectively. These production rates
approximate 60% and 80%, respectively, of the stated capacity of 285 tons per
day assuming 338 days of annual production. In October, 1998, management
completed certain corrective actions at the DSN Plant. As a result of these
corrective actions, the DSN Plant has since produced at rates equal to or
above the stated capacity of 285 tons per day. While the Company will seek to
market the additional capacity of concentrated nitric acid output to
commercial markets, there can be no assurance that the Company will be able
to sell all of the additional capacity in this market. However, to the extent
that there is insufficient demand for concentrated nitric acid, the Company
believes it can profitably use the concentrated nitric acid in the production
of mixed and blended acids and ammonium nitrate based fertilizer and
explosives (although at lower margins than if the production were sold as
concentrated nitric acid). See "Special Note Regarding Forward-Looking
Statements".
EDNC BAYTOWN PLANT
In June, 1997, two wholly owned subsidiaries of the Company, El
Dorado Chemical Company ("EDC") and El Dorado Nitrogen Company ("EDNC"),
entered into a series of agreements with Bayer Corporation
("Bayer")(collectively, the "Bayer Agreement"). Under the Bayer Agreement,
EDNC will act as an agent to construct and, upon completion of construction,
will operate a nitric acid plant (the "EDNC Baytown Plant") at Bayer's
Baytown, Texas chemical facility. EDC has guaranteed the performance of
EDNC's obligations under the Bayer Agreement.
Under the terms of the Bayer Agreement, EDNC is to lease the EDNC
Baytown Plant pursuant to a leveraged lease from an unrelated third party
with an initial lease term of ten years from the date on which the EDNC
Baytown Plant becomes fully operational. Bayer will purchase from EDNC all of
its requirements for nitric acid to be used by Bayer at its Baytown, Texas
facility for ten years from the date on which the EDNC Baytown Plant becomes
fully operational. EDNC will purchase from Bayer its requirements for
anhydrous ammonia for the manufacture of nitric acid as well as utilities and
other services. Subject to certain conditions, EDNC will be entitled to sell
the amount of nitric acid manufactured at the EDNC Baytown Plant which is in
excess of Bayer's requirements to third parties. The Bayer Agreement provides
that Bayer will make certain net monthly payments to EDNC which will be
sufficient for EDNC to recover all of its costs plus a profit. The Company
estimates that, after the initial start-up phase of operations of the EDNC
Baytown Plant, at full production capacity based on terms of the Bayer
Agreement and subject to the price of anhydrous ammonia, the EDNC Baytown
Plant is anticipated to generate approximately $35 million to $50 million in
annual gross revenues. Unlike the Chemical Business' regular sales volume,
the market risk on this additional volume is much less since the contract
provides for recovery of costs, as defined, plus a profit. See "Special Note
Regarding Forward-Looking Statements". Upon expiration of the initial
ten-year term from the date the EDNC Baytown Plant becomes operational, the
Bayer Agreement may be renewed for up to six renewal terms of five years
each; however, prior to each renewal period, either party to the Bayer
Agreement may opt against renewal.
4
Under the original Bayer Agreement, if operations at the EDNC
Baytown Plant were not commenced by February 1, 1999, or upon a change in
control of LSB, EDC or EDNC, Bayer had an option to terminate the Bayer
Agreement. EDNC has an option to terminate the Bayer Agreement upon the
occurrence of certain events of default which remain uncured. Bayer retains
the right of first refusal with respect to any bona fide third-party offer to
purchase any voting stock of EDNC or any portion of the EDNC Baytown Plant.
In January, 1999, the contractor constructing the EDNC Baytown Plant
informed the Company that it could not complete construction alleging a lack
of financial resources. The Company and certain other parties involved in
this project have demanded the contractor's bonding company to provide funds
necessary for subcontractors to complete construction. The Company, the
contractor, the bonding company and Bayer have entered into an agreement
which provides that the bonding company will pay $12.9 million for payments
to subcontractors for work performed prior to February 1, 1999. In addition,
the contractor has agreed to provide, on a no cost basis, labor and to incur
certain other additional costs through the completion of the contract.
Because of this delay, an amendment was entered into in connection with the
Bayer Agreement. The amendment extended the requirement date that the plant
be in production by May 31, 1999, and fully operational by June 30, 1999. The
amendment also requires the Company to reimburse Bayer for certain increased
costs incurred by Bayer due to the failure to complete the construction of
the EDNC Baytown Plant by February 1, 1999. The anticipated construction cost
of the EDNC Baytown Plant, not including the $12.9 million paid to
subcontractors by the bonding company, is currently anticipated to be
approximately $69 million. The Company anticipates that construction of the
EDNC Baytown Plant will be mechanically complete and making acid by April 15,
1999, and, after completion of certain performance tests, be fully
operational by June 1, 1999. Construction financing of the EDNC Baytown Plant
is being provided by an unaffiliated lender up to $75 million. Neither the
Company nor EDC has guaranteed any of the lending obligations for the EDNC
Baytown Plant. See "Special Note Regarding Forward-Looking Statements".
RAW MATERIALS
Anhydrous ammonia represents the primary component in the production
of most of the products of the Chemical Business. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
The Chemical business currently purchases approximately 220,000 tons of
anhydrous ammonia per year for use in its manufacture of its products. The
Company has contracts with three suppliers of anhydrous ammonia. One contract
expires in April, 2000, one expires in June, 2000, and the other expires in
December, 2000. The Chemical Business is required to buy at least 120,000
tons of its annual requirements of anhydrous ammonia under the contract
expiring in April, 2000, at least 24,000 tons of its annual requirements of
anhydrous ammonia under the contract expiring in June, 2000, and at least
60,000 tons of its annual requirements of anhydrous ammonia under the
contract expiring in December, 2000, with additional quantities of anhydrous
ammonia available under each contract. Anhydrous ammonia is not being
currently supplied under the contract expiring in December, 2000, due to that
supplier's declaration of an event of force majeure as a result of a
temporary shut down of its plant caused by mechanical problems. The Company
has
5
been able to, on a temporary basis, obtain anhydrous ammonia from other
sources on similar terms as provided in the contract expiring in December,
2000.
During 1995, 1996, 1997, and the first half of 1998, there were
substantial increases in the price for anhydrous ammonia. During each of
these periods, the Chemical Business was unable to increase its sales prices
to cover all of the higher anhydrous ammonia costs incurred by the Company,
and in the future the Chemical Business may not be able to pass along to its
customers the full amount of increases in anhydrous ammonia costs.
Accordingly, the Company's results of operations and financial condition have
in the past been adversely affected by cost increases of raw materials,
including anhydrous ammonia. During the second half of 1998, cost for
anhydrous ammonia decreased. The ammonia industry added an additional one
million tons of capacity of anhydrous ammonia in the western hemisphere in
1998, and the Company believes there is approximately one million tons of
additional annual capacity of anhydrous ammonia being constructed in the
western hemisphere scheduled for completion in 1999. The Company believes
this additional capacity may contribute to a decline in the future market
price of anhydrous ammonia. See "Special Note Regarding Forward-Looking
Statements".
The Company believes that it could obtain anhydrous 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.
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 are primarily
during the spring and fall planting seasons, which typically extend from
February through May and from September through November in the geographical
markets in which the majority of the Company's agricultural products are
distributed. As a result, the Chemical Business increases its inventory of
ammonium nitrate prior to the beginning of each planting season. Sales to the
agricultural markets depend upon weather conditions and other circumstances
beyond the control of the Company.
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 will expire in
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. The
Australian distribution centers are subject to comparable licensing
requirements imposed by their controlling government authorities. The
Chemical Business is also subject to
6
extensive federal, state and local environmental laws, rules and regulations.
See "Environmental Compliance", "Environmental Matters" and "Legal
Proceedings".
COMPETITION
The Chemical business competes with other chemical companies in its
markets, many of whom have greater financial and other resources than the
Company. The Company believes that competition within the markets served by
the Chemical Business is primarily based upon price, service, warranty and
product performance. The Company believes that the Chemical Business is the
leader in the Texas ammonium nitrate market and is the leading producer of
concentrated nitric acid in the United States for third party sales. See
"Special Note Regarding Forward-Looking Statements".
DEVELOPMENTS IN ASIA
The Chemical Business' Australian subsidiaries' results of
operations have been adversely affected during 1997 and 1998 due to economic
developments in certain countries in Asia. These economic developments in
Asia have had a negative impact on the mining industry in Australia which the
Chemical Business services. The Company received in 1999 an offer for the
purchase of the Australian subsidiary, and, as of the date of this report,
the Company is negotiating with the company that made the offer. There are no
assurances that the Company will sell the Australian subsidiary.
CLIMATE CONTROL BUSINESS
GENERAL
The Company's Climate Control Business manufactures and sells a
broad range of standard and custom designed hydronic fan coils and water
source heat pumps as well as other products for use in commercial and
residential heating ventilation and air conditioning ("HVAC") systems. Demand
for the Climate Control Business' products is driven by the construction of
commercial, institutional and residential buildings, the renovation of
existing buildings and the replacement of existing systems. The Climate
Control Business' commercial products are used in a wide variety of
buildings, such as: hotels, motels, office buildings, schools, universities,
apartments, condominiums, hospitals, nursing homes, extended care facilities,
supermarkets and superstores. Many of the Company's products are targeted to
meet increasingly stringent indoor air quality and energy efficiency
standards. The Climate Control Business accounted for approximately 45%, 40%
and 35% of the Company's 1998, 1997 and 1996 consolidated sales, respectively.
HYDRONIC FAN COILS
The Climate Control Business is the leading provider of hydronic fan
coils targeted to the commercial and institutional markets in the U.S.
Hydronic fan coils use heated or chilled water, provided by a centralized
chiller or boiler through a water pipe system, to condition the air and allow
individual room control. Hydronic fan coil systems are quieter and have
longer lives and lower
7
maintenance costs than comparable systems used where individual room control
is required. The Company believes that its product line of hydronic fan coils
is the most extensive offered by any domestic producer. The breadth of this
product line coupled with customization capability provided by a flexible
manufacturing process are important components of the Company's strategy for
competing in the commercial and institutional renovation and replacement
markets. See "Special Note Regarding Forward-Looking Statements".
WATER SOURCE HEAT PUMPS
The Company is a leading U.S. provider of water source heat pumps to
the commercial construction and renovation markets. These are highly
efficient heating and cooling units which enable individual room climate
control through the transfer of heat through a water pipe system which is
connected to a centralized cooling tower or heat injector. Water source heat
pumps enjoy a broad range of commercial applications, particularly in medium
to large sized buildings with many small, individually controlled spaces. The
Company believes the market for commercial water source heat pumps will
continue to grow due to the relative efficiency and long life of such systems
as compared to other air conditioning and heating systems, as well as to the
emergence of the replacement market for those systems. See "Special Note
Regarding Forward-Looking Statements".
GEOTHERMAL PRODUCTS
The Climate Control Business is a pioneer in the use of geothermal
water source heat pumps in residential and commercial applications.
Geothermal systems, which circulate water or antifreeze through an
underground heat exchanger, are among the most energy efficient systems
available. The Company believes that an aging installed base of residential
HVAC systems, coupled with the longer life, lower cost to operate, and
relatively short payback periods of geothermal systems will continue to
increase demand for its geothermal products, particularly in the residential
replacement market. See "Special Note Regarding Forward-Looking Statements".
HYDRONIC FAN COIL AND WATER SOURCE HEAT PUMP MARKET
The Company has pursued a strategy of specializing in hydronic fan
coils and water source heat pump products. The annual U.S. market for
hydronic fan coils and water source heat pumps is approximately $273 million.
Demand in these markets is generally driven by levels of repair, replacement,
and new construction activity. The U.S. market for fan coils and water source
heat pump products has grown on average 14% per year over the last 4 years.
This growth has been fueled by new construction, the aging of the installed
base of units, the introduction of new energy efficient systems, upgrades to
central air conditioning and increased governmental regulations restricting
the use of ozone depleting refrigerants in HVAC systems.
PRODUCTION AND BACKLOG
8
Most of the Climate Control Business' production of the
above-described products occurs on a specific order basis. The Company
manufactures the units in many sizes and configurations, as required by the
purchaser, to fit the space and capacity requirements of hotels, motels,
school, hospitals, apartment buildings, office buildings and other commercial
or residential structures. As of December 31, 1998, the backlog of confirmed
orders for the Climate Control Business was approximately $21.1 million as
compared to approximately $28.8 million at December 31, 1997. 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 March 31, 1999, the
Climate Control Business had released substantially all of the December 31,
1998 backlog to production. All of the December 31, 1998 backlog is expected
to be filled by December 31, 1999. See "Special Note Regarding
Forward-Looking Statements".
MARKETING AND DISTRIBUTION
DISTRIBUTION
The Climate 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 complementary product
lines not manufactured by the Company. 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 Climate Control Business in competition with the Company. Sales to
original equipment manufacturers accounted for approximately 25% of the sales
of the Climate Control Business in 1998 and approximately 11% of the
Company's 1998 consolidated sales.
MARKET
The Climate 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 Climate 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 Climate Control
Business. See "Special Note Regarding Forward-Looking Statements".
COMPETITION
The Climate Control Business competes with approximately eight
companies, some of whom are also customers of the Company. Some of the
competitors have
9
greater financial and other resources than the Company. The Climate Control
Business manufactures a broader line of fan coil and water source heat pump
products than any other manufacturer in the United States, and the Company
believes that it is competitive as to price, service, warranty and product
performance.
EMPLOYEES
As of December 31, 1998, the Company employed 1,264 persons. As of
that date, (a) the Chemical Business employed 578 persons, with 133
represented by unions under agreements expiring in August, 2001, and
February, 2002, and (b) the Climate Control Business employed 686 persons,
none of whom are represented by a union.
RESEARCH AND DEVELOPMENT
The Company incurred approximately $377,000 in 1998, $367,000 in
1997, and $514,000 in 1996 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 expensed by the Company.
ENVIRONMENTAL MATTERS
The Company and its operations are subject to numerous Environmental
Laws and to other federal, state and local laws regarding health and safety
matters ("Health Laws"). In particular, the manufacture and distribution of
chemical products are activities which entail environmental risks and impose
obligations under the Environmental Laws and the Health Laws, many of which
provide for substantial fines and criminal sanctions for violations, and
there can be no assurance that material costs or liabilities will not be
incurred by the Company in complying with such laws or in paying fines or
penalties for violation of such laws. The Environmental Laws and Health Laws
and enforcement policies thereunder relating to the Chemical Business have in
the past resulted, and could in the future result, in penalties, cleanup
costs, or other liabilities relating to the handling, manufacture, use,
emission, discharge or disposal of pollutants or other substances at or from
the Company's facilities or the use or disposal of certain of its chemical
products. Significant expenditures have been incurred by the Chemical
Business at the El Dorado Facility in order to comply with the Environmental
Laws and Health Laws. The Chemical Business may be required to make
additional significant site or operational modifications at the El Dorado
Facility, potentially involving substantial expenditures and reduction,
suspension or cessation of certain operations. See "Special Note Regarding
Forward-Looking Statements"; "Management's Discussion and Analysis of
Financial Condition and Results of Operations-Chemical Business" and "Legal
Proceedings."
Due to a consent order entered into with the Arkansas Department of
Pollution Control & Ecology ("ADPC&E"), the Chemical Business has installed
additional monitoring wells at the El Dorado Facility in accordance with a
workplan approved by the ADPC&E, and submitted the test results to ADPC&E.
The results indicated that a risk assessment should be conducted on nitrates
present
10
in the shallow groundwater. The Chemical Business' consultant has completed
this risk assessment, and has forwarded it to the ADPC&E for approval. The
risk assessment concludes that, although there are contaminants at the El
Dorado Facility and in the groundwater, the levels of such contaminants at
the El Dorado Facility and in the groundwater do not present an unacceptable
risk to human health and the environment. Based on this conclusion, the
Chemical Business' consultant has recommended continued monitoring at the
site for five years.
A second consent order was entered into with ADPC&E in August, 1998
(the "Wastewater Consent Order"), which required installation of an interim
groundwater treatment system (which is now operating) and certain
improvements in the wastewater collection and treatment system (discussed
below). Twelve months after all improvements are in place, the risk will be
reevaluated, and a final decision will be made on what additional groundwater
remediation, if any, is required. There can be no assurance that the risk
assessment will be approved by the ADPC&E, or that further work will not be
required.
In addition, in accordance with the consent order, the Chemical
Business currently plans to upgrade the El Dorado Facility's wastewater
treatment plant. Current estimates of the cost of the planned upgrade are
that approximately $4.6 million in future capital expenditures will be
incurred to complete this project. Furthermore, the El Dorado Facility's new
wastewater permit currently is being reviewed for renewal by the ADPC&E. The
new permit may impose additional or more stringent limitations on the plant's
wastewater discharges. The Company believes, although there can be no
assurance, that any such new limitations would not have a material adverse
effect on the Company. See "Special Note Regarding Forward-Looking
Statements."
During May, 1997, approximately 2,300 gallons of caustic material
spilled when a valve in a storage vessel located at the El Dorado Facility
failed, resulting in a release of such material to a stormwater drain, and
according to ADPC&E records, a minor fish kill in a creek near the El Dorado
Facility. In 1998, the Chemical Business entered into a Consent
Administrative Order (the "Wastewater Consent Order") with the ADPC&E to
resolve this event, as well as certain violations of the facility's NPDES
permit for wastewater discharge. The Wastewater Consent Order also resolved
several issues relating to a Consent Administrative Order that the Chemical
Business had entered into in May, 1995, which ordered closure of a solid
waste landfill. The Wastewater Consent Order requires the Chemical Business
to complete a waste minimization plan and characterize the wastewater before
obtaining a new NPDES permit, which is expected to have more restrictive
effluent limits, to install additional treatment to meet the new effluent
limits by August 1, 2001, and achieve compliance with the new effluent limits
by February 1, 2002. The Chemical Business is currently undertaking the waste
minimization activities. The Wastewater Consent Order recognizes the presence
of nitrate contamination in the groundwater and requires the Chemical
Business to undertake on-site bioremediation, which is currently underway.
Upon completion of the waste minimization activities referenced above, a
final remedy for groundwater contamination will be selected, based on an
evaluation of risk. There are no known users of groundwater in the area, and
preliminary risk assessments have not identified any risk that would require
additional remediation. The Wastewater
11
Consent Order included a $183,700 penalty assessment, of which $125,000 will
be satisfied over five years at expenditures of $25,000 per year for waste
minimization activities. The Chemical Business has documented in excess of
$25,000 on expenditures for the first year, 1998. An additional $57,000 of
the assessed penalty was satisfied by funding approved supplemental
environmental projects and the $1,700 required monetary civil penalty has
been paid.
The El Dorado Facility's air permit required it to cease operation
of certain older nitric acid concentrators (the "Older Nitric Acid
Concentrators") within a certain period of time after the initiation of
operations of the DSN Plant. Due to certain start-up problems with the DSN
Plant, including excess emissions from various emission sources, the Chemical
Business and the ADPC&E entered into certain agreements, including an
administrative consent order (the "Air Consent Order") in 1995 to resolve
certain of the Chemical Business' past violations and to permit the Chemical
Business to operate the Older Nitric Acid Concentrators until the ADPC&E has
made a final decision regarding the El Dorado Facility's air permit,
including whether the Older Nitric Acid Concentrators may continue to
operate. Although the Company expects that the Chemical Business will be able
to continue to operate the Older Nitric Acid Concentrators, there can be no
assurance that the ADPC&E will allow it to continue to do so. The Air Consent
Order also provides for payment of a civil penalty of $50,000, which the
Chemical Business has paid, and requires installation of certain pollution
control equipment and completion of certain maintenance activities at the El
Dorado Facility to eliminate certain off-site hazing problems. The Air
Consent Order was amended in 1996 and 1997. The second amendment to the Air
Consent Order (the "1997 Amendment") provided for certain stipulated
penalties of $1,000 per hour to $10,000 per day for continued off-site
emission events and deferred enforcement for other alleged air permit
violations. The 1997 Amendment acknowledges that the Chemical Business has
completed the installation of the pollution control equipment and maintenance
activities required under the Air Consent Order. Nonetheless, the Chemical
Business was assessed an additional penalty of $150,000, as well as a payment
of an additional $50,000 to fund certain environmental projects, with respect
to a number of alleged permit violations relating to off-site emissions and
other air permit conditions. The Chemical Business has paid both the penalty
and the additional sums required by the 1997 Amendment. Since the 1997
Amendment and as of the date of this report, the Chemical Business has been
assessed stipulated penalties of approximately $67,000 by the ADPC&E for
violations of certain provisions of the 1997 Amendment. In 1998, a third
amendment to the Air Consent Order provided for the stipulated penalties to
be reset at $1,000 per hour after ninety (90) days without any confirmed
events. The Chemical Business believes that the El Dorado Facility has made
progress in controlling certain off-site emissions; however, such off-site
emissions have occurred, and may continue, from time to time, which could
result in the assessment of additional penalties against the Chemical
Business by the ADPC&E and could have a material adverse effect on the
Company. In addition, prior to 1998, the El Dorado Facility was identified as
one of 33 significant violators of the federal Clean Air Act in a review of
Arkansas air programs by the EPA Office of Inspector General. The Company is
unable to predict the impact, if any, of such designation. See "Special Note
Regarding Forward-Looking Statements."
