LSB Industries' CEO Discusses Q2 2012 Earnings Results - Earnings Call Transcript

Aug. 9.12 | About: LSB Industries, (LXU)

LSB Industries, Inc. (NYSE:LXU)

Q2 2012 Earnings Call

August 8, 2012 5:15 pm ET

Executives

Carol Oden – Executive Administrative Assistant

Jack E. Golsen – Chairman of the Board & Chief Executive Officer

Barry H. Golsen, J.D. – Vice Chairman of the Board, President & President Climate Control Business

Tony M. Shelby – Chief Financial Officer, Executive Vice President Finance & Director

Analyst

Daniel Mannes – Avondale Partners

Joe Mondillo - Sidoti & Company

[Rob Longnecker – Joe Street Capital]

R. Gregg Hillman – First Wilshire Securities

[Eli Nushan – Core Share]

Operator

Welcome to the LSB Industries second quarter 2012 conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions) It is now my pleasure to introduce your host Ms. Carol Oden, Executive Administrative Assistant.

Carol Oden

Again, we would like to say welcome to the LSB Industries, Inc. 2012 second quarter conference call. Today LSB’s management participants are Jack Golsen, Chairman and Chief Executive Officer; Barry Golsen, President and Chief Operating Officer; and Tony Shelby, our Chief Financial Officer. This conference call is being broadcast live over the Internet. It is also being recorded. An archive of the webcast will be available shortly after the call on our website at www.LSB-OKC.com.

After comments by management a question and answer session will be held. Instructions for asking questions will be provided at that time. Information reported on this call speaks only as of today, August 8, 2012 and therefore you are advised that time sensitive information may no longer be accurate as of the time of any replay. After the question and answer session I will have some important comments and disclaimers about forward-looking statements and our references to EBITDA.

We encourage you to view the power point PDF that is posted on our website at www.LSB-OKC.com in the webcast section of the investor information tab. Please note that the presentation starts on page three of the power point. Now, I will turn the call over to Mr. Jack Golsen.

Jack E. Golsen

Today I’m going to try to give you a comprehensive picture of the company. The details of some of the things I mentioned will be given to you by Tony and Barry when I complete my section of this conference call. This afternoon we released our 2012 six months and second quarter earnings report and we also filed our 10Q for the quarter.

Net income for the first six months was $40 million or $1.72 per diluted share on $400 million in sales. Net income for the second quarter was $26 million or $1.11 per diluted share on sales of $209 million compared to $1.22 per share in the second quarter of 2011. Second quarter results were below the same period last year but because of the recent events in our chemical operations I consider our results are acceptable. Also, in last year’s second quarter we had an $8.6 million business interruption insurance recovery equating to $0.23 per share which somewhat skews the quarterly comparisons.

As we previously informed you, our second quarter results were impacted by three events. These were unplanned downtime at our prior Oklahoma chemical facility to repair the urea plant, the destruction of the 98% nitric acid plant at our El Dorado Arkansas facility, and the collateral damage to our other asset plants at the El Dorado site caused by the explosion in mid May.

To bring you up to date on what’s been going on with these things, repairs to the urea plant at Pryor were completed the first week of July and the plant is now operational. However, we expect production at Pryor to be below targeted rates until we replace the converter in the main ammonia plant and make certain other modifications. We expect these to be completed early in 2013.

The repairs to our El Dorado plants have been made in remarkably short time. Two of the three remaining nitric acid plants are back in production and the third nitric acid plant is scheduled to be completed this month. Sulfuric acid plant repairs are expected to occur during the fourth quarter of 2012. A new nitric acid plant will replace the destroyed plant and we plan to install a separate nitric acid concentrator for the production of concentrated nitric acid. These projects should take at least two years to complete due to delivery schedules on major equipment components for the new plant.

Our Climate Control business continues to operate in a very competitive market. It is profitable but sales volume has not completely recovered from the recent recession. Overall we believe the outlook for LSB for the balance of 2012 and forward for 2013 is positive. Please keep in mind that during the third quarter we scheduled most of our plant turnarounds. We suggest that you do not annualize the second quarter results in forming your expectation for our results for the year.

We also believe we have substantially more potential to develop the company and we are increasing capacity at Pryor Oklahoma, Cherokee Alabama, and El Dorado Arkansas to accommodate increased demand. Tony will give you more financial details and Barry will cover operations and market conditions throughout our businesses.

Now, I’ll turn this call over to Tony Shelby our CFO.

Tony M. Shelby

Our results for the second quarter are summarized on page four of the power point presentation. Comparing the second quarter 2012 to the second quarter of 2011 fully diluted earnings per share were $1.11 compared to $1.22 a decrease of 9%. During both quarters there were certain significant events in the chemical business that affected the comparability of earnings for the two quarters which we will describe in detail when we turn to business segment discussions.