12
During 1997 and 1998, the Chemical Business expended approximately
$1.1 million and $.7 million, respectively, in connection with capital
expenditures relating to compliance with federal, state and local
Environmental Laws at its El Dorado Facility, including, but not limited to,
compliance with the Air Consent Order, as amended. The Company anticipates
that the Chemical Business will spend approximately $4.6 million for capital
expenditures relating to environmental control facilities at its El Dorado
Facility to comply with Environmental Laws, including, but not limited to,
the Air Consent Order, as amended, with $2.4 million being spent in 1999 and
the balance being spent in 2000. No assurance can be made that the actual
expenditures of the Chemical Business for such matters will not exceed the
estimated amounts by a substantial margin, which could have a material
adverse effect on the Company and its financial condition. The amount to be
spent during 1999 for capital expenditures related to compliance with
Environmental Laws is dependent upon a variety of factors, including, but not
limited to, the occurrence of additional releases or threatened releases
(particularly air emissions) into the environment, or changes in the
Environmental Laws (or in the enforcement or interpretation by any federal or
state agency or court of competent jurisdiction). See "Special Note Regarding
Forward-Looking Statements." Failure to satisfactorily resolve the pending
noncompliance issues with the ADPC&E, or additional orders from the ADPC&E
imposing penalties, or requiring the Chemical Business to spend more for
environmental improvements or curtail production activities at the El Dorado
Facility, could have a material adverse effect on the Company.
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 "El Dorado Facility"), (ii) in a facility of approximately 60,000 square
feet located on ten acres of land in Hallowell, Kansas ("Kansas Facility")
and (iii) in a mixed acid plant in Wilmington, North Carolina ("Wilmington
Plant"). The Chemical Business owns all of its manufacturing facilities, with
the El Dorado Facility and the Wilmington Plant subject to mortgages. In
addition, the Chemical Business has four manufacturing facilities in
Australia that produce bulk and packaged explosives.
As of December 31, 1998, the El Dorado Facility was utilized at
approximately 74% of capacity, based on continuous operation.
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 approximately ten acres, including
buildings and equipment thereon, located in southeastern Kansas, which it
owns.
In addition, the Chemical Business distributes its products through
32 agricultural and explosive distribution centers. The Chemical Business
currently operates 22 agricultural distribution centers, with 16 of the
centers located in Texas (13 of which the Company owns and three of which it
leases); one center located in Oklahoma which the Company owns; two centers
located in Missouri (one
13
of which the Company owns and one of which it leases); and three centers
located in Tennessee (all of which the company owns). The Chemical Business
currently operates six domestic explosives distribution centers located in
Hallowell, Kansas (owned); Bonne Terre, Missouri (owned); Poca, West Virginia
(leased); Owensboro and Combs, Kentucky (leased); and Pryor, Oklahoma
(leased). The Chemical Business also has four explosives distribution centers
in Australia, all of which are leased.
CLIMATE CONTROL BUSINESS
The Climate Control Business conducts its fan coil manufacturing
operations in a facility located in Oklahoma City, Oklahoma, consisting of
approximately 265,000 square feet. The Company owns this facility subject to
a mortgage. As of December 31, 1998, the Climate Control Business was using
the productive capacity of the above referenced facilities to the extent of
approximately 87%, based on three, eight-hour shifts per day and a five-day
week in one department and one and one half eight-hour shifts per day and a
five-day week in all other departments.
The Climate Control Business manufactures most of its heat pump
products in a leased 270,000 square foot facility in Oklahoma City, Oklahoma,
which it leases from an unrelated party. The lease term began March 1, 1988,
after renewal in October 1997, and expires February 28, 2003, 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,
1998, the productive capacity of this manufacturing operation was being
utilized to the extent of approximately 81%, based on two twelve-hour shifts
per day and a seven-day week in one department and one eight-hour shift per
day and a five-day week in all other departments.
All of the properties utilized by the Climate Control Business are
considered by the Company management to be suitable and adequate to meet the
current needs of that Business.
ITEM 3. LEGAL PROCEEDINGS
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 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 seeking be trebled,
together with costs. Plaintiffs are also seeking a permanent injunction
enjoining defendants from further alleged anti-competitive activities. 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 other
defendants, to fix prices in connection with the sale of commercial
explosives. This action has been
14
consolidated, for discovery purposes only, with several other actions in a
multi-district litigation proceeding in Utah. Discovery in this litigation is
in process. EDC intends to vigorously defend itself in this matter. See
"Special Note Regarding Forward-Looking Statements."
ASARCO V. ICI, ET AL. The U.S. 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. 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. See "Special Note Regarding Forward-Looking Statements."
EUGENE LOWE, ET AL. V. TERESA TRUCKING, INC., pending in the Circuit
Court of Lincoln County, West Virginia. During the third quarter of 1997, EDC
was served with this lawsuit in which approximately 27 plaintiffs have sued
approximately 13 defendants, including EDC, alleging personal injury and
property damage for undifferentiated compensatory and punitive damages of
approximately $7,000,000. Specifically, the plaintiffs assert property damage
to their residence and wells, annoyance and inconvenience, and nuisance as a
result of daily blasting and round-the-clock mining activities. The
plaintiffs are residents living near the Heartland Coal Company ("Heartland")
strip mine in Lincoln County, West Virginia, and an unrelated mining
operation operated by Pen Coal Inc. During the first quarter of 1999, the
plaintiffs withdrew all personal injury claims previously asserted in this
litigation. Heartland employed EDC to provide blasting materials and
personnel to load and shoot holes drilled by employees of Heartland. Down
hole blasting services were provided by EDC at Heartland's premises from
approximately August 1991, until approximately August 1994. Subsequent to
August 1994, EDC supplied blasting materials to the reclamation contractor at
Heartland's mine. In connection with EDC's activities at Heartland, EDC has
entered into a contractual indemnity to Heartland to indemnify Heartland
under certain conditions for acts or actions taken by EDC or for which EDC
failed to take, and Heartland is alleging that EDC is liable thereunder for
Heartland's defense costs and any losses to, or damages sustained by, the
plaintiffs in this lawsuit as a result of EDC's operations.
Discovery in this litigation is in process. The Company intends to
vigorously defend itself in this matter. EDC has provided notification of
this lawsuit to its two insurance carriers providing primary insurance
coverage to EDC during the period covered by the plaintiff's allegations.
Based on information provided to EDC by its counsel handling this matter, the
Company does not believe that this matter will have a material adverse effect
on the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
15
Not applicable.
ITEM 4A. EXECUTIVE OFFICERS OF THE COMPANY
IDENTIFICATION OF EXECUTIVE OFFICERS
The following table lists the executive officers of the Company, each
of whom also serves as an executive officer of LSB, except for James L. Wewers.
NAME OFFICE
- ----------------- ------------------------------------------------------------
Jack E. Golsen Chairman of the Board, Chief Executive Officer and President
Barry H. Golsen Vice Chairman of the Board and Vice President
Tony M. Shelby Vice President and Chief Financial Officer
David R. Goss Vice President
Jim D. Jones Vice President and Treasurer
James L. Wewers Vice President
David M. Shear Secretary
The Company's officers serve one-year terms, renewable on an annual
basis by the Board of Directors. All of the individuals listed above have
served in substantially the same capacity with LSB and/or its subsidiaries
for the last five years.
FAMILY RELATIONSHIPS
16
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.
17
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
The Company is a wholly-owned subsidiary of LSB. As such, the
Company does not have any shares of common equity that trade in the public
market.
Under the terms of an indenture, the Company cannot transfer funds
to LSB in the form of cash dividends or other distributions or advances,
except for (i) the amount of taxes that the Company would be required to pay
if they were not consolidated with LSB and (ii) an amount not to exceed fifty
percent (50%) of the Company's net income for the year in question and (iii)
the amount of direct and indirect costs and expenses incurred by LSB on
behalf of the Company pursuant to a certain services agreement and a certain
management agreement to which the Company and LSB are parties. The Company
and LSB are parties to a services agreement, management agreement and tax
sharing agreement, and under the Indenture the Company may pay amounts to LSB
under each such agreement. In addition, under the Indenture, the Company may
enter into other transactions with LSB under certain conditions. See Note 3
of Notes to Consolidated Financial Statements and Item 7 "Management's
Discussion and Analysis of Financial Condition and Results of Operations".
18
ITEM 6. SELECTED FINANCIAL DATA
Years ended December 31,
-----------------------------------------------------------------------------
1998 1997 1996 1995 1994
--------- --------- --------- --------- ----------
(Dollars in Thousands)
Selected Statement of Operations Data:
Net sales $ 255,730 $ 262,847 $ 255,285 $ 220,743 $ 201,486
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Total revenues $ 257,198 $ 263,740 $ 255,618 $ 221,541 $ 201,900
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Interest expense $ 13,944 $ 9,788 $ 6,247 $ 7,185 $ 6,150
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Income (loss) from continuing
operations before extraordinary
charge $ (2,569) $ 897 $ 5,753 $ 5,899 $ 5,449
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
Net income (loss) $ (2,569) $ (1,972) $ 5,753 $ 5,899 $ 5,449
--------- --------- --------- --------- ----------
--------- --------- --------- --------- ----------
19
ITEM 6. SELECTED FINANCIAL DATA (CONTINUED)
Years ended December 31,
--------------------------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- --------
(Dollars in Thousands)
Selected Balance Sheet Data:
Total assets $194,704 $200,875 $173,734 $146,719 $129,444
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Total debt $137,931 $136,184 $ 82,588 $ 78,959 $ 69,140
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
Total stockholders' equity $ 23,758 $ 27,289 $ 32,843 $ 28,675 $ 24,204
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
20
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, 1998 Consolidated Financial Statements,
Item 6 "SELECTED FINANCIAL DATA" and Item 1 "BUSINESS" included elsewhere in
this report.
Certain Statements contained in this "Management's Discussion and
Analysis of Financial Conditions and Results of Operations" may be deemed
forward-looking statements. See "Special Note Regarding Forward-Looking
Statements".
OVERVIEW
The following table contains selected historical financial
information about the Company's operating segments for each of the three
years in the period ended December 31, 1998. The information for each of the
three years in the period ended December 31, 1998, was derived from the
consolidated financial statements of the Company included elsewhere herein
and were audited by Ernst & Young LLP independent auditors.
Year Ended December 31,
--------------------------------------------------
1998 1997 1996
--------- --------- ---------
Net Sales:
Chemical $ 139,945 $ 156,948 $ 166,164
Climate Control 115,785 105,899 89,121
--------- --------- ---------
Total $ 255,730 $ 262,847 $ 255,285
--------- --------- ---------
--------- --------- ---------
Gross Profit: (1)
Chemical $ 18,348 $ 19,356 $ 25,400
Climate Control 32,234 29,719 22,057
--------- --------- ---------
Total $ 50,582 $ 49,075 $ 47,457
--------- --------- ---------
--------- --------- ---------
Operating Profit: (2)
Chemical $ 3,457 $ 4,849 $ 10,710
Climate Control 9,723 8,481 5,425
--------- --------- ---------
Total $ 13,180 $ 13,330 $ 16,135
--------- --------- ---------
--------- --------- ---------
Total Assets:
Chemical $ 133,452 $ 137,156 $ 133,794
Climate Control 40,498 42,497 39,960
Corporate 20,754 21,222 -
--------- --------- ---------
Total $ 194,704 $ 200,875 $ 173,754
--------- --------- ---------
--------- --------- ---------
- --------
(1) Gross profit by industry segment represents net sales less cost of sales.
(2) Operating profit by industry segment represents gross profit less operating
expenses before deducting interest expense and income taxes.
21
CHEMICAL BUSINESS
Although sales in the Chemical Business have declined from $156.9
million in the twelve months ended December 31, 1997, to $139.9 million in the
twelve months ended December 31, 1998 (a decrease of 10.8%) and the gross profit
has decreased from $19.3 million in 1997 to $18.3 million in 1998, the gross
profit percentage has increased from 12.3% in 1997 to 13.1% in 1998.
In 1998, the Chemical Business was adversely affected by the extreme
drought conditions in the mid-south market during the primary fertilizer season,
followed by excess wet conditions and floods in the fall season, resulting in
substantially lower volume and lower sales prices for certain of its products
sold in its agricultural markets. The operating profit of the Chemical Business
decreased from $4.8 million in 1997 to $3.5 million in 1998 (a decrease of
28.7%). The decline in sales volume explains approximately $1.0 million of this
decrease. An additional $800,000 is primarily attributable to a provision for
possible loss on a note receivable recorded in the fourth quarter of 1998.
During 1997, limitations on production, as a result of certain
mechanical and design problems relating to the construction and start-up of a
concentrated nitric acid plant, resulted in significant fixed costs being
expended as period costs rather than being absorbed as cost of product being
produced and sold. In addition, significant amounts were expended for
engineering, consulting, and other costs to bring the nitric acid plant up to
its stated capacity.
Additionally, the cost of the Chemical Business' primary raw material,
anhydrous ammonia, averaged approximately $184 per ton in 1997, compared to
approximately $154 per ton in 1998. The Chemical Business purchases
approximately 220,000 tons of anhydrous ammonia per year under three contracts
expiring in April, 2000, June, 2000, and December, 2000, respectively. The
Company's purchase price of anhydrous ammonia under these contracts can be
higher or lower than the current market spot price of anhydrous ammonia. Pricing
is subject to variations due to numerous factors contained in these contracts.
Based on the price calculations contained in the contracts, one contract is
presently priced above the current market spot price. The Chemical Business is
required to purchase 120,000 tons of its requirements under the contract
expiring in April, 2000, at least 24,000 tons of its requirements under the
contract expiring in June, 2000, and 60,000 tons of its requirements under the
contract expiring in December, 2000, with additional quantities of anhydrous
ammonia available under each contract. Anhydrous ammonia is not being currently
supplied under the contract expiring in December, 2000, due to that supplier's
declaration of an event of force majeure as a result of a temporary shut down of
its plant due to mechanical problems. The Company been able to, on a temporary
basis, obtain anhydrous ammonia from other sources on similar terms as provided
in the contract expiring in December, 2000.
The anhydrous ammonia industry added an additional one million tons of
capacity of anhydrous ammonia in the western hemisphere in 1998, and the Company
believes there is approximately one million tons of additional annual capacity
of anhydrous ammonia being constructed in the western hemisphere scheduled for
completion in 1999. The Company believes this additional capacity may contribute
22
to a decline in the future market price of anhydrous ammonia. See "Special Note
Regarding Forward-Looking Statements".
In June, 1997, a subsidiary of the Company entered into an agreement
with Bayer Corporation ("Bayer") whereby one of the Company's subsidiaries is
acting as agent to construct a nitric acid plant located within Bayer's Baytown,
Texas chemical plant complex. This plant, when constructed, will be operated by
the Company's subsidiary and will supply nitric acid for Bayer's polyurethane
business under a long-term supply contract. Management estimates that, after the
initial startup phase of operations at the plant, at full production capacity
based on terms of the Bayer Agreement and dependent upon the price of anhydrous
ammonia, based on the price of anhydrous ammonia as of the date of this report,
the plant should generate approximately $35 million to $50 million in annual
gross revenues. Unlike the Chemical Business' regular sales volume, the market
risk on this additional volume is much less since the contract provides for
recovery of costs, as defined, plus a profit. It is anticipated that the
construction of the nitric acid plant at Bayer's facility in Baytown, Texas,
will cost approximately $69 million and construction is scheduled to be
completed in the second quarter of 1999. The Company's subsidiary is to lease
the nitric acid plant pursuant to a leverage lease from an unrelated third party
for an initial term of ten (10) years from the date that the plant becomes fully
operational, and the construction financing of this plant is being provided by
an unaffiliated lender. (See Item 1 - "Business Chemical Business" for a further
discussion of the Baytown, Texas nitric acid plant facility.)
The results of operation of the Chemical Business' Australian
subsidiary have been adversely affected due to the recent economic developments
in certain countries in Asia. These economic developments in Asia have had a
negative impact on the mining industry in Australia which the Company's Chemical
Business services. As these adverse economic conditions in Asia have continued,
such have had an adverse effect on the Company's consolidated results of
operations in 1998. The Company received an offer in 1999 to purchase its
Australian subsidiary. As of the date of this report, the Company is negotiating
with the company that offered to buy the Australian subsidiary. During 1998, TES
had net sales of $14.2 million, and reported a net loss of $2.9 million. There
are no assurances that the Company will sell the Australian subsidiary.
CLIMATE CONTROL
The Climate Control Business manufactures and sells a broad range of
hydronic fan coil, air handling, air conditioning, heating, water source heat
pump, and dehumidification products targeted to both commercial and residential
new building construction and renovation.
The Climate Control Business focuses on product lines in the specific
niche markets of hydronic 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 Climate Control Business reported
improved sales (an increase of 9.3%) and improved operating profit (an increase
of 14.6%) for 1998, as compared to 1997.
23
RESULTS OF OPERATIONS
YEAR ENDED DECEMBER 31, 1998 COMPARED TO YEAR ENDED DECEMBER 31, 1997
NET SALES
Consolidated net sales for 1998 were $255.7 million, compared to $262.8
million for 1997, a decrease of $7.1 million or 2.7%. This sales decrease
resulted principally from decreased sales in the Chemical Business of $17.0
million primarily due to lower sales volume in the U.S. of agricultural and
blasting products and decreased business volume of its Australian subsidiary.
Sales were lower in the Chemical Business during 1998, compared to 1997, as a
result of adverse weather conditions in its agricultural markets during the
spring and fall planting seasons. Blasting sales in the Chemical Business
declined as a result of elimination of certain low profit margin sales and
decreased volume in the Australian subsidiary resulting from adverse economic
developments in Asia. These decreases were offset by increased sales in the
Climate Control Business of $9.9 million, primarily due to increased volume and
price increases in both the heat pump and fan coil product lines.
GROSS PROFIT
Gross profit increased $1.5 million and was 19.8% of net sales for
1998, compared to 18.7% of net sales for 1997. The increase in the gross profit
percentage was due primarily to lower production costs in the Chemical Business
due to the effect of lower prices of anhydrous ammonia in 1998, and lower
unabsorbed overhead costs caused by excessive downtime related to problems
associated with mechanical failures at the Chemical Business' primary
manufacturing plant in the first half of 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative expenses ("SG&A"), as a percent of
net sales, were 15.5% in 1998, and 14.3% in 1997. SG&A, as a percent of sales,
was approximately 11.5% in 1998, compared to 9.8% in 1997 for the Chemical
Business; 20.3% in 1998, compared to 21.0% in 1997 for the Climate Control
Business.
The increase in the Chemical Business was the result of lower sales in
1998 with relatively constant SG&A expenses. Within SG&A of the Chemical
Business, higher provisions for uncollectible accounts receivable in 1998 were
offset by decreased expenses at the Company's Australian subsidiary in
anticipation of sustaining a lower level of business activity. The decrease in
the Climate Control Business' SG&A as a percentage of sales was the result of
increases in sales. The Climate Control Business' amount of SG&A increased in
1998 due to additional information technology personnel to support management
information systems changes and higher variable costs due to a change in sales
mix toward greater domestic sales which carry a higher SG&A percent.
INTEREST EXPENSE
24
Interest expense for the Company, before deducting capitalized
interest, was $13.9 million during 1998, compared to $10.9 million during 1997.
During 1997, $1.1 million of interest expense was capitalized in connection with
construction of the DSN Plant. The increase of $3.0 million before the effect of
capitalization primarily resulted from increased borrowings and higher interest
rates associated with the 10 3/4% unsecured senior notes issued November 26,
1997. 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.
PROVISION FOR INCOME TAXES
The provision for income taxes was $.4 million in 1998 on a pre-tax
loss of $2.2 million, compared to $1.4 million in 1997 on pre-tax income of $2.3
million. The effective tax rate is greater than the statutory rate due to losses
associated with the Company's Australian subsidiary, which provides no current
benefit due to its cumulative tax loss position.
EXTRAORDINARY CHARGE
In 1997, in connection with the issuance of the 10 3/4% unsecured
senior notes due 2007, a subsidiary of the Company retired the outstanding
principal associated with a certain financing arrangement and incurred a
prepayment fee. The prepayment fee and loan origination costs expensed in 1997
related to the financing arrangement aggregated approximately $4.6 million. The
extraordinary charge of $2.9 million is net of an income tax benefit of $1.7
million.
NET LOSS
The Company had a net loss of $2.6 million in 1998, compared to a net
loss of $2.0 million in 1997. The increased loss of $.6 million was primarily
due to increased SG&A and interest expense offset by increased gross profit as
discussed above.
YEAR ENDED DECEMBER 31, 1997, COMPARED TO YEAR ENDED DECEMBER 31, 1996
NET SALES
Consolidated net sales for 1997 were $262.8 million, compared to $255.3
million for 1996, an increase of $7.5 million. This increase in sales resulted
from increased sales in the Climate Control Business of $16.7 million, primarily
due to increased sales of heat pumps partially offset by decreased sales in the
Chemical Business of $9.2 million primarily due to reduced sales of the
Company's wholly-owned Australian subsidiary due to expiration of certain
customer contracts and recent economic developments in Asia.
GROSS PROFIT
Gross profit increased $1.6 million and was 18.7% of net sales for
1997, compared to 18.6% of net sales for 1996. The gross profit increase was
primarily
25
attributable to increased absorption of costs due to higher production
volumes and focus on sales of more profitable product lines in the Climate
Control Business. This improvement was offset by higher production costs in
the Chemical Business due to (i) the higher cost of anhydrous ammonia which
was only partially passed on in the form of higher selling prices, (ii)
unabsorbed overhead costs caused by down time related to modifications made
to resolve problems associated with mechanical failures, and (iii)
environmental matters at the Chemical Business' primary manufacturing plant.
These increased costs in 1997 were partially offset by a reduction in cost of
sales of $2.1 million through recapture of manufacturing variances of the
Chemical Business in the form of business interruption insurance settlements.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSE
Selling, general and administrative ("SG&A") expenses, as a percent of
net sales, were 14.3% and 13.0% in 1997 and 1996, respectively. SG&A, as a
percent of sales, was approximately 9.8% in 1997, compared to 9.3% in 1996 for
the Chemical Business and 21.0% in 1997, compared to 19.8% in 1996 for the
Climate Control Business. The increase in the Chemical Business was the result
of lower sales in 1997 with relatively constant SG&A expenses. Within the SG&A
of the Chemical Business, lower provisions for uncollectible accounts receivable
in 1997 were offset by increased expense at the Company's Australian subsidiary
in anticipation of sustaining a higher level of business activity. The increase
in the Climate Control Business' SG&A was the result of increases in sales
personnel costs to support higher sales in future periods, additional
informational technology personnel to support management information systems
changes and higher freight costs due to a change in sales mix toward greater
domestic sales which carry a higher SG&A percent.
INTEREST EXPENSE
Interest expense for the Company, before deducting capitalized
interest, was approximately $10.9 million during 1997, compared to approximately
$8.7 million during 1996. During 1997 and 1996, $1.1 million and $2.4 million,
respectively, of interest expense was capitalized in connection with
construction of the DSN Plant. The 1997 increase of $2.2 million before the
effect of capitalization primarily resulted from increased borrowings needed to
support capital expenditures, higher inventory balances and to meet the
operational requirements of the Company.
PROVISION FOR INCOME TAXES
The provision for income taxes was $1.4 million in 1997 on pre-tax
income of $2.3 million (61%), compared to $2.7 million in 1996 on pre-tax income
of $8.4 million (32%). This change, as a percentage of pre-tax income, was
primarily the result of the change in the foreign subsidiary TES' net income
which decreased by US$2.5 million from US$1.7 million in 1996 to a net loss of
US$.8 million in 1997.
EXTRAORDINARY CHARGE
26
In 1997, in connection with the issuance of the Notes, a subsidiary of
the Company retired the outstanding principal associated with the John Hancock
financing arrangement and incurred a prepayment fee. The prepayment fee and loan
origination costs expensed in 1997 related to the John Hancock financing
arrangement aggregated approximately $4.6 million. The extraordinary charge of
$2.9 million is net of an income tax benefit of $1.7 million.
NET INCOME
The Company had a net loss of $2.0 million in 1997, compared to net
income of $5.8 million in 1996. The decreased profitability of $7.8 million was
primarily due to increased SG&A, increased income taxes as a percentage of
income and the extraordinary charge as discussed above.
LIQUIDITY AND CAPITAL RESOURCES
CASH FLOW FROM OPERATIONS
Historically, the Company's primary cash needs have been for operating
expenses, working capital and capital expenditures. The Company has financed its
cash requirements primarily through internally generated cash flow and
borrowings under its revolving credit facilities, and more recently, by the
issuance of senior unsecured notes.
Net cash provided by operations for the year ended December 31, 1998,
was $3.9 million, after adjustments to income of $10.9 million for noncash
depreciation and amortization, $1.8 million in provisions for possible losses on
accounts receivable, $.4 million increase in cash surrender value on certain
life insurance policies, $.4 million in provisions for deferred income taxes,
and includes the following changes in assets and liabilities: (i) accounts
receivable increases of $1.5 million, (ii) inventory decreases of $.9 million,
(iii) increases in supplies and prepaid items of $1.3 million, and (iv)
decreases in accounts payable and accrued liabilities of $4.5 million. The
increase in accounts receivable is due to increased sales in the Climate Control
Business (see "Results of Operations" for discussion of increase in sales) and
sales of nitric acid products pursuant to the Bayer Agreement. The decrease in
inventory was due primarily to reduction and control measures taken in all of
the Company's Businesses. The increase in supplies and prepaid items was due
primarily to an increase in maintenance and manufacturing supplies at the
Chemical Business. The decrease in accounts payable and accrued liabilities was
primarily due to timing of payments for inventory purchases in the Chemical
Business.
CASH FLOW FROM INVESTING AND FINANCING ACTIVITIES
Cash used by investing activities for the year ended December 31, 1998,
included $7.4 million in capital expenditures and $1.1 million increases in
other assets. The capital expenditures took place in the Chemical and Climate
Control Businesses to enhance production and product delivery capabilities. The
increase in other assets was primarily attributable to approximately $.7 million
in
27
deposits made in connection with an interest rate hedge contract related to
the agreement with Bayer.
Net cash provided by financing activities included (i) payments on
long-term debt of $4.7 million, (ii) deferred loan costs of approximately $.6
million associated with the 10 3/4% Senior Notes, (iii) net increases in
revolving debt of $6.3 million, (iv) reductions of amounts due from LSB and
affiliates of $1.1 million, and (v) dividends paid to LSB of $.4 million.
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.
The Company owns substantially all of LSB's Chemical and Climate
Control Businesses. On November 26, 1997, the Company issued senior unsecured
notes which were exchanged with registered senior notes of the same amount and
substantially the same terms in April, 1998 ("Notes"), in the aggregate amount
of $105 million pursuant to the terms of an indenture (the "Indenture"). The
Notes are jointly and severally and fully and unconditionally guaranteed on a
senior basis by all, except for one inconsequential subsidiary, of the existing
and all of the future subsidiaries of the Company.
Interest on the Notes is payable semiannually on June 1 and December 1
of each year, commencing June 1, 1998. The Notes will mature on December 1,
2007, unless earlier redeemed. The Notes are redeemable at the option of the
Company on December 1, 2002 at 105.375% of the principal amount declining to
face amount at December 1, 2005 and thereafter under the terms set forth in the
Indenture. The Notes are effectively subordinated to all secured indebtedness of
the Company and its subsidiaries.
LSB, certain subsidiaries of LSB that are not subsidiaries of the
Company, and certain subsidiaries of the Company are parties to a working
capital revolving line of credit evidenced by four loan agreements ("Revolving
Credit Agreement") with an unrelated lender ("Lender") collateralized by
receivables, inventory, proprietary rights and proceeds thereof of the Company
and the subsidiaries that are parties to the Revolving Credit Agreement. The
Revolving Credit Agreement, as amended, provides for revolving credit facilities
("Revolver") for total direct borrowings up to $65.0 million, including the
issuance of letters of credit. Under the Revolver, the Company can borrow up to
the full $65 million based on certain percentages of eligible collateral, with
LSB and certain subsidiaries of LSB that are not the Company or subsidiaries of
the Company having the right to borrow, on a revolving basis, up to $24 million
of the $65 million based on eligible collateral. As of December 31, 1998, LSB
and its subsidiaries other than the Company and its subsidiaries have borrowed
$14.5 million under the Revolver. Any amounts borrowed by LSB and its
subsidiaries that are not subsidiaries of the Company will reduce the amount
that the subsidiaries of the Company may borrow at any one time under the
Revolver. The Revolver provides for advances at varying percentages of eligible
inventory and trade receivables. The Revolving Credit Agreement, as amended,
provides for
28
interest at the Lender's prime rate plus .5% per annum or, at the Company's
option, on the Lender's LIBOR rate plus 2.875% per annum (which rates are
subject to increase or reduction based upon achieving specified availability
and adjusted tangible net worth levels). At December 31, 1998, the effective
interest rate was 8.18%. The term of the Revolving Credit Agreement is
through December 31, 2000, and is renewable thereafter for successive
thirteen month terms. At December 31, 1998, the availability for borrowings
by the subsidiaries of the Company, based on eligible collateral,
approximated $31.0 million. Borrowings by subsidiaries of the Company under
the Revolver outstanding at December 31, 1998, were $11.7 million.
Availability for additional borrowings under the Revolver at December 31,
1998, approximated $19.3 million. The Revolving Credit Agreement requires the
Company to maintain certain financial ratios and contains other financial
covenants, including tangible net worth requirements and capital expenditure
limitations. At December 31, 1998, the Company was not in compliance with
certain of these financial covenants. In April, 1999, the Company obtained
waivers for such noncompliance and amendments to reset the covenants to
amounts the Company expects to achieve in future periods. The annual interest
on the outstanding debt under the Revolver at December 31, 1998, at the rates
then in effect would approximate $2.1 million. The Revolving Credit Agreement
also requires the payment of an annual facility fee of 0.5% of the unused
Revolver.
In addition to the Revolving Credit Agreement discussed above, as of
December 31, 1998, the Company's wholly-owned subsidiary, DSN Corporation
("DSN"), is a party to several loan agreements with a financial company (the
"Financing Company") for three projects. At December 31, 1998, DSN had
outstanding borrowings of $11.0 million under these loans. The loans have
repayment schedules of 84 consecutive monthly installments of principal and
interest. The interest rate on each of the loans is fixed and range from 8.2% to
8.9%. Annual interest, for the three notes as a whole, at December 31, 1998, at
the agreed to interest rates would approximate $1.0 million. The loans are
secured by the various DSN property and equipment. The loan agreements require
the Company to maintain certain financial ratios, including tangible net worth
requirements.
The Company's wholly-owned Australian subsidiary, TES, has a revolving
credit working capital facility (the "TES Revolving Facility") with Bank of New
Zealand, Australia, in the amount of AUS$10.5 million (approximately US$6.5
million). The TES Revolving Facility allows for borrowings based on specific
percentages of qualified eligible assets. Based on the effective exchange rate
at December 31, 1998, approximately US$5.0 million (AUS$8.1 million
approximately) was borrowed at December 31, 1998. Such debt is secured by
substantially all the assets of TES, plus an unlimited guarantee and indemnity
from LSB and certain subsidiaries of TES. The interest rate on this debt is
dependent upon the borrowing option elected by TES and had a weighted average
rate of 7.01% at December 31, 1998. TES is in technical noncompliance with a
certain financial covenant contained in the loan agreement involving the TES
Revolving Facility. However, this covenant was not met at the time of closing of
this loan and the Bank of New Zealand, Australia has continued to extend credit
under the Facility. The outstanding borrowing under the TES Revolving Facility
at December 31, 1998 has been classified as due within one year in the
accompanying consolidated financial statements. As previously noted in this
report, the Company has received an offer in 1999, the terms of which it is
29
presently negotiating with the Company that made the offer, to purchase TES;
however, there are no assurances that the Company will sell TES. Under the terms
of the Indenture to which ClimaChem is bound by, the net cash proceeds from the
sale of TES, if completed, are required (1) within 270 days from the date of the
sale to be applied to the redemption of the notes issued under the Indenture or
to the repurchase of such notes, or (2) within 240 days from the date of such
sale, the amount of the net cash proceeds be invested in a related business of
ClimaChem or the Australian subsidiary or used to reduce indebtedness of
ClimaChem.
In 1995, a subsidiary of LSB 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 which it completed during 1996. 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. In January, 1999, the Company agreed to purchase
this investment by purchasing the stock of an LSB subsidiary that owned the
Project. The Company paid $3.1 million to LSB in connection with this purchase.
This amount equaled the book value of the investment on the books of LSB's
subsidiary, which approximated the investment's fair value, at the date of
purchase.
During the latter part of March, 1999 LSB's management began
considering the realignment of certain of LSB's overhead to better match its
focus on the Company and its subsidiaries' operations. Consistent with this
realignment, in April, 1999, the Company's Board of Directors approved the
acquisition of certain assets from LSB in accordance with the terms of the
Indenture to which the Company and its subsidiaries are parties to and the
loan agreement that LSB and subsidiaries of the Company are borrowing under,
which assets are materially related to the lines of business of the Chemical
and Climate Control Businesses. These assets are real estate and improvements
located thereon in which the Climate Control Business will conduct certain
manufacturing operations, and an option, presently held by LSB or a
subsidiary of LSB, in connection with the acquisition of a French HVAC
manufacturing company. The purchase price to be paid to LSB will be in the
approximate range of $4.0 - $4.7 million for the real estate and improvements
and the option on the French HVAC manufacturer.
As discussed in Note 3 of Notes to Consolidated Financial Statements
included elsewhere in this report, during 1998 the Company paid approximately
$4.2 million to LSB under the services agreements, management agreements and tax
sharing agreements. As a result of increased services to be provided by LSB on
behalf of the Company during 1999, and the anticipated results of the Company
for 1999, the Company anticipates that the amounts to be paid to LSB under these
agreements will be greater than the amount paid during 1998.
30
Future cash requirements include working capital requirements for
anticipated sales increases in all businesses, funding for anticipated increased
payments to LSB pursuant to the Services Agreement, the Management Agreement and
the Tax Sharing Agreement as discussed fully in Note 3 of Notes to Consolidated
Financial Statements and funding for future capital expenditures (including the
purchase of certain assets from LSB as discussed above). Funding for the higher
accounts receivable and inventory requirements resulting from anticipated sales
increases, funding for anticipated purchases of certain assets from LSB and
funding for payments under the Services Agreement, Management Agreement and Tax
Sharing Agreement will be provided by cash flow generated by the Company and the
revolving credit facilities discussed elsewhere in this report. Currently, LSB
and certain subsidiaries of LSB, including the Company, are limited to capital
expenditures of $10.0 million annually under the Revolving Credit Agreement
discussed above. The Company expended approximately $7.4 million for capital
expenditures in 1998. In 1999, the Company has planned capital expenditures of
approximately $9.5 million, a certain amount of which it anticipates will be
financed by equipment finance contracts on a term basis and in a manner allowed
under its various loan agreements. Such capital expenditures include
approximately $2.4 million, which the Chemical Business anticipates spending
related to environmental control facilities at its El Dorado Facility, as
previously discussed in this report. The Company currently has no material
commitment for capital expenditures.
Management believes that cash flows from operations, the Company's
revolving credit facilities, and other sources will be adequate to meet its
presently anticipated capital expenditure, working capital, and debt service
requirements. The Company's subsidiary has agreed to act as an agent to
construct a nitric acid plant for Bayer's Baytown, Texas facility. See
"Overview - Chemical Business" of this "Management's Discussion and Analysis
of Financial Condition and Results of Operations" regarding the fact that the
Company's subsidiary has agreed to act as agent to construct a nitric acid
plant. Further, the Company's Chemical Business will be required to incur
additional capital expenditures as discussed in Note 9 of Notes to the
Company's Consolidated Financial Statements regarding an Administrative
Agreement and Consent Administrative Order related to the Chemical Business'
wastewater treatment system. At the date of this report, the future cost of
the expenditures for these environmental matters has been estimated to be
approximately $4.6 million, with $2.4 million being paid in 1999 and the
balance in 2000.
YEAR 2000 ISSUES
The Year 2000 Issue is the result of computer programs being written
using two digits rather than four to define the applicable year. Any of the
Company's computer programs or hardware that have date-sensitive software or
embedded chips may recognize a date using "00" as the Year 1900 rather than the
Year 2000. This could result in a system failure or miscalculations causing
disruptions of operations, including, among other things, a temporary inability
to process transactions, create invoices, or engage in similar normal business
activities.
31
Beginning in 1996, LSB undertook a project to enhance certain of its
Information Technology ("IT") systems and install certain other technologically
advanced communication systems to provide extended functionality for operational
purposes. A major part of LSB's program was to implement a standardized IT
system purchased from a national software distributor at all of the Company and
subsidiary operations, as well as other LSB subsidiaries, and to install a Local
Area Network ("LAN"). The IT system and the LAN necessitated the purchase of
additional hardware, as well as software. The process implemented by LSB to
advance its systems to be more "state-of-the-art" systems had an added benefit
in that the software and hardware changes necessary to achieve LSB's goals are
Year 2000 compliant.
Starting in 1996 through December 31, 1998, LSB has capitalized
approximately $1.0 million in costs to accomplish its enhancement program. The
capitalized costs include $425,000 in external programming costs, with the
remainder representing hardware and software purchases. LSB anticipates that the
remaining cost to complete this IT systems enhancement project will be less than
$100,000, and such costs will be capitalized.
LSB's plan to identify and resolve the Year 2000 Issue involved the
following phases: assessment, remediation, testing, and implementation. To date,
the Company has fully completed its assessment of all systems that could be
significantly affected by the Year 2000. Based on assessments, the Company
determined that it was required to modify or replace certain portions of its
software and hardware so that those systems will properly utilize dates beyond
December 31, 1999. For its IT exposures which include financial, order
management, and manufacturing scheduling systems, the Company is 100% complete
on the assessment and remediation phases. As of the date of this report, the
Company has completed its testing and has implemented its remediated systems for
all of its businesses. The assessments also indicated that limited software and
hardware (embedded chips) used in production and manufacturing systems
("operating equipment") also are at limited risk. The Company has completed its
assessment and identified remedial action which will be completed in the second
quarter 1999. In addition, the Company has completed its assessment of its
product line and determined that the products it has sold and will continue to
sell do not require remediation to be Year 2000 compliant. Accordingly, based on
the Company's current assessment, the Company does not believe that the Year
2000 presents a material exposure as it relates to the Company's products.
The Company has queried its significant suppliers, subcontractors,
distributors and other third parties (external agents). The Company does not
have any direct system interfaces with external agents. To date, the Company is
not aware of any external agent with a Year 2000 Issue that would materially
impact the Company's results of operations, liquidity, or capital resources.
However, the Company has no means of ensuring that external agents will be Year
2000 ready. The inability of external agents to complete their Year 2000
resolution process in a timely fashion could materially impact the Company. The
effect of non-compliance by external agents is not determinable at this time.
Management of the Company believes it has an effective program in place
to resolve the remaining aspects of the Year 2000 Issue applicable to its
businesses in a timely manner. If the Company does not complete the remaining
phases of its
32
program, the Year 2000 Issue could have a negative impact on the operations
of the Company; however, management does not believe that, under the most
reasonably likely worst case scenario, such potential impact would be
material.