Consolidated sales were $209 million, a decrease of $26 million or 11%. Operating income was $42 million, a decrease of $6 million or 12%. Chemical’s operating income was down $3.6 million and Climate Control was down $1.9 million. After interest expense and an effective tax rate of 36%, net income was $26 million compared to $28.6 million last year. The effective tax rate was lower than the combined federal and state statutory rates due to our Section 199 allowable domestic manufacturer’s deduction.

Also noted on this page, cash flow from operations was $45 million. After cash for capital expenditures of $17 million, payments on current and long term debt of $3 million and other offsetting items, net cash increased $25 million for the quarter. The increase in the cash for the quarter was due to the seasonal sources and uses of working capital which would be consistent with the second quarter of ’11. At June 30, 2012 our cash balance including short term investments was $149 million. EBITDA for the quarter was $48 million versus $53 million in ’11.

Turning to page five and comparing chemical’s second quarter ’12 to the second quarter ’11 sales for the quarter were $138 million versus $156 million, a decrease of $18 million or 11%. By product line agricultural sales were $83 million compared to $82 million and industrial and mining product sales were a combined $55 million compared to $74 million in 2011, a 26% decrease.

So, the question is why in such a strong agricultural market were total sales down 11%? The answer is that we incurred unexpected interruptions of production at two of our major facilities. On page 34 of our 10Q is a formal discussion of our downtime at our Pryor and El Dorado facilities during the second quarter of 2012 both of which Jack alluded to in the overview.

To summarize, after failed attempts to repair the leaks in Pryor’s urea plant reactor, we determined that the stainless steel liner was non-repairable and had to be replaced. The attempted repairs and subsequent replacement resulted in the urea plant being down for the entire quarter. Due to the downtime of the urea reactor the Pryor facility was unable to produce urea and as a result loss an estimated 70,000 tons of UAN production during the quarter. The impact was offset in part by the continued production and sales of ammonia primarily into agricultural markets at very strong gross profit margins.

Summarizing further, the El Dorado facility lost all asset production in mid May due to damage caused by the explosion of the DSN plant. Without asset production until the restart of one asset plant in mid June, most production at El Dorado stopped and as a result of sales of all products were adversely affected. Looking forward into future quarters, until we replace the approximately 20% of El Dorado’s lost asset capacity El Dorado’s future earnings will be adversely affected.

We believe we will be reimbursed by our business interruption insurance coverage for that earnings effect but not in the same quarter as the loss. The business interruption insurance recovery will be recorded as income in the quarter received. Continuing with the chemical operating income for the quarter, operating income for the quarter was $39 million versus $43 million a year ago and as indicated in the initial overview there were certain significant events in the two quarters that affected the comparability as follows. The second quarter 2011 operating income was favorably affected by an $8.6 million insurance recovery. The second quarter ’12 operating income was adversely affected by [inaudible] fixed overhead cost and maintenance repair costs due to the unplanned downtime at the Pryor and El Dorado facilities.

The negative effect of the unplanned downtime in 2012 was partially offset by improved UAN margins and increased agricultural ammonia nitrate sales and margins. Barry will provide an update and current status of both Pryor and El Dorado in the business overview. Reflected in the chart on page six is Pryor’s operating income for the second quarter of 2012. The Pryor facility generated $13 million of operating income from the production and sale of anhydrous ammonia into the fertilizer market which was less income than if UAN was up and running and both products were available for sale.

Continuing with the quarter-over-quarter comparison by business segment, please refer to page seven. Climate Control sales were $68 million or $10 million lower than a year ago. Climate Control’s gross profit as a percent of sales was 31.1% compared to 30.3% and operating income was $7.3 million compared to $9.2 million in the second quarter 2011. Generally the decline in sales and operating income in 2012 for Climate Control is attributable to lower order intake during the first quarter of 2012 compared to the same quarter in 2011.

The lower sales order intake is a result of continued lower construction activity in most of the markets that we serve. Barry will review the quarterly results and current market conditions in more exact terms and greater detail.

Capital expenditures; during the quarter total capital expenditures were $23 million including $22 million for the chemical business. We are currently considering future capital spending for the remainder of 2012 of approximately $54 million including committed expenditures of approximately $23 million. Chemical’s plan and our committed spending for the remainder of 2012 is $46 million including $12 million rebuilding costs at the El Dorado facility. Planned spending is subject to change based upon economic conditions, regulatory requirements, and any opportunities for profit improvement that might arise from time-to-time.

Briefly reviewing our liquidity and capital resources, the summary on page four reflects our continued strengthening of our balance sheet. Cash in excess of total interest bearing debt was $74 million. The outstanding balance of the secured term loan is $70 million and total long term debt including the current portion is $75 million. At June 30, 2012 stockholders’ equity was $335 million and the ratio of long term debt to stockholders’ equity was approximately 0.22 to 1.