The Company is creating contingency plans for certain critical
applications. These contingency plans will involve, among other actions, manual
workarounds, increasing inventories, and adjusting staffing strategies. In
addition, disruptions in the economy generally resulting from Year 2000 Issues
could also materially adversely affect the Company. See "Special Note Regarding
Forward-Looking Statements".
CONTINGENCIES
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. The preceding sentence is a forward-looking statement that involves
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 penalties, 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 or a court finds
the Chemical Business liable for a material amount of damages in the antitrust
lawsuits pending against the Chemical Business in a manner not presently
anticipated by the Company. See "Business", "Legal Proceedings" and Note 9 of
Notes to Consolidated Financial Statements.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
GENERAL
The Company's results of operations and operating cash flows are
impacted by changes in market interest rates and raw material prices for
products used in its manufacturing processes. The Company also has a
wholly-owned subsidiary in Australia, for which the company has foreign currency
translation exposure. The derivative contracts used by the Company are entered
into to hedge these risks and exposures and not for trading purposes. All
information is presented in U.S. dollars. See Item 1. - "Business - Chemical"
for a discussion of an offer to purchase the Australian subsidiary which the
company received in 1999.
INTEREST RATE RISK
The Company's interest rate risk exposure results from its debt
portfolio which is impacted by short-term rates, primarily prime rate-based
borrowings from commercial banks, and long-term rates, primarily fixed-rate
notes, some of which prohibit prepayment or require substantial prepayment
penalties.
33
The Company is also a party to a series of agreements under which, upon
completion of construction, it will lease a nitric acid plant. The minimum lease
payments associated therewith until execution will be directly impacted by the
change in interest rates. To mitigate a portion of the Company's exposure to
adverse market changes related to this leveraged lease, in 1997 the Company
entered into an interest rate forward agreement whereby the Company is the fixed
rate payor on notional amounts aggregating $25 million, net to its 50% interest,
with a weighted average of 7.12%. The Company accounts for this forward under
the deferral method, so long as high correlation is maintained, whereby the net
gain or loss upon settlement will adjust the item being hedged, the minimum
lease rentals, in periods commencing with the lease execution. As of December
31, 1998, the fair value of this interest rate forward agreement represented a
liability of approximately $3.3 million, net to the Company's 50% interest. The
following table provides information about the Company's interest rate sensitive
financial instruments as of December 31, 1998.
34
YEARS ENDING DECEMBER 31,
THEREAFTER
THROUGH
1999 2000 2001 2002 2003 2007 TOTAL
--------------------------------------------------------------------------------
Expected maturities of long-term debt:
Variable rate debt $ 5,009 $11,793 $ - $ - $ - $ - $ 16,802
Weighted average
interest rate (1) 8.01% 8.18% - - - - 8.10%
Fixed rate debt $ 5,451 $ 3,971 $ 3,889 $ 2,377 $ 274 $105,167 $121,129
Weighted average
interest rate (2) 10.56% 10.62% 10.67% 10.73% 10.75% 10.75% $ 10.70%
- -------------------
(1) Interest rate is based on the aggregate rate of debt outstanding as of
December 31, 1998. Interest is generally at a floating rate based on the
lender's prime rate plus .5% to 1.5% per annum, or at the Company's option,
under its Revolving Credit Agreements, on the lender's LIBOR rate plus
2.875% per annum (rates under its Revolving Credit Agreements are subject
to change based upon specified availability and adjusted tangible net worth
levels).
(2) Interest rate is based on the aggregate rate of debt outstanding as of
December 31, 1998.
35
As of December 31, 1998, the Company's variable-rate and fixed-rate
debt which aggregated $137.9 million approximated their fair value. The fair
value of the Company's Senior Notes was determined based on a market quotation
for such securities.
RAW MATERIAL PRICE RISK
The Company enters into long-term supply agreements with certain third
parties to insure availability of certain raw materials used in its
manufacturing processes. To mitigate a portion of its price risk, the Company
has entered into swap agreements whereby it receives a floating price and pays a
fixed price. As of December 31, 1998, the Company had outstanding natural gas
contracts requiring settlement in January and February, 1999, involving notional
amounts of 590,000 MMBtu for which the fair value represented a liability of
approximately $255,000. The Company follows the deferral method of accounting
for these swap agreements.
FOREIGN CURRENCY RISK
The Company has a wholly-owned subsidiary located in Australia, for
which the functional currency is the local currency, the Australian dollar.
Since the Australian subsidiary accounts are converted into U.S. dollars upon
consolidation using the end of the period exchange rate, declines in value of
the Australian dollar to the U.S. dollar result in translation loss to the
Company. Additionally, any cumulative foreign currency translation loss will
impact operating results in the period the Company sells or disposes of
substantially all of its investment in the subsidiary. As of December 31, 1998,
the Company's net investment in this Australian subsidiary was $5.8 million with
the cumulative translation loss not recognized in results of operations
aggregating approximately $1.6 million.
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. 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.
36
SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS
Certain statements contained within this report may be deemed
"Forward-Looking Statements" within the meaning of Section 27A of the Securities
Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934,
as amended. All statements in this report other than statements of historical
fact are Forward-Looking Statements that are subject to known and unknown risks,
uncertainties and other factors which could cause actual results and performance
of the Company to differ materially from such statements. The words "believe",
"expect", "anticipate", "intend", "will", and similar expressions identify
Forward-Looking Statements. Forward-Looking Statements contained herein relate
to, among other things, (i) additional capacity for anhydrous ammonia coming
on-line, and such additional capacity may contribute to a decline in future
market price for such ammonia, (ii) construction costs of the EDNC Baytown Plant
will approximate $69 million (excluding the $12.9 million paid to subcontractors
by the bonding company); it will be completed by the second quarter of 1999;
and, when the EDNC Baytown Plant is fully operational, the annual sales volume
from such plant will be approximately $35 million to $50 million, (iii) future
cash requirements, (iv) ability to meet presently anticipated capital
expenditures, working capital, and debt service requirements, (v) ability to
comply with the Company's general working capital requirements, (vi) ability to
be able to continue to borrow under the Company's revolving line of credit,
(vii) contingencies should not have a material adverse impact on the Company's
liquidity, (viii) ability to be in compliance with certain financial covenants
contained in certain loan agreements, (ix) ability to complete resolution of the
Year 2000 Issues in a timely manner, (x) capital expenditures for 1999, (xi)
additional capacity for the production of anhydrous ammonia constructed in 1998,
and being constructed in 1999, may contribute to the decline of its future
market prices, and (xii) ability to comply with revised financial covenants
under the Revolver. While the Company believes the expectations reflected in
such Forward-Looking Statements are reasonable, it can give no assurance such
expectations will prove to have been correct. There are a variety of factors
which could cause future outcomes to differ materially from those described in
this report, including, but not limited to, (i) decline in general economic
conditions, both domestic and foreign, (ii) material reduction in revenues,
(iii) inability to collect in a timely manner a material amount of receivables,
(iv) increased competitive pressures, (v) contracts are not obtained or projects
are not finalized within a reasonable period of time or on schedule, (vi)
changes in federal, state and local laws and regulations, especially
environmental regulations, or in interpretation of such, (vii) additional
releases (particularly air emissions into the environment), (viii) potential
increases in equipment, maintenance, operating or labor costs not presently
anticipated by the Company, (ix) inability to retain management or to develop
new management, (x) the requirement to use internally generated funds for
purposes not presently anticipated, (xi) the effect of additional production
capacity of anhydrous ammonia in the western hemisphere, (xii) the cost for the
purchase of anhydrous ammonia not reducing or continuing to increase or the cost
for natural gas increases, (xiii) changes in operating strategy or development
plans, (xiv) inability to fund the expansion of the Company's businesses, (xv)
adverse results in any of the Company's pending litigation, (xvi) inability by
37
others to complete construction of additional capacity for the production of
anhydrous ammonia, (xvii) inability to obtain necessary raw materials, and
(xviii) other factors described in "Management's Discussion and Analysis of
Financial Condition and Results of Operation" contained in this report. Given
these uncertainties, all parties are cautioned not to place undue reliance on
such Forward-Looking Statements. The Company disclaims any obligation to update
any such factors or to publicly announce the result of any revisions to any of
the Forward-Looking Statements contained herein to reflect future events or
developments.
38
PART III
Because all of the Company's outstanding capital stock is owned
directly or indirectly by its parent, LSB Industries, Inc., the Company is not
required to file a definitive proxy statement, and, as a result, the Company
will provide the information required by Part III of this report by amending
this report on or before April 30, 1999, to include such information (except for
the information of the Company's executive officers included under Item 4A of
Part I of this report), and incorporate such by reference.
39
PART IV
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 F-1
Consolidated Balance Sheets at December 31, 1998
and 1997 F-2
Consolidated Statements of Operations for each of
the three years in the period ended December 31,
1998 F-3
Consolidated Statements of Stockholders' Equity
for each of the three years in the period ended
December 31, 1998 F-4
Consolidated Statements of Cash Flows for
each of the three years in the period
ended December 31, 1998 F-5 to F-6
Notes to Consolidated Financial Statements F-7 to F-41
Quarterly Financial Data (Unaudited) F-42
(a)(2) FINANCIAL STATEMENT SCHEDULE
The Company has included the following schedule in this report:
II - Valuation and Qualifying Accounts F-43
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.
40
(a)(3) EXHIBITS
3.1. Certificate of Incorporation of ClimaChem, Inc., which
the Company hereby incorporates by reference from Exhibit 3.1 to the
Company's Registration Statement, No. 333-44905.
3.2. Bylaws of ClimaChem, Inc., which the Company hereby
incorporates by reference from Exhibit 3.2 to the Company's
Registration Statement, No. 333-44905.
4.1. Indenture, dated as of November 26, 1997, by and among
ClimaChem, Inc., the Subsidiary Guarantors and Bank One, N.A., as
trustee, which the Company hereby incorporates by reference from
Exhibit 4.1 to LSB Industries, Inc.'s Form 8-K, dated November 26,
1997.
4.2. Form 10 3/4% Series B Senior Notes due 2007, which the
Company hereby incorporates by reference from Exhibit 4.3 to the
Company's Registration Statement, No. 333-44905.
4.3. Promissory Note, dated November 26, 1997, executed by LSB
Industries, Inc. in favor of ClimaChem, Inc., which the Company hereby
incorporates by reference from Exhibit 10.1 to the Company's
Registration Statement, No. 333-44905.
4.4. Amended and Restated Loan and Security Agreement, dated
November 21, 1997, by and between BankAmerica Business Credit, Inc.,
and Climate Master, Inc., International Environmental Corporation, El
Dorado Chemical Company and Slurry Explosive Corporation, which the
Company hereby incorporates by reference from Exhibit 10.2 to the
Company's Registration Statement, No. 333-44905.
4.5. First Amendment to Amended and Restated Loan and Security
Agreement, dated March 12, 1998, between BankAmerica Business Credit,
Inc., and Climate Master, Inc., International Environmental
Corporation, El Dorado Chemical Company and Slurry Explosive
Corporation, which the Company hereby incorporates by reference from
Exhibit 10.53 to the Company's Registration Statement, No. 333-44905.
4.6. Third Amendment to Amended and Restated Loan and Security
Agreement, dated August 14, 1998, between BankAmerica Business Credit,
Inc., and Climate Master, Inc., International Environmental
Corporation, El Dorado Chemical Company and Slurry Explosive
Corporation, which the Company hereby incorporates by reference from
Exhibit 4.1 to LSB Industries, Inc.'s Form 10-Q for the quarter ended
June 30, 1998.
4.7. Fourth Amendment to Amended and Restated Loan and
Security Agreement, dated November 19, 1998, between BankAmerica
Business Credit, Inc., and Climate Master, Inc., International
Environmental Corporation, El Dorado Chemical Company and Slurry
Explosive Corporation, which the
41
Company hereby incorporates by reference from Exhibit 4.1 to LSB
Industries, Inc.'s Form 10-Q for the quarter ended September 30,
1998.
4.8. Fifth Amendment to Amended and Restated Loan and Security
Agreement, dated April 8, 1999, between BankAmerica Business Credit,
Inc., and Climate Master, Inc., International Environmental
Corporation, El Dorado Chemical Company and Slurry Explosive
Corporation, which the Company hereby incorporates by reference from
Exhibit 4.16 to LSB Industries, Inc.'s Form 10-K for the fiscal year
ended December 31, 1998.
4.9. Waiver Letter, dated March 16, 1998, from BankAmerica
Business Credit, Inc., which the Company hereby incorporates by
reference from Exhibit 10.55 to the Company's Registration Statement,
No. 333-44905.
4.10. First supplement to indenture dated as of February 9,
1999 which is incorporated by reference from Exhibit 4.19 to LSB's
Form 10-K for the year ended December 31, 1998.
10.1. Continuing Guaranty, dated November 21, 1997, between
ClimaChem, Inc. and BankAmerica Business Credit, Inc., which the
Company hereby incorporates by reference from Exhibit 10.3 to the
Company's Registration Statement, No. 333-44905.
10.2. Services Agreement, dated November 21, 1997, between LSB
Industries, Inc. and ClimaChem, Inc., which the Company hereby
incorporates by reference from Exhibit 10.4 to the Company's
Registration Statement, No. 333-44905.
10.3. Management Agreement, dated November 21, 1997, between
LSB Industries, Inc. and ClimaChem, Inc., which the Company hereby
incorporates by reference from Exhibit 10.5 to the Company's
Registration Statement, No. 333-44905.
10.4. Tax Sharing Agreement, dated November 21, 1997, between
LSB Industries, Inc. and ClimaChem, Inc., which the Company hereby
incorporates by reference from Exhibit 10.6 to the Company's
Registration Statement, No. 333-44905.
10.8. Union Contracts, dated August 5, 1995, between EDC and
the Oil, Chemical and Atomic 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. Severance Agreement, dated January 17, 1989, between LSB
Industries, Inc. and Jack E. Golsen, which the Company hereby
incorporates by reference from Exhibit 10.48 to LSB Industries, Inc.'s
Form 10-K for fiscal year ended December 31, 1988. LSB Industries, Inc.
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.
10.10. Employment Agreement and Amendment to Severance
Agreement, dated January 12, 1989 between LSB Industries, Inc. and Jack
E. Golsen, dated March 21, 1996, which the Company hereby incorporates
by reference
42
from Exhibit 10.15 to LSB Industries, Inc.'s Form 10-K for fiscal
year ended December 31, 1995.
10.11. Letter Amendment, dated May 14, 1997, to Loan and
Security Agreement between DSN Corporation and The CIT Group/Equipment
Financing, Inc., is incorporated by reference from Exhibit 10.1 to LSB
Industries, Inc.'s Form 10-Q for the fiscal quarter ended March 31,
1997.
10.12. Amendment to Loan and Security Agreement, dated
November 21, 1997, between DSN Corporation and The CIT Group/Equipment
Financing, Inc., which the Company hereby incorporates by reference
from Exhibit 10.19 to the Company's Registration Statement, No.
333-44905.
10.13. Guaranty Agreement, dated November 21, 1997, executed
by ClimaChem, Inc. in favor of The CIT Group/Equipment Financing, Inc.,
which the Company hereby incorporates by reference from Exhibit 10.20
to the Company's Registration Statement, No. 333-44905.
10.14. Promissory Note, dated July 14, 1989, from Climate
Master, Inc. to Oklahoma County Finance Authority, which the Company
hereby incorporates by reference from Exhibit 10.21 to the Company's
Registration Statement, No. 333-44905.
10.15. Extension of Maturity on Promissory Note, dated
February 7, 1997, relating to the Promissory Note, dated July 14, 1989,
from Climate Master, Inc., to Oklahoma County Finance Authority, which
the Company hereby incorporates by reference from Exhibit 10.22 to the
Company's Registration Statement, No. 333-44905.
10.16. Mortgage of Tenant's Interest in Lease, dated July 1,
1989, executed by Climate Master, Inc. in favor of the Oklahoma County
Finance Authority, which the Company hereby incorporates by reference
from Exhibit 10.23 to the Company's Registration Statement, No.
333-44905.
10.17. Project Loan Agreement, dated July 1, 1989, between
Climate Master, Inc., and the Oklahoma County Finance Authority, which
the Company hereby incorporates by reference from Exhibit 10.24 to the
Company's Registration Statement, No. 333-44905.
10.18. Hire-Purchase Agreement, dated November 21, 1994,
between Total Energy Systems Limited and Toyota Finance Australia
Limited, which the Company hereby incorporates by reference from
Exhibit 10.25 to the Company's Registration Statement, No. 333-44905.
10.19. Lease Agreement, dated October 25, 1996, between Total
Energy Systems Limited and Sanwa Australia Finance Limited, which the
Company hereby incorporates by reference from Exhibit 10.26 to the
Company's Registration Statement, No. 333-44905. Total Energy Systems
Limited has entered into a second Lease Agreement which is
substantially identical, copies of which will be provided to the
Commission upon request.
43
10.20. Master Lease Agreement, dated October 10, 1995, between
Total Energy Systems (NZ) Limited and GE Capital (NZ) Limited, which
the Company hereby incorporates by reference from Exhibit 10.27 to the
Company's Registration Statement, No. 333-44905.
10.21. Master Lease Agreement, dated December 15, 1994,
between Total Energy Systems Limited and KE Financial Corporation
Limited, which the Company hereby incorporates by reference from
Exhibit 10.28 to the Company's Registration Statement, No. 333-44905.
10.22. Land Lease, dated March 1, 1995, between DSN
Corporation and Koch Sulphur Products Company, which the Company hereby
incorporates by reference from Exhibit 10.29 to the Company's
Registration Statement, No. 333-44905.
10.23. Promissory Note, dated June 2, 1997, executed by
International Environmental Corporation in favor of ORIX Credit
Alliance, Inc., which the Company hereby incorporates by reference from
Exhibit 10.30 to the Company's Registration Statement, No. 333-44905.
10.24. Security Agreement-Mortgage on Goods and Chattels,
dated April 18, 1997, executed by International Environmental
Corporation in favor of ORIX Credit Alliance, Inc., which the Company
hereby incorporates by reference from Exhibit 10.31 to the Company's
Registration Statement, No. 333-44905.
10.25. Lease Agreement, dated March 7, 1988, between Northwest
Financial Corporation and International Environmental Corporation,
which the Company hereby incorporates by reference from Exhibit 10.32
to the Company's Registration Statement, No. 333-44905.
10.26. First Amendment, dated August 17, 1995, to Lease
Agreement, dated March 7, 1988, between Prime Financial Corporation and
International Environmental Corporation, which the Company hereby
incorporates by reference from Exhibit 10.33 to the Company's
Registration Statement, No. 333-44905.
10.27. Assignment, dated August 17, 1995, between Northwest
Financial Corporation and Prime Financial Corporation, which the
Company hereby incorporates by reference from Exhibit 10.34 to the
Company's Registration Statement, No. 333-44905.
10.28. Loan and Security Agreement, dated March 14, 1995,
between International Environmental Corporation and MetLife Capital
Corporation, which the Company hereby incorporates by reference from
Exhibit 10.35 to the Company's Registration Statement, No. 333-44905.
10.29. Lease Agreement, dated April 3, 1996, between Amplicon
Financial and International Environmental Corporation, which the
Company hereby incorporates by reference from Exhibit 10.36 to the
Company's Registration Statement, No. 333-44905.
44
10.30. Equipment Purchase and Security Agreement, dated
February 1, 1994, between U.S. Amada Ltd. and Climate Master, Inc.,
which the Company hereby incorporates by reference from Exhibit 10.37
to the Company's Registration Statement, No. 333-44905. Climate Master
has entered into three other Equipment Purchase and Security Agreements
which are substantially identical in all material respects except the
principal amount is $380,000, $88,000, and $330,000, respectively.
Copies of each of the foregoing will be provided to the Commission upon
request.
10.31. Master Commercial Hire and Purchase Agreement (New
South Wales), dated November 14, 1994, between G.E. Capital Australia
Limited and Total Energy Systems Limited, which the Company hereby
incorporates by reference from Exhibit 10.41 to the Company's
Registration Statement, No. 333-44905.
10.32. Master Commercial Hire Purchase Agreement (Western
Australia), dated November 14, 1994, between G.E. Capital Australia
Limited and Total Energy Systems Limited, which the Company hereby
incorporates by reference from Exhibit 10.42 to the Company's
Registration Statement, No. 333-44905.
10.33. Master Commercial Hire Purchase Agreement (Queensland),
dated November 14, 1994, between G.E. Capital Australia Limited and
Total Energy Systems Limited, which the Company hereby incorporates by
reference from Exhibit 10.43 to the Company's Registration Statement,
No. 333-44905.
10.34. Loan and Security Agreement (DSN Plant), dated October
31, 1994, between DSN Corporation and The CIT Group, which the Company
hereby incorporates by reference from Exhibit 10.1 to LSB Industries,
Inc.'s Form 10-Q for the fiscal quarter ended September 30, 1994.
10.35. Loan and Security Agreement (Mixed Acid Plant), dated
April 5, 1995, between DSN Corporation and The CIT Group, which the
Company hereby incorporates by reference from Exhibit 10.25 to LSB
Industries, Inc.'s Form 10-K for the fiscal year ended December 31,
1994.
10.36. First Amendment to Loan and Security Agreement (DSN
Plant), dated June 1, 1995, between DSN Corporation and The CIT
Group/Equipment Financing, Inc., which the Company hereby incorporates
by reference from Exhibit 10.13 to the Company's Registration
Statement, No. 333-44905.
10.37. First Amendment to Loan and Security Agreement (Mixed
Acid Plant), dated November 15, 1995, between DSN Corporation and The
CIT Group/Equipment Financing, Inc., which the Company hereby
incorporates by reference from Exhibit 10.15 to the Company's
Registration Statement, No. 333-44905.
10.38. Loan and Security Agreement (Rail Tank Cars), dated
November 15, 1995, between DSN Corporation and The CIT Group/Equipment
Financing, Inc., which the Company hereby incorporates by reference
from Exhibit 10.16 to the Company's Registration Statement, No.
333-44905.
45
10.39. First Amendment to Loan and Security Agreement (Rail
Tank Cars), dated November 15, 1995, between DSN Corporation and The
CIT Group/Equipment Financing, Inc., which the Company hereby
incorporates by reference from Exhibit 10.17 to the Company's
Registration Statement, No. 333-44905.
10.40. Letter Amendment, dated May 14, 1997, to Loan and
Security Agreement between DSN Corporation and The CIT Group/Equipment
Financing, Inc., which the Company hereby incorporates by reference
from Exhibit 10.1 to LSB Industries, Inc.'s Form 10-Q for the fiscal
quarter ended March 31, 1997.
10.41. Amendment to Loan and Security Agreement, dated
November 21, 1997, between DSN Corporation and The CIT Group/Equipment
Financing, Inc., which the Company hereby incorporates by reference
from Exhibit 10.19 to the Company's Registration Statement, No.
333-44905.
10.42. Facility Letter, dated August 20, 1997, between Bank of
New Zealand, Australia, and Total Energy Systems Limited, which the
Company hereby incorporates by reference from Exhibit 10.38 to the
Company's Registration Statement, No. 333-44905.
10.43. Variation Letter, dated February 10, 1998, between Bank
of New Zealand, Australia, and Total Energy Systems Limited, which the
Company hereby incorporates by reference from Exhibit 10.39 to the
Company's Registration Statement, No. 333-44905.
10.44. Debenture Charge, dated March 7, 1995, between Total
Energy Systems Limited and Bank of New Zealand, which the Company
hereby incorporates by reference from Exhibit 10.40 to the Company's
Registration Statement, No. 333-44905. T.E.S. Mining Services Pty. Ltd.
and Total Energy Systems (NZ) Limited are each parties to substantially
identical Debentures, copies of which will be provided to the
Commission upon request.
10.45. Anhydrous Ammonia Sales Agreement, dated May 28, 1997,
to be effective January 1, 1997, between Koch Nitrogen Company and El
Dorado Chemical Company, which the Company hereby incorporates by
reference from Exhibit 10.1 to LSB Industries, Inc.'s Form 10-Q for the
fiscal quarter ended June 30, 1997. CERTAIN INFORMATION WITHIN THIS
EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION ORDER CF
#5551, DATED SEPTEMBER 25, 1997, GRANTING A REQUEST FOR CONFIDENTIAL
TREATMENT UNDER THE FREEDOM OF INFORMATION ACT AND THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED.
10.46. Baytown Nitric Acid Project and Supply Agreement, dated
June 27, 1997, by and among El Dorado Nitrogen Company, El Dorado
Chemical Company and Bayer Corporation, which the Company hereby
incorporates by reference from Exhibit 10.2 to LSB Industries, Inc.'s
Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT
OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997, GRANTING A
REQUEST FOR CONFIDENTIAL
46
TREATMENT UNDER THE FREEDOM OF INFORMATION ACT AND THE SECURITIES
EXCHANGE ACT OF 1934, AS AMENDED.
10.47. First Amendment to Baytown Nitric Acid Supply
Agreement, dated February 1, 1999, between El Dorado Nitrogen Company
and Bayer Corporation, which the Company hereby incorporates by
reference from Exhibit 10.30 to LSB Industries, Inc.'s Form 10-K for
the fiscal year ended December 31, 1998. CERTAIN INFORMATION WITHIN
THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF A REQUEST BY THE
COMPANY FOR CONFIDENTIAL TREATMENT BY THE SECURITIES AND EXCHANGE
COMMISSION UNDER THE FREEDOM OF INFORMATION ACT. THE OMITTED
INFORMATION HAS BEEN FILED SEPARATELY WITH THE SECRETARY OF THE
SECURITIES AND EXCHANGE COMMISSION FOR PURPOSES OF SUCH REQUEST.
10.48. Service Agreement, dated June 27, 1997, between Bayer
Corporation and El Dorado Nitrogen Company, which the Company hereby
incorporates by reference from Exhibit 10.3 to LSB Industries, Inc.'s
Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT
OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997, GRANTING A
REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE FREEDOM OF INFORMATION ACT
AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.
10.49. Ground Lease, dated June 27, 1997, between Bayer
Corporation and El Dorado Nitrogen Company, which the Company hereby
incorporates by reference from Exhibit 10.4 to LSB Industries, Inc.'s
Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT
OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997, GRANTING A
REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE FREEDOM OF INFORMATION ACT
AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.
10.50. Participation Agreement, dated as of June 27, 1997,
among El Dorado Nitrogen Company, Boatmen's Trust Company of Texas as
Owner Trustee, Security Pacific Leasing corporation, as Owner
Participant and a Construction Lender, Wilmington Trust Company,
Bayerische Landesbank, New York Branch, as a Construction Lender and
the Note Purchaser, and Bank of America National Trust and Savings
Association, as Construction Loan Agent, which the Company hereby
incorporates by reference from Exhibit 10.5 to LSB Industries, Inc.'s
Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT
OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997, GRANTING A
REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE FREEDOM OF INFORMATION ACT
AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.
10.51. Lease Agreement, dated as of June 27, 1997, between
Boatmen's Trust Company of Texas as Owner Trustee and El Dorado
Nitrogen Company, which the Company hereby incorporates by reference
from Exhibit 10.6 to LSB Industries, Inc.'s Form 10-Q for the fiscal
quarter ended June 30, 1997.
47
10.52. Security Agreement and Collateral Assignment of
Construction Documents, dated as of June 27, 1997, made by El Dorado
Nitrogen Company, which the Company hereby incorporates by reference
from Exhibit 10.7 to LSB Industries, Inc.'s Form 10-Q for the fiscal
quarter ended June 30, 1997.
10.53. Security Agreement and Collateral Assignment of
Facility Documents, dated as of June 27, 1997, made by El Dorado
Nitrogen Company and consented to by Bayer Corporation, which the
Company hereby incorporates by reference from Exhibit 10.8 to LSB
Industries, Inc.'s Form 10-Q for the fiscal quarter ended June 30,
1997.
10.54. Amendment to Loan and Security Agreement, dated March
16, 1998, between The CIT Group/Equipment Financing, Inc., and DSN
Corporation, which the Company hereby incorporates by reference from
Exhibit 10.54 to the Company's Registration Statement, No. 333-44905.
10.55. Sales Contract, dated December 7, 1998, between
Solutia, Inc. and El Dorado Chemical Company, which the Company hereby
incorporates by reference from Exhibit 10.39 to LSB Industries, Inc.'s
Form 10-K for the fiscal year ended December 31, 1998. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT
OF A REQUEST BY THE COMPANY FOR CONFIDENTIAL TREATMENT BY THE
SECURITIES AND EXCHANGE COMMISSION UNDER THE FREEDOM OF INFORMATION
ACT. THE OMITTED INFORMATION HAS BEEN FILED SEPARATELY WITH THE
SECRETARY OF THE SECURITIES AND EXCHANGE COMMISSION FOR PURPOSES OF
SUCH REQUEST.
10.56. Agreement for Purchase and Sale of Anhydrous Ammonia,
dated January 1, 1999, between El Dorado Chemical Company and Farmland
Industries, Inc., which the Company hereby incorporates by reference
from Exhibit 10.40 to LSB Industries, Inc.'s Form 10-K for the fiscal
year ended December 31, 1998. CERTAIN INFORMATION WITHIN THIS EXHIBIT
HAS BEEN OMITTED AS IT IS THE SUBJECT OF A REQUEST BY THE COMPANY FOR
CONFIDENTIAL TREATMENT BY THE SECURITIES AND EXCHANGE COMMISSION UNDER
THE FREEDOM OF INFORMATION ACT. THE OMITTED INFORMATION HAS BEEN FILED
SEPARATELY WITH THE SECRETARY OF THE SECURITIES AND EXCHANGE COMMISSION
FOR PURPOSES OF SUCH REQUEST.
10.57. Agreement, dated March 23, 1999, among El Dorado
Chemical Company, El Dorado Nitrogen Company, Bayer Corporation, ICF
Kaiser Engineers, Inc., ICF Kaiser International, Inc., and Acstar
Insurance Company, which the Company hereby incorporates by reference
from Exhibit 10.41 to LSB Industries, Inc.'s Form 10-K for the fiscal
year ended December 31, 1998.
10.58. Union Contract, dated as of August 1, 1998, between EDC
and the International Association of Machinists and Aerospace Workers,
which the Company hereby incorporates by reference from Exhibit 10.42
to LSB Industries, Inc.'s Form 10-K for the year ended December 31,
1998.
48
10.59. Stock Purchase Agreement, dated February 9, 1999, by
and between LSB Holdings, Inc. and ClimaChem, Inc.
10.60. Covenant Waiver Letter, dated April 13, 1999, between
The CIT Group and DSN Corporation, which the Company hereby
incorporates by reference from Exhibit 10.46 to LSB Industries, Inc.'s
Form 10-K for the fiscal year ended December 31, 1998.
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 1998.
49
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
ClimaChem, Inc.
We have audited the accompanying consolidated balance sheets of ClimaChem,
Inc. as of December 31, 1998 and 1997, and the related consolidated
statements of operations, stockholders' equity and cash flows for each of the
three years in the period ended December 31, 1998. 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 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 ClimaChem, Inc. at December 31, 1998 and 1997, and the consolidated
results of its operations and its cash flows for each of the three years in
the period ended December 31, 1998, 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
February 19, 1999,
except for paragraphs (A) and (D) of Note 6, as to which the date is
April 14, 1999
F-1
CLIMACHEM, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31,
1998 1997
----------------- ----------------
(In Thousands)
ASSETS
Current assets (NOTE 6):
Cash and cash equivalents $ 750 $ 3,534
Trade accounts receivable, net 38,817 38,521
Inventories (NOTE 4) 37,367 38,760
Supplies and prepaid items 7,023 6,282
Income tax receivable (NOTE 7) 2,050 2,142
Current deferred income taxes 1,338 1,345
Due from LSB and affiliates (NOTE 3) 1,350 2,157
----------------- ----------------
Total current assets 88,695 92,741
Property, plant and equipment, net (NOTES 5 AND 6) 82,389 84,329
Due from LSB and affiliates, net (NOTE 3) 13,140 13,443
Other assets, net 10,480 10,362
----------------- ----------------
$ 194,704 $200,875
================= ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Accounts payable $ 17,416 $ 19,091
Accrued liabilities 6,019 9,075
Current portion of long-term debt (NOTE 6) 10,460 9,838
----------------- ----------------
Total current liabilities 33,895 38,004
Long-term debt (NOTE 6) 127,471 126,346
Deferred income taxes (NOTE 7) 9,580 9,236
Commitments and contingencies (NOTE 9)
Stockholders' equity (NOTES 6 AND 8):
Common stock, $.10 par value; 500,000 shares authorized, 10,000 shares
issued 1 1
Capital in excess of par value 12,652 12,652
Accumulated other comprehensive loss (1,559) (1,003)
Retained earnings 12,664 15,639
----------------- ----------------
Total stockholders' equity 23,758 27,289
----------------- ----------------
$ 194,704 $200,875
================= ================
SEE ACCOMPANYING NOTES.
F-2
CLIMACHEM, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
Revenues:
Net sales $255,730 $262,847 $255,285
Interest and other income 1,468 893 333
---------------- ----------------- ----------------
257,198 263,740 255,618
Costs and expenses:
Cost of sales 205,148 213,772 207,828
Selling, general and administrative 40,283 37,854 33,122
Interest (NOTE 3) 13,944 9,788 6,247
---------------- ----------------- ----------------
259,375 261,414 247,197
---------------- ----------------- ----------------
Income (loss) before provision for income taxes and
extraordinary charge (2,177) 2,326 8,421
Provision for income taxes (NOTE 7) 392 1,429 2,668
---------------- ----------------- ----------------
Income (loss) before extraordinary charge (2,569) 897 5,753
Extraordinary charge, net of income tax benefit of $1,750,000
(NOTE 6) - 2,869 -
---------------- ----------------- ----------------
Net income (loss) $(2,569) $(1,972) $5,753
================ ================= ================
SEE ACCOMPANYING NOTES.
F-3
CLIMACHEM, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)
ACCUMULATED
OTHER
COMMON STOCK CAPITAL IN COMPREHENSIVE
-------------------------- EXCESS OF INCOME RETAINED
SHARES PAR VALUE PAR VALUE (LOSS) EARNINGS TOTAL
-------------------------------------------------------------------------------------
Balance at December 31, 1995 10,000 $1 $12,652 $ 278 $15,744 $28,675
Net income - - - - 5,753 5,753
Foreign currency translation
adjustment - - - (2) - (2)
-------------
Total comprehensive income 5,751
Dividends to Parent - - - - (1,583) (1,583)
-------------------------------------------------------------------------------------
Balance at December 31, 1996 10,000 1 12,652 276 19,914 32,843
Net loss - - - - (1,972) (1,972)
Foreign currency translation
adjustment - - - (1,279) - (1,279)
-------------
Total comprehensive loss (3,251)
Dividends to Parent - - - - (2,303) (2,303)
-------------------------------------------------------------------------------------
Balance at December 31, 1997 10,000 1 12,652 (1,003) 15,639 27,289
Net loss - - - - (2,569) (2,569)
Foreign currency translation
adjustment - - - (556) - (556)
-------------
Total comprehensive loss (3,125)
Dividends to Parent - - - - (406) (406)
-------------------------------------------------------------------------------------
Balance at December 31, 1998 10,000 $1 $12,652 $(1,559) $12,664 $23,758
=====================================================================================
SEE ACCOMPANYING NOTES.
F-4
CLIMACHEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income (loss) $ (2,569) $ (1,972) $ 5,753
Adjustments to reconcile net income (loss) to net cash
provided (used) by operations:
Extraordinary charge, net of tax, related to financing
activities - 2,869 -
Depreciation of property, plant and equipment 9,545 8,130 6,707
Amortization 1,324 756 719
Provision for losses:
Trade accounts receivable 971 521 280
Notes receivable 854 175 1,015
Environmental matters and other (387) - 100
Deferred income tax provision (credit) 351 209 (246)
Loss (gain) on sales of assets (30) 138 (20)
Cash provided (used) by changes in assets and liabilities:
Trade accounts receivable (1,484) (2,384) (6,235)
Inventories 904 (3,128) (6,819)
Supplies and prepaid items (1,252) (191) (1,923)
Income tax receivable 92 (2,142) -
Accounts payable (1,598) (13,706) 12,563
Accrued liabilities (2,859) 1,014 3,069
---------------- ----------------- ----------------
Net cash provided (used) by operating activities 3,862 (9,711) 14,963
CASH FLOWS FROM INVESTING ACTIVITIES
Capital expenditures (7,418) (9,357) (18,554)
Proceeds from sales of equipment 65 194 36
Increase in other assets (1,072) (3,609) (432)
---------------- ----------------- ----------------
Net cash used by investing activities (8,425) (12,772) (18,950)
(CONTINUED ON FOLLOWING PAGE)
F-5
CLIMACHEM, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
CASH FLOWS FROM FINANCING ACTIVITIES
Payments on long-term and other debt $ (4,690) $(72,504) $ (9,716)
Long-term and other borrowings, net of
origination fees (583) 155,000 12,644
Debt prepayment charge, net of tax - (2,869) -
Net change in revolving debt facilities 6,348 (28,478) (1,463)
Net change in due to/from LSB and affiliates 1,110 (23,938) 2,802
Dividends paid to parent (406) (2,303) (1,583)
---------------- ----------------- ----------------
Net cash provided by financing activities 1,779 24,908 2,684
---------------- ----------------- ----------------
Net increase (decrease) in cash and cash equivalents (2,784) 2,425 (1,303)
Cash and cash equivalents at beginning of year 3,534 1,109 2,412
---------------- ----------------- ----------------
Cash and cash equivalents at end of year $ 750 $ 3,534 $ 1,109
================ ================= ================
SEE ACCOMPANYING NOTES.
F-6
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996
1. BASIS OF PRESENTATION
ClimaChem, Inc. (the "Company"), a wholly-owned subsidiary of LSB Industries,
Inc. ("LSB" or "Parent"), was organized under the laws of the State of
Oklahoma in October 1997. The Company's Certificate of Incorporation
authorizes the issuance of 500,000 shares of $.10 par value common stock.
Prior years' authorized, issued and outstanding shares of common stock in the
accompanying consolidated financial statements reflect this issuance as
though it occurred at the earliest period presented. The Company is a holding
company which maintains operations through various wholly-owned subsidiaries.
The Company owns, through its subsidiaries, a substantial portion, but not
all, of the operations comprising the Chemical Business and Climate Control
Business as previously owned by LSB. Prior to November 21, 1997, all of the
Company's subsidiaries were wholly-owned subsidiaries of LSB, directly or
through one or more intermediaries, and were contributed to the Company,
following its formation, by LSB or other subsidiaries in exchange for all of
the outstanding common stock of the Company. These exchanges have been
accounted for as a reorganization of entities under common control and,
accordingly, reflect LSB's and its subsidiaries' historical cost of such
subsidiaries and net assets. Accordingly, the consolidated financial
statements of ClimaChem, Inc. and its subsidiaries for all periods reflect
this reorganization in a manner similar to a pooling of interests.
The consolidated financial statements include the accounts of ClimaChem, Inc.
and its wholly-owned subsidiaries. All significant intercompany transactions
have been eliminated in the accompanying financial statements.
The Company has historically had significant transactions with LSB and its
subsidiaries which are reflected in the accompanying consolidated financial
statements on the basis established between the Company and LSB and its
subsidiaries. See Notes 3, 7, 8 and 9.
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.
F-7
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
INVENTORIES
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 $7,095,000 and $8,151,000 at December 31,
1998 and 1997, respectively, 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 was $1,062,000 and
$1,223,000 at December 31, 1998 and 1997, respectively.
DEPRECIATION
For financial reporting purposes, depreciation is primarily computed using
the straight-line method over the estimated useful lives of the assets.
EXCESS OF PURCHASE PRICE OVER NET ASSETS ACQUIRED
The excess of purchase price over net assets acquired, which is included in
other assets in the accompanying consolidated balance sheets, totaling
$2,654,000 and $2,997,000, net of accumulated amortization, of $3,758,000 and
$3,415,000 at December 31, 1998 and 1997, respectively, 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 expected proceeds
from disposal) if the facts and circumstances indicate that it may be
impaired. No impairment provisions were required in 1998, 1997 or 1996.