Also as noted on the slide, EBTIDA interest coverage was 33 times. We have continued to strengthen our balance sheet which provides safety and soundness in a period where the global economy continues to be a concern. At the same time LSB is positioned to be prepared to take advantage of opportunities to grow the two business segments.

We’ve addressed our results from operations for the quarter and the comparisons to the 2011 quarter in greater detail in the MD&A of the 10Q which we filed earlier today and we suggest that you review these disclosures and discussions for additional analysis. I’ll now turn the call over to Barry to discuss both businesses for the quarter and the outlook going forward.

Barry H. Golsen, J.D.

Since Tony covered the financial results I’m going to focus on our sales activity, product backlogs where pertinent, and market drivers. I’ll also give you a little more detailed update on our Pryor and El Dorado facilities. To start, please turn to page nine which shows you our sales mix for 2012 by the markets we serve.

For the first half of 2012 approximately two thirds was chemical and one third climate control. In our chemical business about 55% of sales were nitrogen based agricultural fertilizers and associated products. The other 45% was industrial and mining products which were lower than usual as a result of the explosion at El Dorado in May and the subsequent down time in parts of that facility.

In our Climate Control business approximately 82% were sales of various heating, ventilation, and air conditioning products to commercial and institutional markets. The remaining 18% was the sale of geothermal heat pumps for single family residential applications.

Focusing first on our chemical business, please go to page 10. Second quarter sales were $138 million, 11% lower than second quarter of 2011. Agricultural products were up 2% over the 2011 level. Industrial and mining sales were down 15% and 43% respectively primarily caused by the unplanned downtime at El Dorado.

Turn to page 11 for sales of our key agricultural products. During the second quarter tons shipped of urea ammonia nitrate or UAN were 45% lower than during the 2011 second quarter while net sales decreased 43%. The decrease in tons sold was a result of unplanned downtime at Pryor while its urea reactor was being prepared. UAN shipments from our Cherokee facility actually increased slightly over the second quarter of 2011.

Tons shipped of agricultural grade high density ammonia nitrate or HDAN were 14% higher than the second quarter 2011 and sales were 36% higher. Higher shipments of HDAN were driven by generally better weather conditions during the planting season, more acres of wheat planted than in previous years, and early push by ranchers to rebuild depleted forage inventories, and lower than usual starting inventories at the dealer level. Delayed shipments of urea and high urea prices also pushed some users to nitrate as a better alternative.

Tons shipped of ammonia to agricultural markets increased 65% resulting in a 61% increase in ammonia sales compared to 2011. This was a result of having more ammonia available to sell from our Pryor facility due to curtailed UAN production.

Turning to our industrial and mining products on page 12, sales of all products during the second quarter were lower than 2011. Again, this was a result of the explosion and subsequent downtime at El Dorado. On page 13 are some price trends for both the feed stocks we use and the key ag products we sell. The cost of natural gas continues to be very low and this is benefitting margins at our Cherokee and Pryor facilities which use natural gas as their primary feed stock.

The conventional wisdom is that natural gas will remain low for some time. The cost of anhydrous ammonia, the feed stock we use at our El Dorado Arkansas and Baytown Texas facilities, although slightly lower during the second quarter than in the second quarter of 2011 continues to be high compared to previous years and has recently increased to $690 per metric ton. High ammonia prices have increased production costs at our facilities that use ammonia as a feed stock.

While we’re on that subject, the chart on the lower right shows pricing for ag grade HDAN. In July 2012 Southern Plains for HDAN were $465 per ton compared to $390 per ton 12 months earlier. Increased selling prices coupled with lower average ammonia feed stock cost during the second quarter resulted in higher margins on agricultural grade AN than during 2011. Currently HDAN is selling at about $395 per ton.

If you look at the chart at the lower left you can see that the Southern Plains price for UAN was $340 per ton this July compared to $360 in July of 2011. Today pricing is about $320 to $330 per ton and it’s on the rise. Prices have declined seasonally since our last conference call as we predicted they would at that time.

Focusing on the outlook for the chemical markets we serve, page 14 lists several indicators for our agricultural products. Most of these indicators are favorable. Grain stock to use ratios both worldwide and the US continue to be low, planting levels are generally high, very high in the case of corn, market prices for corn and wheat remain high as well so farmers are incentivized to plant and sell more. All of this is creating strong continuing demand for fertilizers. Finally, low natural gas prices have reduced the costs to manufacture UAN and ammonia at our plants that use it as feed stock. Factoring in the total cost of production plus freight and distribution, North America is the low cost producer of nitrogen fertilizers.

The industry consensus is that the positive fundamentals of the ag business should continue. In addition, to general industry drivers weather can have a significant impact on fertilizer use, demand, and prices. Although there has been much publicity about the current drought its impact was too late to affect the sale of our fertilizers during the second quarter and there should be little or no affect on demand for our products during the third quarter since we’re currently between planting seasons.