DEBT ISSUANCE COST
Debt issuance costs are amortized over the term of the associated debt
instrument using the straight-line method. Such costs, which are included in
other assets in the accompanying consolidated balance sheets, were $3,878,000
and $3,737,000 net of accumulated amortization of $525,000 and $103,000 as of
December 31, 1998 and 1997, respectively.
INCOME TAXES
Taxable income of the Company is included in the consolidated federal income
tax return of LSB. The provision for or benefit from income taxes is
calculated as if the Company filed a separate federal income tax return. To
the extent a state or other taxing jurisdiction requires or permits a
consolidated, combined, or unitary tax return to be filed, and such return
includes the Company, the principles expressed with respect to consolidated
federal income tax allocation shall apply.
F-8
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
Deferred income taxes result from the Company having different bases for
financial and income tax reporting principally from utilizing different lives
for income taxes purposes than for financial reporting purposes.
RESEARCH AND DEVELOPMENT COSTS
Costs incurred in connection with product research and development are
expensed as incurred. Such costs amounted to $377,000, $367,000 and $514,000
for the years ended December 31, 1998, 1997 and 1996, respectively.
ADVERTISING COSTS
Costs incurred in connection with advertising and promotion of the Company's
products are expensed as incurred. Such costs amounted to $1,152,000,
$1,160,000 and $893,000 for the years ended December 31, 1998, 1997 and 1996,
respectively.
CAPITALIZED INTEREST
Interest costs of $1,113,000 and $2,405,000 related to the construction of a
nitric acid plant were capitalized for the years ended December 31, 1997 and
1996, respectively (none in 1998), and are being amortized over the related
plant's estimated useful life.
TRANSLATION OF FOREIGN CURRENCY
Assets and liabilities of foreign operations, where the functional currency
is the local currency, are translated into U.S. dollars at the fiscal year
end exchange rate. The related translation adjustments are recorded as
cumulative translation adjustments, a separate component of stockholders'
equity. Revenues and expenses are translated using average exchange rates
prevailing during the year.
HEDGING
In 1997, the Company entered into interest rate forward contracts to effectively
fix the interest rate on a long-term lease commitment to become effective in
1999 (not for trading purposes). The Company accounts for these contracts under
the deferral method, whereby the net gain or loss upon settlement will serve to
adjust the item being hedged, the minimum lease rentals, in periods commencing
with the lease execution. If the necessary correlation (generally a correlation
coefficient of between 80% and 125%) ceases, the differential between the market
value and the carrying value will be recognized in operations as a gain or loss.
Under the interest
F-9
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
rate forward agreement, the subsidiary of the Company is the fixed rate payor
on notional amounts aggregating $50 million with a weighted average interest
rate of 7.12%. The agreement requires a net settlement on maturity in 1999,
of which an unrelated third party is contractually obligated for 50%. The
Company is required to post margin in the form of bank letters of credit or
treasury bills under this interest rate hedge agreement equal to the loss in
market value of the contracts since inception. See Note 9 -- Commitments and
Contingencies and Note 10 -- Fair Value of Financial Instruments.
In August 1998, the Company entered into a three month natural gas swap
agreement at a price of $2.56 per MMBtu for the months of December 1998
through February 1999 to hedge the price volatility of ammonia (not for
trading purposes). Under these swap agreements, the Company is the
fixed-price payor. Monthly payments are made or received based on the
differential between the fixed price and the specified index price of natural
gas on the settlement date. Gains or losses resulting from the settlement of
the swap transactions are recognized in cost of sales when the inventory is
sold. At December 31, 1998, commodity contracts involving notional amounts of
590,000 MMBtu were outstanding and are not reflected in the accompanying
consolidated balance sheet. These notional amounts do not represent amounts
exchanged by the parties; rather, they are used as the basis to calculate the
amounts due under the agreements.
CHANGES IN ACCOUNTING
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS 130").
The provisions of SFAS 130 require the Company to classify items of other
comprehensive income in the financial statements and display the accumulated
balance of other comprehensive income separately from retained earnings and
additional paid-in capital in the equity section of the balance sheet. The
Company has also made similar reclassifications for all prior periods for
comparative purposes.
Effective January 1, 1998, the Company changed its method of accounting for
the costs of computer software developed for internal use to capitalize costs
incurred after the preliminary project stage as outlined in Statement of
Position 98-1, "Accounting for the Costs of Computer Software Developed or
Obtained for Internal Use" ("SOP 98-1"). These capitalized costs will be
amortized over their estimated useful life. Prior to 1998, these costs were
expensed as incurred. The effect of this change on net income for the year
ended December 31, 1998 was not material.
F-10
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
Effective January 1, 1998, the Company adopted the Financial Accounting
Standards Board's Statement of Financial Accounting Standards No. 131,
"Disclosures about Segments of an Enterprise and Related Information"
(Statement 131). Statement 131 superseded FASB Statement No. 14, "Financial
Reporting for Segments of a Business Enterprise." Statement 131 establishes
standards for the way that public business enterprises report information
about operating segments in annual financial statements and requires that
those enterprises report selected information about operating segments in
interim financial reports. Statement 131 also establishes standards for
related disclosures about products and services, geographic areas, and major
customers. The adoption of Statement 131 did not affect results of operations
or financial position, but did affect the disclosure of segment information
(NOTE 11).
RECENTLY ISSUED PRONOUNCEMENTS
In the second quarter of 1998, the Accounting Standards Executive Committee
of the Securities and Exchange Commission released Statement of Position
98-5, "Reporting on the Costs of Start-up Activities" ("SOP 98-5"). SOP 98-5
requires that the costs of start-up activities, including organization costs,
be expensed as incurred. As of December 31, 1998, the start-up costs
capitalized on the balance sheet are immaterial. SOP 98-5 is effective for
fiscal years ending after December 15, 1998 and, accordingly, will be adopted
January 1, 1999.
In June 1998, the Financial Accounting Standards Board issued Statement No.
133 ("SFAS 133"), "Accounting for Derivative Instruments and Hedging
Activities," which is required to be adopted in years beginning after June
15, 1999. The Statement permits early adoption as of the beginning of any
fiscal quarter after its issuance. The Company expects to adopt this new
Statement January 1, 2000. The Statement will require the Company to
recognize all derivatives on the balance sheet at fair value. Derivatives
that are not hedges must be adjusted to fair value through income. If the
derivative is a hedge, depending on the nature of the hedge, changes in the
fair value of derivatives will either be offset against the change in fair
value of the hedged assets, liabilities, or firm commitments through earnings
or recognized in other comprehensive income until the hedged item is
recognized in earnings. The ineffective portion of a derivative's change in
fair value will be immediately recognized in earnings. The Company has not
yet determined what all of the effects of SFAS 133 will be on the earnings
and financial position of the Company; however, the Company expects that the
interest rate forward contracts, discussed under Accounting Policies --
Hedging, will be accounted for as a cash flow hedge upon adoption of SFAS
133, with the effective portion of the hedge being classified in equity in
accumulated other comprehensive income or loss. The amount included in
accumulated other comprehensive income or loss will be amortized to
operations over the initial term of the leveraged lease.
F-11
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
2. ACCOUNTING POLICIES (CONTINUED)
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:
YEAR ENDED DECEMBER 31,
1998 1997 1996
-------------- -------------- --------------
(In Thousands)
Cash payments for interest and income taxes:
Interest on long-term debt and other $14,079 $9,864 $8,259
Income taxes:
Paid to state taxing authorities 65 86 263
Paid to Parent 1,908 1,013 3,500
Noncash financing and investing activities--
Long-term debt issued for property, plant and equipment 523 1,108 2,165
3. TRANSACTIONS WITH RELATED PARTIES
On November 21, 1997, the Company and LSB entered into a services agreement
(the "Services Agreement") pursuant to which LSB will continue to provide to
the Company various services, including financial and accounting, order
entry, billing, credit, payable, insurance, legal, human resources,
advertising and marketing, and related administrative and management
services, that LSB has historically provided to the operations and businesses
of the Company. The Company will pay to, or reimburse, LSB for the costs and
expenses incurred by LSB in the performance of the Services Agreement.
Under the terms of the Services Agreement, the Company will pay to, or
reimburse, LSB for the value of the office facilities of LSB, including LSB's
principal offices and financial accounting offices utilized in the
performance of the Services Agreement. LSB will determine the proportionate
usage of such facilities by LSB and the Company, and the Company will pay to,
or reimburse, LSB for its proportionate share of such usage.
Charges for such services aggregate $2,265,000, $1,950,000 and $1,800,000 for
the years ended December 31, 1998, 1997 and 1996, respectively. Management of
the Company believes these charges from LSB reasonably approximate additional
general and administrative costs which would have been incurred if the
Company had been an independent entity during such periods.
F-12
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
These amounts do not include reimbursements for costs described in the next
paragraph or amounts paid by LSB relating to certain of the Company's payroll
that are directly charged to the Company by LSB.
The Services Agreement also provides that LSB will permit employees of the
Company and its subsidiaries to continue to participate in the benefit plans
and programs sponsored by LSB. The Company will pay to, or reimburse, LSB for
the costs associated with participation by the employees of the Company in
LSB's benefit plans and programs.
The Company also leases the facilities of one of its Climate Control
manufacturing subsidiaries from an affiliate under an operating lease. See
Note 9 -- Commitments and Contingencies, Operating Leases. Rental expense
associated with the lease was $475,000, $475,000 and $447,000 for the years
ended December 31, 1998, 1997 and 1996, respectively.
On November 21, 1997, LSB and the Company entered into a management agreement
(the "Management Agreement"), which provides that in future periods LSB will
provide to the Company, managerial oversight and guidance concerning the broad
policies, strategic decisions and operations of the Company and the subsidiaries
and the rendering of such further managerial assistance as deemed reasonably
necessary by LSB. Under the Management Agreement, the Company is to pay LSB a
fee for such services which will not exceed $1.8 million annually. The fee will
be paid quarterly based upon the excess of actual earnings before interest,
income taxes, depreciation and amortization ("EBITDA") for the quarter minus
$6,500,000, not to exceed $450,000. If at the end of the calendar year, EBITDA
is less than $26 million, management fees paid to LSB during the year shall be
refunded to the Company for the first three quarters of the year, not to exceed
$1,350,000. The maximum management fee amount to be paid to LSB by the Company
is adjusted annually commensurate with the percentage change, if any, in the
Consumer Price Index during the preceding calendar year. The Company has a
receivable of $1,350,000 at December 31, 1998 (none at December 31, 1997) for
refunds of amounts paid in 1998 under the management agreement.
On November 21, 1997, the Company and LSB entered into a tax sharing agreement
(the "Tax Sharing Agreement") which provides for (i) the allocation of payments
of taxes for periods during which the Company and its subsidiaries and LSB are
included in the same consolidated group for federal income tax purposes or the
same consolidated, combined or unitary returns for
F-13
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
state, local or foreign tax purposes, (ii) the allocation of responsibility
for the filing of tax returns, (iii) the conduct of tax audits and the
handling of tax controversies, and (iv) various related matters. For tax
periods beginning after December 1996 and ending ten years thereafter, so
long as the Company is included in LSB's consolidated federal income tax
returns or state consolidated combined or unitary tax returns, the Company
will be required to pay to LSB an amount equal to the Company's consolidated
federal and state income tax liability calculated as if the Company and its
subsidiaries were a separate consolidated tax group and not part of LSB's
consolidated tax group. Such amount is payable in estimated quarterly
installments. If the sum of the estimated quarterly installments is (a)
greater than the tax liability of the Company, on a consolidated basis, as
determined by LSB, under the Tax Sharing Agreement, then LSB will refund the
amount of the excess to the Company, or (b) less than the Company's tax
liability, on a consolidated basis, as determined by LSB, under the Tax
Sharing Agreement, then the Company will pay to LSB the amount of the
deficiency. For the years ended December 31, 1998 and 1997, respectively, the
Company paid to LSB $1.9 million and $1.0 million under the Tax Sharing
Agreement, approximately $2.1 million of which represents an income tax
receivable at December 31, 1998 and 1997 for amounts paid during the year
based on quarterly estimates in excess of actual amounts due based on annual
calculations (which include fourth quarter losses).
Under the terms of an Indenture between the Company, the guarantors and the
trustee relating to the Notes (as defined in Note 6), the Company is
permitted to distribute or pay in the form of dividends and other
distributions to LSB in connection with the Company's outstanding equity
securities or loans, (a) advances or investments to any person (including
LSB), up to 50% of the Company's consolidated net income for the period
(taken as one accounting period), commencing on the first day of the first
full fiscal quarter commencing after the Issue Date of the Notes to and
including the last day of the fiscal quarter ended immediately prior to the
date of said calculation (or, in the event consolidated net income for such
period is a deficit, then minus 100% of such deficit), plus (b) the aggregate
net cash proceeds received by the Company from the sale of its capital stock.
This limitation will not prohibit (i) payment to LSB under the Services
Agreement, Management Agreement and the Tax Sharing Agreement, or (ii) the
payment of any dividend within 60 days after the date of its declaration if
such dividend could have been made on the date of such declaration. Based on
the terms stated above, the Company declared and paid to LSB a dividend, in
the fourth quarter of 1998, in the amount of $406,000 representing 50% of the
Company's consolidated net income for the nine months ended September 30,
1998 (none in 1997).
F-14
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
3. TRANSACTIONS WITH RELATED PARTIES (CONTINUED)
The Company has, at various times, maintained certain unsecured borrowings
from LSB and its subsidiaries and made loans and advances to LSB which
generally bear interest. At December 31, 1998 and 1997, the Company had loans
and advances due from LSB of approximately $13.1 million and $13.4 million,
respectively, $10.0 million of which was loaned to LSB from the proceeds of
the sale of the Notes, as defined (Note 6 -- Long-Term Debt), and bears
interest at 10-3/4%, maturing November 2007 with the remainder of the
receivable from LSB and affiliates relating to cash advances from the Company
to LSB and affiliates prior to the sale of the Notes, as defined, from
borrowings on the Company's credit facilities. These loans are due November
2007 and bear interest at 7% per annum. At December 31, 1998 and 1997, the
Company had $1.4 million and $2.2 million, respectively, due from LSB and
affiliates included in current assets related to operations under the
Services Agreement or refunds under the management agreement, which is
non-interest bearing. The amount outstanding at December 31, 1997 was
received by the Company in March 1998. Prior to 1997, the Company had net
amounts due to LSB and subsidiaries and, accordingly, incurred interest
expense on such borrowings aggregating approximately $338,000 for the year
ended December 31, 1996. The Company earned interest income on net loans and
advances due from LSB and affiliates aggregating approximately $1,316,000 and
$357,000 for the years ended December 31, 1998 and 1997, respectively.
LSB and its subsidiaries (other than the Company and its subsidiaries), the
"LSB Non-ClimaChem Entities," are dependent upon their separate cash flows
and the restricted funds which can be distributed by the Company under the
above mentioned agreements. As of December 31, 1998, the LSB Non-ClimaChem
Entities had working capital of $13.7 million (including $26.5 million of
inventories and $13.9 million of accounts receivable), stockholders' equity
of $11.3 million (exclusive of their equity in the Company and its
subsidiaries) and long-term debt of $31.7 million (including that owed to the
Company), $3.5 million of which is due within one year. For the year ended
December 31, 1998, the LSB Non-ClimaChem Entities had net income of $.6
million, including a gain on the sale of an office tower of $13.0 million,
and used cash in operating activities approximating $8.1 million. LSB is
focusing its efforts and resources on its core businesses, which represent
that of the Company, and is evaluating the spin-off of its automotive
business and the most appropriate means of realizing its investments in
certain other non-core assets. LSB is also realigning its overhead to better
match its focus on the Chemical and Climate Control Businesses of the
Company. Based on these plans, management of LSB believes the LSB
Non-ClimaChem Entities will have sufficient operating capital to meet its
obligations as they come due, including those to the Company. If LSB
management is not successful in executing this plan, including realignment of
overhead to reduce its operating costs or realizing certain excess and
non-core assets, it is reasonably possible that this evaluation could change
in the near term.
F-15
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
4. INVENTORIES
Inventories consist of:
FINISHED
(OR PURCHASED) WORK-IN- RAW
GOODS PROCESS MATERIALS TOTAL
----------------------------------------------------------------------
(In Thousands)
December 31, 1998:
Climate Control products $ 3,233 $2,442 $ 6,673 $12,348
Chemical products 10,890 3,848 10,281 25,019
----------------------------------------------------------------------
Total $14,123 $6,290 $16,954 $37,367
======================================================================
December 31, 1997:
Climate Control products $ 2,920 $3,246 $ 6,748 $12,914
Chemical products 10,269 4,557 11,020 25,846
----------------------------------------------------------------------
Total $13,189 $7,803 $17,768 $38,760
======================================================================
5. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment, at cost, consist of:
DECEMBER 31,
1998 1997
----------------- ----------------
(In Thousands)
Land and improvements $ 1,340 $ 1,340
Buildings and improvements 8,037 7,584
Machinery, equipment and automotive 130,951 124,919
Furniture and fixtures 3,277 2,593
----------------- ----------------
143,605 136,436
Less accumulated depreciation 61,216 52,107
----------------- ----------------
$ 82,389 $ 84,329
================= ================
F-16
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT
Long-term debt consists of the following:
DECEMBER 31,
1998 1997
----------------- ----------------
(In Thousands)
Secured revolving credit facility with interest at a base rate plus a specified
percentage (8.18% aggregate rate at December 31, 1998) (A) $ 11,793 $ 6,136
Secured revolving credit facility (weighted average interest rate of 7.1% at
December 31, 1998) (B) 5,009 4,592
10 3/4% Senior Notes due 2007 (C) 105,000 105,000
Secured loan (D) 9,570 11,806
Other, with interest at rates of 8.3% to 10.90%, most of which is secured by
machinery and equipment 6,559 8,650
----------------- ----------------
137,931 136,184
Less current portion of long-term debt 10,460 9,838
----------------- ----------------
Long-term debt due after one year $127,471 $126,346
================= ================
(A) In December 1994, LSB and certain of its subsidiaries (the "Borrowing
Group ") and a bank entered into a series of asset-based revolving
credit facilities which provided for an initial term of three years. In
November 1997, the Company amended the agreement to provide for a $65
million revolving credit facility (the "Revolving Credit Facility ")
with four separate loan agreements (the "Credit Facility Agreements "),
one for the subsidiaries of the Company and three for LSB and its
subsidiaries which are not subsidiaries of the Company. Under the
Revolving Credit Facility, LSB and certain subsidiaries of LSB that are
not subsidiaries of the Company have a right to borrow on a revolving
basis, up to $24 million ($14.5 million outstanding at December 31,
1998). Any amounts borrowed by LSB and its subsidiaries that are not
subsidiaries of the Company will reduce the amount that the
subsidiaries of the Company may borrow at any one time under the
Revolving Credit Facility. Borrowings under the Revolving Credit
Facility bear an annual rate of interest at a floating rate based on
the lender's prime rate plus .5% per annum or, at the Company's option,
on the lender's LIBOR rate plus
F-17
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT (CONTINUED)
2.875% per annum (which rates are subject to increase or reduction
based upon specified availability and adjusted tangible net worth
levels). The Revolving Credit Facility will terminate on December 31,
2000, subject to automatic renewal for terms of 13 months each, unless
terminated by either party. The Credit Facility Agreement also requires
the payment of an annual facility fee equal to 0.5% of the unused
Revolving Credit Facility. The Company may terminate the Revolving
Credit Facility prior to maturity; however, should the Company do so,
it would be required to pay a termination fee of $500,000.
Each of the Credit Facility Agreements specify a number of events of
default and require the Company to maintain certain financial ratios
(including adjusted tangible net worth and debt ratios), limits the
amount of capital expenditures, and contains other covenants which
restrict, among other things, (i) the incurrence of additional debt;
(ii) the payment of dividends and other distributions; (iii) the making
of certain investments; (iv) certain mergers, acquisitions and
dispositions; (v) the issuance of secured guarantees; and (vi) the
granting of certain liens.
Events of default under the Revolving Credit Facility include, among
other things, (i) the failure to make payments of principal, interest,
and fees, when due; (ii) the failure to perform covenants contained
therein; (iii) the occurrence of a change in control of LSB if any
party is or becomes the beneficial owner of more than 50% of the total
voting securities of LSB, except for Jack E. Golsen or members of his
immediate family; (iv) default under any material agreement or
instrument (other than an agreement or instrument evidencing the
lending of money) which would have a material adverse effect on the
Company and its subsidiaries which are borrowers under the Revolving
Credit Facility, taken as a whole, and which is not cured within the
grace period; (v) a default under any other agreement relating to
borrowed money exceeding certain limits; and (vi) customary bankruptcy
or insolvency defaults. In November 1998, the Company and LSB and its
subsidiaries, not affiliated with the Company (the "borrowers") amended
the financial covenants of the Revolving Credit Facility (the "Amended
Covenants"). The Amended Covenants provide for elimination of financial
covenants upon the sale, disposal or spin-off of LSB's Automotive
subsidiaries, which are not subsidiaries of the Company, so long as the
remaining borrowing group maintains a minimum aggregate availability
under the Revolving Credit Facility of $15 million.
F-18
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT (CONTINUED)
At December 31, 1998, the Company and LSB and its subsidiaries which
are not subsidiaries of the Company were not in compliance with certain
of the financial covenants of the Revolving Credit Facility. In April
1999, the Company obtained a waiver of the noncompliance and an
amendment to reset the financial covenants through maturity.
The Revolving Credit Facility is secured by the accounts receivable,
inventory, proprietary rights, general intangibles, books and records,
and proceeds thereof of the Company.
(B) At December 31, 1998, the Company's wholly-owned Australian subsidiary,
TES, had an AUS $10.5 million (U.S. $6.5 million) revolving credit
facility with a bank (the "Amended TES Revolver") which is renewed by
the bank on an annual basis. The Amended TES Revolver provides for
borrowings based on specified percentages of qualified eligible assets.
The interest rate on the Amended TES Revolver is dependent upon the
borrowing option elected by TES. Borrowings under an overdraft option,
as defined, generally bear interest at the bank's base lending rate
(which approximates the U.S. prime rate) plus .5% per annum. Borrowings
under the commercial bill option generally bear interest at the bank's
yield rate, as defined, plus 1.5% per annum.
The Amended TES Revolver contains certain financial covenants with
which the subsidiary must comply. At December 31, 1998, the Company was
in technical noncompliance with certain financial covenants contained
in the Amended TES Revolver; however, the bank has confirmed that it
will not act on any default so long as, in its opinion, such default
will not impact the ability of TES or LSB to continue operations or
service and repay its borrowings outstanding under the Amended TES
Revolver. At December 31, 1998 and 1997, all borrowings outstanding
under the TES Revolver have been classified as due within one year in
the consolidated balance sheets.
The Amended TES Revolver is secured by substantially all of the assets
of TES, plus an unlimited guarantee and indemnity from LSB and certain
subsidiaries.
F-19
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT (CONTINUED)
(C) On November 26, 1997, the Company completed the sale of $105 million
principal amount of 10 3/4% Senior Notes due 2007 (the "Notes"). The
proceeds of the Notes were used to (a) fully repay the principal and
prepayment fees of a $50 million John Hancock Mutual Life Insurance
Company financing arrangement described below, (b) reduce amounts
outstanding under various revolving credit facilities with respect to
the Chemical Business and the Climate Control Business; and (c) fund a
loan to LSB, the Company's parent, of $10 million. The Notes bear
interest at an annual rate of 10 3/4% payable semiannually in arrears
on June 1 and December 1 of each year. The Notes are senior unsecured
obligations of the Company and rank PARI PASSU in right of payment to
all existing senior unsecured indebtedness of the Company. The Notes
are effectively subordinated to all existing and future senior secured
indebtedness of the Company and its subsidiaries.
The Notes were issued pursuant to an Indenture, which contains certain
covenants that, among other things, limit the ability of the Company
and its subsidiaries to: (i) incur additional indebtedness; (ii) incur
certain liens; (iii) engage in certain transactions with affiliates;
(iv) make certain restricted payments; (v) agree to payment
restrictions affecting subsidiaries; (vi) engage in unrelated lines of
business; or (vii) engage in mergers, consolidations or the transfer of
all or substantially all of the assets of the Company to another
person. In addition, in the event of certain asset sales, the Company
will be required to use the proceeds to reinvest in the Company's
business, to repay certain debt or to offer to purchase Notes at 100%
of the principal amount thereof, plus accrued and unpaid interest, if
any, thereon, plus liquidated damages, if any, to the date of purchase.
Except as described below, the Notes are not redeemable at the
Company's option prior to December 1, 2002. After December 1, 2002, the
Notes will be subject to redemption at the option of the Company, in
whole or in part, at the redemption prices set forth in the indenture,
plus accrued and unpaid interest thereon, plus liquidated damages, if
any, to the applicable redemption date. In addition, until December 1,
2000, up to $35 million in aggregate principal amount of Notes are
redeemable, at the option of the Company, at a price of 110.75% of the
principal amount of the Notes, together with accrued and unpaid
interest, if any, thereon, plus liquidated damages, if any, to the date
of the redemption, with the net cash proceeds of a public equity
offering; provided, however, that at least $65 million in aggregate
principal amount of the Notes remain outstanding following such
redemption.
F-20
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT (CONTINUED)
In the event of a Change of Control of LSB or the Company, holders of
the Notes will have the right to require the Company to repurchase the
Notes, in whole or in part, at a redemption price of 101% of the
principal amount thereof, plus accrued and unpaid interest, if any,
thereon, plus liquidated damages, if any, to the date of repurchase.
The Company is a holding company with no assets (other than the notes
and accounts receivable from LSB, specified in the accompanying
consolidated balance sheets, and the Notes origination fees which have
a net book value of $3.7 million as of December 31, 1998) or operations
other than its investments in its subsidiaries, and each of its
subsidiaries is wholly owned, directly or indirectly. ClimaChem's
payment obligations under the Notes are fully, unconditionally and
joint and severally guaranteed by all of the existing subsidiaries of
the Company, except for El Dorado Nitrogen Company ("EDNC"). The
assets, equity, and earnings of EDNC are inconsequential for all
periods presented and management of the Company does not believe
separate financial information of the guaranteeing subsidiaries is
material to the understanding of investors of the Notes.
In February 1997, certain subsidiaries of the Company's Chemical
Business entered into a $50 million financing arrangement with John
Hancock. The financing arrangement consisted of $25 million of fixed
rate notes and $25 million of floating rate notes. In connection with
the issuance of the Notes, a subsidiary of the Company retired the
outstanding principal associated with the John Hancock financing
arrangement and incurred a prepayment fee. The prepayment fee paid and
loan origination costs expensed in 1997 related to the John Hancock
financing arrangement aggregated $4,619,000 ($2,869,000 net of income
tax benefit of $1,750,000).
(D) This agreement, as amended, between a subsidiary of the Company and an
institutional lender provides for a loan, the proceeds of which were
used in the construction of a nitric acid plant, in the aggregate
amount of $16.5 million requiring 84 equal monthly payments of
principal plus interest, with interest at a fixed rate of 8.86% through
maturity in 2002. This agreement is secured by the plant, equipment and
machinery, and proprietary rights associated with the plant which has
an approximate carrying value of $28.7 million at December 31, 1998.
F-21
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
6. LONG-TERM DEBT (CONTINUED)
This agreement, as amended, contains covenants (i) requiring
maintenance of an escalating tangible net worth, (ii) restricting
distributions and dividends from a subsidiary of the Company to the
Company to 50% of the subsidiary's annual net income, as defined, (iii)
restricting a change of control of the Company and (iv) requiring
maintenance of a debt to tangible net worth ratio. In November 1998,
the subsidiary of the Company received a waiver for noncompliance of
the tangible net worth and debt to tangible net worth ratio through the
period ended September 30, 1999. In April 1999, the subsidiary of the
Company obtained a waiver of the covenants through June 2000.
Maturities of long-term debt for each of the five years after December 31,
1998 are as follows: (in thousands) 1999--$10,460; 2000--$15,764;
2001--$3,889; 2002--$2,377; 2003--$274 and thereafter--$105,167.
7. INCOME TAXES
The provision for income taxes consists of:
YEAR ENDED DECEMBER 31,
1998 1997 1996
----------------- ---------------- -----------------
(In Thousands)
Current:
Federal $ 35 $1,027 $2,456
State 6 193 458
----------------- ---------------- -----------------
41 1,220 2,914
Deferred:
Federal 299 178 (222)
State 52 31 (24)
----------------- ---------------- -----------------
351 209 (246)
----------------- ---------------- -----------------
Provision for income taxes $392 $1,429 $2,668
================= ================ =================
F-22
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
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, 1998 and
1997 are as follows:
DECEMBER 31,
1998 1997
----------------- ----------------
(In Thousands)
DEFERRED TAX LIABILITIES
Accelerated depreciation used for tax purposes $10,174 $ 9,117
Inventory basis difference resulting from a business combination 2,133 2,139
Other 69 119
----------------- ----------------
Total deferred tax liabilities 12,376 11,375
DEFERRED TAX ASSETS
Allowances for doubtful accounts and other asset impairments not deductible for
tax purposes 2,530 1,735
Capitalization of certain costs as inventory for tax purposes 1,604 1,746
Other - 3
----------------- ----------------
Total deferred tax assets 4,134 3,484
Valuation allowance - -
----------------- ----------------
Total deferred tax assets 4,134 3,484
----------------- ----------------
Net deferred tax liabilities $ 8,242 $ 7,891
================= ================
F-23
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
7. INCOME TAXES (CONTINUED)
The provision for income taxes differs from the amount computed by applying the
federal statutory rate to "Income (loss) before provision for income taxes and
extraordinary charge" due to the following:
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
Provision (benefit) for income taxes at federal
statutory rate $ (762) $ 814 $2,947
State income taxes, net of federal benefit 38 146 282
Amortization of excess of purchase price over net assets
acquired 120 120 120
Foreign subsidiary loss (income) 1,016 270 (597)
Other (20) 79 (84)
---------------- ----------------- ----------------
Provision for income taxes $ 392 $1,429 $2,668
================ ================= ================
At December 31, 1998 and 1997, the Company had an income tax receivable of
approximately $2.1 million, including $1.75 million associated with the
extraordinary charge discussed in Note 6 -- Long-term Debt. The receivable
will be recovered through offset against future tax liabilities of the
Company under its tax sharing agreement with LSB.
8. STOCKHOLDERS' EQUITY
STOCK OPTIONS
Certain employees of the Company, including members of management of LSB
devoting time to the Company, participate in the incentive stock option plans
of LSB (the "Stock Option Plans"). As a result thereof, 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 such 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 employee stock options equals
the market price of the underlying LSB stock on the date of grant, no
compensation expense is recognized.
F-24
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
Pro forma information regarding net income is required by Statement 123,
which also requires that the information be determined as if the Company has
accounted for such 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 by LSB at the date of grant using a Black-Scholes
option pricing model with the following weighted average assumptions for 1998
and 1996, respectively (none granted in 1997): risk-free interest rates of
5.75% and 6.0%; a dividend yield of .5% and 1.38%; a volatility factor of the
expected market price of LSB's common stock of .57 and .41; and a weighted
average expected life of the option of 8 and 6.2 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 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 such employee stock options.
For purposes of pro forma disclosures, the estimated fair value of the
qualified options is amortized to expense over the options' vesting period.
The Company's pro forma information follows:
YEAR ENDED DECEMBER 31,
1998 1997 1996
------------------------------------------------------
(In Thousands)
Pro forma net income (loss) $(3,208) $(2,381) $5,645
Because Statement 123 is applicable only to options granted subsequent to
December 31, 1994, its pro forma effect was not fully reflected until 1998.
QUALIFIED STOCK OPTION PLAN
At December 31, 1998, there are 462,550 options outstanding under the
Qualified Stock Option Plans related to employees of the Company and members
of LSB management devoting time to the Company. 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 LSB's common stock at the date of grant.
F-25
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
On April 22, 1998, the Company terminated 85,000 qualified stock options (the
"terminated options"), previously granted and replaced the terminated options
with newly granted options (the "replacement options"). The replacement
options were granted at the fair market value of the Company's stock on April
22, 1998, have a life and vesting schedule based on the terminated options.
Activity in the Qualified Stock Option Plans related to Company employees and
members of LSB management devoting time to the Company during each of the
three years in the period ended December 31, 1998 is as follows:
1998 1997 1996
-------------------------- ------------------------ ---------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE PRICE
SHARES PRICE SHARES PRICE SHARES
---------------------------------------------------------------------------------
Outstanding at beginning of year 519,550 $4.39 549,050 $4.32 267,050 $3.86
Granted 85,000 4.19 - - 332,000 4.44
Exercised (55,000) 1.13 (29,500) 3.01 (30,000) 2.46
Canceled, forfeited or expired (87,000) 6.15 - - (20,000) 2.64
------------- ---------- ----------
Outstanding at end of year 462,550 4.39 519,550 4.39 549,050 4.32
============= ========== ===========
Exercisable at end of year 248,750 $4.43 170,450 $3.96 149,450 $3.22
============= ========== ===========
Weighted average fair value of
options granted during year $2.22 $ - $1.91
Outstanding options to acquire 440,550 shares of stock at December 31, 1998
had exercise prices ranging from $1.38 to $4.88 per share (231,550 of which
are exercisable at a weighted average price of $4.12 per share) and had a
weighted average exercise price of $4.25 and remaining contractual life of
5.1 years. The balance of options outstanding at December 31, 1998 had
exercise prices ranging from $5.36 to $9.00 per share (17,200 of which are
exercisable at a weighted average price of $8.36 per share) and a weighted
average exercise price of $7.68 and remaining contractual life of 3.6 years.
F-26
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
NON-QUALIFIED STOCK OPTIONS PLANS
Certain outside directors, the President and certain key employees of the
Company participate in LSB's Non-qualified Stock Option Plan. The exercise
prices of the options are based on the market value of LSB's common stock at
the date of grant. These options have vesting terms and lives specific to
each grant but generally vest over 48 months and expire five or ten years
from the grant date (except for the 1998 grants discussed below).
In 1998, the LSB Board of Directors granted employees of the Company 175,000
stock options, at the price equivalent to LSB's stock price at the date of
grant. Options to two key employees for 100,000 shares have a nine-year
vesting schedule while the remaining 75,000 vest over 48 months. These
options expire ten years from the date of grant. During 1998, the Company
granted 52,500 options (none in 1997 or 1996), respectively, under LSB's
Outside Director Plan. The granted options vested over six months and expire
ten years from the date of grant. In 1997, the LSB Board of Directors granted
employees of the Company 50,000 options that vest over 60 months and expire
ten years from the date of grant.
Activity in the Non-qualified Stock Option Plans related to Company employees
and members of LSB management or directors devoting time to the Company
during each of the three years in the period ended December 31, 1998 is as
follows:
1998 1997 1996
------------------------ ----------------------- ----------------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE PRICE
SHARES PRICE SHARES PRICE SHARES
------------------------------------------------------------------------------
Outstanding at beginning of year 116,250 $3.03 66,250 $2.15 66,250 $2.15
Granted 227,500 4.19 50,000 4.19 -
---------- --------- --------
Outstanding at end of year 343,750 3.80 116,250 3.03 66,250 2.15
========== ========= ========
Exercisable at end of year 118,750 $3.05 49,750 $2.00 41,500 $1.87
========== ========= ========
Weighted average fair value of
options granted during year $2.61 $2.00 $ -
F-27
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
8. STOCKHOLDERS' EQUITY (CONTINUED)
Outstanding options to acquire 66,250 shares of stock at December 31, 1998 had
exercise prices ranging from $1.38 to $2.63 per share all of which are
exercisable at a weighted average exercise price of $2.15 and have a remaining
contractual life of 3.9 years. The balance of options outstanding at December
31, 1998 had exercise prices ranging from $4.13 to $4.25 per share (52,500 of
which are exercisable at a weighted average price of $4.19 per share) and a
weighted average exercise price of $4.18 and remaining contractual life of 9.2
years.
9. COMMITMENTS AND CONTINGENCIES
OPERATING LEASES
The Company leases certain property, plant and equipment under operating lease
agreements from related parties (NOTE 3) and others. The Company also leases
certain precious metals under operating lease agreements from an unrelated third
party. Future annual minimum payments on operating leases with initial or
remaining terms of one year or more at December 31, 1998 are as follows:
RELATED PARTIES OTHERS
----------------------------------------
(In Thousands)
1999 $ 650 $ 2,506
2000 650 2,190
2001 650 1,957
2002 492 1,740
2003 175 1,140
After 2003 - 4,774
----------------------------------------
$2,617 $14,307
========================================
Rent expense under all operating lease agreements, including month-to-month
leases, was $3,903,000 in 1998, $4,104,000 in 1997 and $4,265,000 in 1996.
Renewal options are available under certain of the lease agreements for
various periods at approximately the existing annual rental amounts.
F-28
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In June 1997, two wholly owned subsidiaries of the Company, El Dorado
Chemical Company ("EDC"), and El Dorado Nitrogen Company ("EDNC"), entered
into a series of agreements with Bayer Corporation ("Bayer") (collectively,
the "Bayer Agreement"). Under the Bayer Agreement, EDNC will act as an agent
to construct, and upon completion of construction, will operate a nitric acid
plant (the "EDNC Baytown Plant") at Bayer's Baytown, Texas chemical facility.
EDC has guaranteed the performance of EDNC's obligations under the Bayer
Agreement. Under the terms of the Bayer Agreement, EDNC is to lease the EDNC
Baytown Plant pursuant to a leveraged lease from an unrelated third party
with an initial lease term of ten years from the date on which the EDNC
Baytown Plant becomes fully operational. Upon expiration of the initial
ten-year term from the date the EDNC Baytown Plant becomes operational, the
Bayer Agreement may be renewed for up to six renewal terms of five years
each; however, prior to each renewal period, either party to the Bayer
Agreement may opt against renewal. It is anticipated that construction cost
of the EDNC Baytown Plant will approximate $69 million and will be completed
in the second quarter of 1999. Construction financing of the EDNC Baytown
Plant is to be provided by an unaffiliated lender. Neither the Company nor
EDC has guaranteed any of the lending obligations for the EDNC Baytown Plant.
In January 1999, the contractor constructing the EDNC Baytown Plant under a
turnkey agreement, informed the Company that it could not complete
construction alleging a lack of financial resources. The parties to this
agreement have demanded the contractor's bonding company to provide funds
necessary for subcontractors to complete construction. The Company believes
that a substantial portion of the costs to complete the EDNC Baytown Plant,
which were to be funded by the construction contractor, will ultimately be
funded by proceeds from the bonding company; however, the cost to the Company
through its leveraged lease is expected to be impacted by these events. As a
result of the delay in completion of the EDNC Baytown Plant, the Company's
subsidiaries, EDNC and EDC, have entered into an interim supply agreement
with Bayer to provide product from the manufacturing facility in El Dorado,
Arkansas. Performance by the Company under this supply agreement will cause
the Company to realign its production mix at its El Dorado manufacturing
facility. While there are no assurances, the realignment of production mix is
not presently anticipated to adversely impact the Company's existing chemical
business or the results of operations related thereto.
F-29
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In connection with the EDNC Baytown Plant, EDNC had entered into a long-term
production and supply agreement with Bayer. This agreement provided for a
commencement date of February 1, 1999. As mentioned above, EDNC is to provide
product under an interim supply agreement until the EDNC Baytown Plant
becomes operational; however, EDNC will be responsible to Bayer for certain
lost operating profits during this time period as reasonably agreed-upon by
the parties. The possible loss, if any, associated with these agreements and
contract provisions is not presently determinable; however, it may be
material.
PURCHASE COMMITMENTS
The Company purchases substantial quantities of anhydrous ammonia for use in
manufacturing its products. The Company has contracts with three suppliers of
ammonia. One contract requires the Company to purchase not less than 24,000
tons nor more than 72,000 tons of anhydrous ammonia during the contract term
which expires on June 30, 2000. A second contract requires the Company to
purchase not less than 5,000 tons of anhydrous ammonia each contract month
and is for a term expiring in December 2000. The third contract requires the
Company to take or pay for an average of 10,000 tons of anhydrous ammonia per
month and expires April 2000. These contracts are at floating prices.
Purchases of anhydrous ammonia under two contracts with similar terms
aggregated $31.9 million in 1998 ($40.1 million and $30.4 million in 1997 and
1996, respectively, under similar arrangements). At December 31, 1998, the
Company was required to make a deficiency payment of $1.3 million for
quantities not taken as deliveries in 1998. The Company is allowed two years
to take delivery of product. The Company believes that their demand for
ammonia will exceed current purchase requirements and thus the Company will
take delivery of the 1998 deficiency prior to expiration of the recovery
period. The pricing volatility of such raw material directly affects the
operating profitability of the Company. The Company also enters into
agreements with suppliers of raw materials which require the Company to
provide finished goods in exchange therefore. The Company did not have a
significant commitment to provide finished goods with its suppliers under
these exchange agreements at December 31, 1998. At December 31, 1998, the
Company has a standby letter of credit outstanding related to its Chemical
Business of $3.5 million.
The Company leases certain precious metals for use in the manufacturing
process. The agreement at December 31, 1998 requires rentals generally based
on 7.5% of the leased metals' market values from January 1999 through July
1999, contract expiration.
F-30
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
In July 1995, the Company entered into a product supply agreement with a
third party whereby the Company is required to make minimum monthly facility
fee and other payments which aggregate $71,965. In return for this payment,
the Company is entitled to certain quantities of compressed oxygen produced
by the third party. Except in circumstances as defined by the agreement, the
monthly payment is payable regardless of the quantity of compressed oxygen
used by the Company. The term of this agreement, which has been included in
the above minimum operating lease commitments, is for a term of 15 years;
however, after the agreement has been in effect for 60 months, the Company
can terminate the agreement without cause at a cost of approximately $4.5
million. Based on the Company's estimate of compressed oxygen demands of the
plant, the cost of the oxygen under this agreement is expected to be
favorable compared to floating market prices. Purchases under this agreement
aggregated $938,000, $938,000 and $913,000 in 1998, 1997 and 1996,
respectively.
LEGAL MATTERS
Following is a summary of certain legal actions involving the Company:
A. On February 12, 1996, the Chemical Business entered into a Consent
Administrative Agreement ("Administrative Agreement") with the state
of Arkansas to resolve certain compliance issues associated with its
nitric acid concentrators. Pursuant to the Administrative Agreement,
the Chemical Business installed additional pollution control equipment
to address the compliance issues. The Company was assessed $50,000 in
civil penalties associated with the Administrative Agreement. In the
summer of 1996 and then on January 28, 1997, the Company executed
amendments to the Administrative Agreement ("Amended Agreements").
The Amended Agreements imposed a $150,000 civil penalty, which penalty
has been paid. Since the 1997 amendment, the Chemical Business has been
assessed stipulated penalties of approximately $67,000 by the Arkansas
Department of Pollution Control and Ecology ("ADPC&E") for violations
of certain provisions of the 1997 Amendment. The Chemical Business
believes that the El Dorado Plant has made progress in controlling
certain off-site emissions; however, such off-site emissions have
occurred and may continue from time to time, which could result in the
assessment of additional penalties against the Chemical Business by the
ADPC&E for violation of the 1997 Amendment.
During May 1997, approximately 2,300 gallons of caustic material
spilled when a valve in a storage vessel failed, which was released to
a stormwater drain, and according to ADPC&E records, resulted in a
minor fish kill in a drainage ditch near the El Dorado Plant. In 1998,
the ADPC&E issued a Consent Administrative Order ("1998 CAO") to
F-31
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
resolve the event. The 1998 CAO includes a civil penalty in the amount
of $183,700 which includes $125,000 to be paid over five years in the
form of environmental improvements at the El Dorado Plant. The
remaining $58,700 has been paid prior to December 31, 1998. The 1998
CAO also requires the Chemical Business to undertake a facility-wide
wastewater evaluation and pollutant source control program and
wastewater minimization program. The program requires that the
subsidiary complete rainwater drain-off studies including engineering
design plans for additional water treatment components to be submitted
to the ADCP&E by August 2000. The construction of the additional water
treatment components shall be completed by August 2001 and the El
Dorado plant has been mandated to be in compliance with final effluent
limits on or before February 2002. The wastewater program is currently
expected to require future capital expenditures of approximately $4.6
million.
B. In 1996, three lawsuits were filed against the Company's Chemical
Business by certain groups of residents of El Dorado, Arkansas,
asserting a citizens' suit and two toxic tort lawsuits against the
Chemical Business. The citizens' suit 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 toxic tort lawsuits alleged that the plaintiffs suffered certain
injuries and damages as a result of alleged releases of toxic
substances from the Chemical Business' El Dorado, Arkansas
manufacturing facility.
The Company and the Chemical Business maintain an Environmental
Impairment Insurance Policy ("EIL Insurance") that provides coverage
through June 30, 2001 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 $20.0 million, except $5.0 million for all remediation
expenses, with the maximum limit of liability for all claims under the
EIL Insurance not to exceed $20.0 million for each loss or remediation
expense and $40.0 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. Previous to
1998, the Company's Chemical Business incurred and expensed $500,000 in
legal, expert and other costs in connection with the toxic tort and
citizen lawsuits described above.
F-32
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
During 1998, the Company's Chemical Business settled all claims
asserted in the citizens' and toxic tort lawsuits. The settlements
required cash payments to the plaintiffs. Substantially all of such
payments were funded directly by the Company's EIL Insurance carrier.
The amount of the settlements of the toxic tort cases as discussed
above paid by the EIL Insurance and the amount paid under the EIL
Insurance for legal and other expenses relating to the defense of the
toxic tort cases and the citizen suit case reduce the coverage amount
available under the policy then in effect.
C. A civil cause of action has been filed against the Company's Chemical
Business 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. 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 the Company, the Company does not
believe that the Chemical Business 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. This litigation has
been consolidated, for discovery purposes only, with several other
actions in a multi-district litigation proceeding in Utah. Discovery in
this litigation is in process. The Chemical Business intends to
vigorously defend itself in this matter.
The Company's Chemical Business has been added as a defendant in a
separate lawsuit pending in Missouri. This lawsuit alleges a national
conspiracy, as well as a regional conspiracy, directed against
explosive customers in Missouri and seeks unspecified damages. The
Company's Chemical Business 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 preceding described lawsuit. Based
on the information presently available to the Company, the Company does
not believe that the Chemical Business conspired with any party, to fix
prices in connection with the sale of commercial explosives. The
Chemical Business intends to vigorously defend itself in this matter.
F-33
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
During the third quarter of 1997, a subsidiary of the Company was
served with a lawsuit in which approximately 27 plaintiffs have sued
approximately 13 defendants, including a subsidiary of the Company
alleging personal injury and property damage for undifferentiated
compensatory and punitive damages of approximately $7,000,000.
Specifically, the plaintiffs assert property damage to their residence
and wells, annoyance and inconvenience, and nuisance as a result of
daily blasting and round-the-clock mining activities. The plaintiffs
are residents living near the Heartland Coal Company ("Heartland")
strip mine in Lincoln County, West Virginia, and an unrelated mining
operation operated by Pen Coal Inc. During 1999, the plaintiffs
withdrew all personal injury claims previously asserted in this
litigation. Heartland employed the subsidiary to provide blasting
materials and personnel to load and shoot holes drilled by employees of
Heartland. Down hole blasting services were provided by the subsidiary
at Heartland's premises from approximately August 1991, until
approximately August 1994. Subsequent to August 1994, the subsidiary
supplied blasting materials to the reclamation contractor at
Heartland's mine. In connection with the subsidiary's activities at
Heartland, the subsidiary has entered into a contractual indemnity to
Heartland to indemnify Heartland under certain conditions for acts or
actions taken by the subsidiary for which the subsidiary failed to
take, and Heartland is alleging that the subsidiary is liable
thereunder for Heartland's defense costs and any losses to or damages
sustained by, the plaintiffs in this lawsuit as a result of the
subsidiary's operations. Discovery in this litigation is in process.
The Company intends to vigorously defend itself in this matter. Based
on the limited information available, the subsidiary's counsel believes
that the subsidiaries' possible loss, if any, related to this
litigation is not presently expected to have a material adverse effect
on the Company.
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 not presently probable of
material loss, 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.
F-34
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
9. COMMITMENTS AND CONTINGENCIES (CONTINUED)
OTHER
LSB and, thus, 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. LSB
reviews such programs on at least an annual basis to balance the cost-benefit
between its coverage and retained exposure. See the Services Agreement,
Note 3.
10. 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 fair value of the interest rate forward agreement is estimated based on
quoted market prices of instruments with similar terms. As of December 31,
1998 and 1997, the financial instruments' fair value (which is not reflected
on the accompanying consolidated balance sheets), net to the Company's 50%
interest, represented a liability of approximately $3.3 million and $1.8
million, respectively. The fair value of the natural gas swap agreements was
estimated based on market prices of natural gas for the periods covered by
the agreements. At December 31, 1998 and 1997, the fair values of such
agreements represented a liability of approximately $255,000 and $165,000,
respectively.
Fair values for fixed rate borrowings, other than the Notes, 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. The fair value of the Notes was determined based on a quotation
for such securities. As of December 31, 1998 and 1997, carrying values of
variable rate and fixed-rate long-term debt which aggregated $137.9 million
and $136.2 million, respectively, approximated their estimated fair value.
At December 31, 1998 and 1997, the carrying value of the intercompany loans
of $13.1 million and $13.4 million exceeded the estimated fair value of such
loans by approximately $.7 million and $.8 million, respectively.
As of December 31, 1998, the carrying values of cash and cash equivalents,
accounts receivable, accounts payable, and accrued liabilities approximated
their estimated fair value.
F-35
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION
FACTORS USED BY MANAGEMENT TO IDENTIFY THE ENTERPRISE'S REPORTABLE SEGMENTS
AND MEASUREMENT OF SEGMENT PROFIT OR LOSS AND SEGMENT ASSETS
ClimaChem, Inc. has two reportable segments: the Chemical Business and the
Climate Control Business. The Company's reportable segments are based on
business units that offer similar products and services. The reportable
segments are each managed separately because they manufacture and distribute
distinct products with different production processes.
The Company evaluates performance and allocates resources based on profit or
loss from operations before allocation of management fees, if any, paid to
LSB, interest expense and income taxes. The accounting policies of the
reportable segments are the same as those described in the summary of
significant accounting policies.
DESCRIPTION OF EACH REPORTABLE SEGMENT
CHEMICAL
This segment manufactures and sells fertilizer grade ammonium nitrate
for the agriculture industry, explosive grade ammonium nitrate for the
mining industry and concentrated, blended and mixed nitric acid for
industrial applications. Production from the Company's primary
manufacturing facility in El Dorado, Arkansas, for the year ended
December 31, 1998 comprises approximately 86% of the chemical segment's
sales. Sales to customers of this segment primarily include farmers in
Texas and Arkansas, coal mining companies in Kentucky, Missouri and
West Virginia, and industrial users of acids in the South and East
regions of the United States.
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' Australian subsidiary's results of operations
have been adversely affected due to the recent economic developments in
certain countries in Asia. These economic developments in Asia have had
a negative impact on the mining industry in Australia, which this
subsidiary services. In February 1999, the Company received a
F-36
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
nonbinding offer to acquire the stock of the Australian subsidiary. At
the present time, the parties are in negotiation; however, there are no
assurances that the transaction will ultimately be consummated. If the
Company does not ultimately consummate this sale and the operating
results of the Australian subsidiary do not reflect markedly improved
conditions, in the near term, it is reasonably possible that the
Company will recognize an impairment charge related to the recovery of
such net assets.
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.
CLIMATE CONTROL
This business segment manufactures and sells, primarily from its
various facilities in Oklahoma City, a variety of hydronic fan coil,
water source heat pump products and other HVAC 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 Climate Control segment's operations. Sales to customers of
this segment primarily include original equipment manufacturers,
contractors and independent sales representatives located throughout
the world which are generally secured by a mechanic's lien, except for
sales to original equipment manufacturers.
Credit, which is generally unsecured, is extended to customers based on an
evaluation of the customers' 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. As of December 31,
1998 and 1997, the Company's accounts and notes receivable are shown net of
allowance for doubtful accounts of $4,346,000 and $3,168,000, respectively.
F-37
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
Information about the Company's operations in different industry segments is
detailed below.
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
Net sales:
Chemical $139,945 $156,948 $166,164
Climate Control 115,785 105,899 89,121
---------------- ----------------- ----------------
$255,730 $262,847 $255,285
================ ================= ================
Gross profit:
Chemical $ 18,348 $ 19,356 $ 25,400
Climate Control 32,234 29,719 22,057
---------------- ----------------- ----------------
$ 50,582 $ 49,075 $ 47,457
================ ================= ================
Operating profit:
Chemical $ 3,457 $ 4,849 $ 10,710
Climate Control 9,723 8,481 5,425
---------------- ----------------- ----------------
13,180 13,330 16,135
Unallocated fees from Services Agreement and general corporate
expenses, net (2,881) (2,109) (1,800)
Interest income 1,445 419 -
Other income, net 23 474 333
Interest expense (13,944) (9,788) (6,247)
---------------- ----------------- ----------------
Income (loss) before provision for income taxes and
extraordinary charge $ (2,177) $ 2,326 $ 8,421
================ ================= ================
Depreciation of property, plant and equipment:
Chemical $ 7,992 $ 6,692 $ 5,329
Climate Control 1,553 1,438 1,378
---------------- ----------------- ----------------
Total depreciation of property, plant and equipment $ 9,545 $ 8,130 $ 6,707
================ ================= ================
F-38
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
YEAR ENDED DECEMBER 31,
1998 1997 1996
---------------- ----------------- ----------------
(In Thousands)
Additions to property, plant and equipment:
Chemical $ 5,221 $ 9,389 $ 19,219
Climate Control 2,720 1,076 1,500
---------------- ----------------- ----------------
Total additions to property, plant and equipment $ 7,941 $ 10,465 $ 20,719
================ ================= ================
Total assets:
Chemical $133,452 $137,156 $133,794
Climate Control 40,498 42,497 39,960
Corporate assets 20,754 21,222 -
---------------- ----------------- ----------------
Total assets $194,704 $200,875 $173,754
================ ================= ================
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.
Gross profit by industry segment represents net sales less cost of sales.
Operating profit by industry segment represents gross profit less selling,
general and administrative expenses. In computing operating profit, none of the
following items have been added or deducted: income taxes, interest expense or
extraordinary charges.
Total assets by industry segment are those assets used in the operations of each
industry. Corporate assets are those principally owned by the parent company not
involved in the two identified industries.
F-39
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
Information about the Company's domestic and foreign operations for each of the
three years in the period ended December 31, 1998 is detailed below:
GEOGRAPHIC REGION 1998 1997 1996
- ------------------------------------------------------------------ ---------------- ----------------- ----------------
(In Thousands)
Sales:
Domestic $239,257 $235,303 $220,632
Foreign:
Australia/New Zealand 14,184 26,482 32,917
Others 2,289 1,062 1,736
---------------- ----------------- ----------------
$255,730 $262,847 $255,285
================ ================= ================
Income (loss) before provision for income taxes
and extraordinary charge:
Domestic $ 961 $ 3,475 $ 6,846
Foreign:
Australia/New Zealand (2,898) (772) 1,705
Others (240) (377) (130)
---------------- ----------------- ----------------
$ (2,177) $ 2,326 $ 8,421
================ ================= ================
Long-lived assets:
Domestic $ 77,724 $ 78,283 $ 76,278
Foreign:
Australia/New Zealand 4,665 6,046 6,398
Others - - -
---------------- ----------------- ----------------
$ 82,389 $ 84,329 $ 82,676
================ ================= ================
Revenues by geographic region include revenues from unaffiliated customers, as
reported in the consolidated financial statements. Revenues earned from sales or
transfers between affiliates in different geographic regions are shown as
revenues of the transferring region and are eliminated in consolidation.
F-40
CLIMACHEM, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SEGMENT INFORMATION (CONTINUED)
Revenues from unaffiliated customers include foreign export sales as follows:
DECEMBER 31,
GEOGRAPHIC REGION 1998 1997 1996
- ------------------------------------------------------------------ ---------------- ----------------- ----------------
(In Thousands)
Canada $ 7,051 $ 4,634 $ 9,255
Middle East 5,055 5,956 6,008
Mexico and Central and South America 493 1,415 2,103
Other 5,077 1,038 7,994
---------------- ----------------- ----------------
$17,676 $13,043 $25,360
================ ================= ================
F-41
CLIMACHEM, INC.
SUPPLEMENTARY FINANCIAL DATA
QUARTERLY FINANCIAL DATA (UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
THREE MONTHS ENDED
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
------------------------------------------------------------------
1998
Total revenues $63,782 $74,308 $65,734 $53,374
==================================================================
Gross profit on net sales $12,949 $16,743 $12,672 $ 8,218
==================================================================
Net income (loss) $ (46) $ 1,613 $ (755) $ (3,381)
==================================================================
1997
Total revenues $62,295 $76,057 $62,587 $62,801
==================================================================
Gross profit on net sales $ 9,367 $16,976 $12,341 $10,391
==================================================================
Income (loss) before extraordinary charge $ (933) $ 3,132 $ 581 $ (1,883)
==================================================================
Net income (loss) $ (933) $ 3,132 $ 581 $ (4,752)
==================================================================
Total revenues, as reported above, includes interest income of $354,000,
$408,000, $344,000 and $339,000 and none, $16,000, $46,000 and $357,000 for the
quarter ended March 31, June 30, September 30 and December 31, 1998 and 1997,
respectively, previously reported with interest expense.
In the fourth quarter of 1998, the Company's Climate Control group recorded an
adjustment to inventory which reduced gross profit by $1.5 million and the
Company's Chemical group recorded a provision for loss of approximately $.8
million for a note receivable which increased the Company's net loss.
In the fourth quarter of 1997, in connection with the issuance of $105 million,
10 3/4% Senior Notes due in 2007, a subsidiary of the Company retired the
outstanding principal associated with a $50 million financing arrangement and
incurred a prepayment fee. The prepayment fee paid and loan origination costs
expensed in 1997 relating to the financing arrangement aggregated approximately
$2.9 million, net of income tax benefit.
F-42
CLIMACHEM, INC.
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
(DOLLARS IN THOUSANDS)
ADDITIONS DEDUCTIONS
--------- ----------
BALANCE AT CHARGED TO WRITE-OFFS/ BALANCE
BEGINNING OF COSTS AND COSTS AT END
DESCRIPTION YEAR EXPENSES INCURRED OF YEAR
- -------------------------------------------------------- --------------- --------------- -------------- ---------------
Accounts receivable--allowance for doubtful
accounts (1):
1998 $1,478 $ 971 $ 647 $1,802
=============== =============== ============== ===============
1997 $1,296 $ 521 $ 339 $1,478
=============== =============== ============== ===============
1996 $1,424 $ 280 $ 408 $1,296
=============== =============== ============== ===============
Notes receivable--allowance for doubtful accounts:
1998 $1,690 $ 854 $ - $2,544
=============== =============== ============== ===============
1997 $1,515 $ 175 $ - $1,690
=============== =============== ============== ===============
1996 $ 500 $1,015 $ - $1,515
=============== =============== ============== ===============
(1) Deducted in the balance sheet from the related assets to which the reserve
applies.
F-43
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 15th day of April,
1999.
CLIMACHEM, 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, 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 15, 1999 By: /s/ Jack E. Golsen
------------------------------
Jack E. Golsen, Director
Dated: April 15, 1999 By: /s/ Tony M. Shelby
------------------------------
Tony M. Shelby, Director
Dated: April 15, 1999 By: /s/ David R. Goss
------------------------------
David R. Goss, Director
Dated: April 15, 1999 By: /s/ Barry H. Golsen
------------------------------
Barry H. Golsen, Director
Dated: April 15, 1999 By: /s/ Robert C. Brown
------------------------------
Robert C. Brown, Director
50
Dated: April 15, 1999 By: /s/ Bernard G. Ille
------------------------------
Bernard G. Ille, Director
Dated: April 15, 1999 By: /s/ Jerome D. Shaffer
------------------------------
Jerome D. Shaffer, Director
Dated: April 15, 1999 By: /s/ Raymond B. Ackerman
------------------------------
Raymond B. Ackerman, Director
Dated: April 15, 1999 By: /s/ Horace Rhodes
------------------------------
Horace Rhodes, Director.
51