The future impact could actually be positive for the sale of fertilizers since lower crop yields this season should result in lower stocks and could also create higher fertilizer demand next season. The big question mark is corn production for the ethanol industry. Although a major reduction of ethanol production could hypothetically affect the demand for corn and its demand for fertilizer, so far we have not felt any meaningful impact from the current level of reduced ethanol production.

We believe this is attributable to the low level of curtailed ethanol production, the reduced levels of corn stock and the anticipated poor yield from the current corn crop. Taking all these factors into consideration we continue to be optimistic about our ag business.

Please turn to page 15. As you can see from the chart on this page, despite lower sales caused by the explosion and subsequent down time at El Dorado, a significant part of our business continues to be industrial and mining products. They’re sold primarily to large customers and most are sold pursuant to contractual cost plus and/or minimum take arrangements. Page 16 contains some market indicators for this area of the business. Most of these indicators forecast growth for the next few years.

Before turning to the Climate Control business I’d like to take a few minutes to update you on the progress at the Pryor and El Dorado operations. Please turn to page 17. During our last conference call we described in detail our attempts to locate a leak in the urea reactor at our Pryor facility which ultimately resulted in the cessation of urea production from February 27th to July 6th. This cessation was to facilitate repairs to that reactor. The objective of those repairs was to replace the stainless steel liner of that high pressure vessel. Those repairs were successful and Pryor’s urea reactor is now operational.

We also advised you during that call that we had received permits to increase ammonia production at Pryor by 60,000 tons per year and were beginning the debugging process on two smaller ammonia plants. That process is now underway and we continue to expect to be in production by the end of the year.

If you’ve been following our progress at Pryor you probably know that we have not been able to sustain ammonia production at our targeted production rate of 700 tons per day. For a short time we were producing at about 600 tons per day but recently we’ve been producing ammonia at approximately 75% of that rate. In addition to the rate of production when running operation has been intermittent rather than continuous. We have had several problems relating to the ammonia conversion process.

We believe that most of these problems are a result of the fact that the current ammonia plant has six outdated small ammonia converters. To correct these problems we plan to install a single, larger, and more current design Kellogg converter early in 2013 to address the converter issues. In addition to a new converter we also plan to replace catalyst that are at the end of their useful life and install a new chiller to lower high temperatures that reduce production capacity in hot weather.

We believe that all of these measures should allow us to achieve our targeted ammonia production rates at Pryor. At this time our plan is to install the larger converter next to the old ones while they’re running and have a quick cut over with minimal disruption of production.

Turning to El Dorado please turn to page 18. On May 15th there was an explosion in the DSN 98% strong nitric acid plant at El Dorado which we refer to as EDC. Fortunately, no EDC team members or local towns’ people were injured. However, the DSN plant was damaged beyond feasible repair. The sulfuric acid plant was seriously damaged and there was less damage to three other nitric acid plant, the prilling towers, and various ancillary equipment.

Since May 15th we have made substantial progress at EDC. A temporary control room was put in place, two of the remaining nitric acid plants have been restarted and the third one is scheduled to restart by the end of August. The prilling towers were repaired and are in operation. The sulfuric acid plant will be brought back online before the end of 2012. The DSN strong nitric acid plant was damaged too seriously to repair and will be replaced with a new acid plant and a concentrator. This will take at least two years to fabricate and install and should cost over $100 million which should be substantially covered by insurance.

As we’ve previously reported we have property insurance coverage above a $1 million deductible. We also have business interruption insurance that activates 30 days after May 15th. We’re pleased with the progress at EDC so far and we’ll keep you posted as appropriate in the future.

Moving on, page 19 contains our chemical business strategies and some of our key initiatives. We’ve reviewed most of these with you on previous conference calls and this page is here for your reference or for those of you who were not on those calls.

Now, please turn to page 20 where we will begin the discussion of our Climate Control business. You can see sales by major product categories on this page. Total sales during the quarter were approximately $68 million, a decrease of 12% compared to the second quarter of 2011. Compared to the second quarter 2011 sales of heat pumps were down 14%, fan coil sales were down 11% and sales of other products were down 10%.

On page 21 you can see that sales of products sold for use in commercial and institutional buildings were down 11% while sales of our residential products were 19% lower than last year’s second quarter. Total bookings during the second quarter were $66.8 million or 4% higher than the 2011 second quarter. Commercial bookings were up 7% and bookings of residential products were up by 8%.

Our backlog of product orders at June 30, 2012 was $50.2 million slightly higher than one year earlier and approximately 13% higher than the $44.5 million backlog at 12/31/11. Total new orders in July were approximately $20.8 million and or backlog of product orders at July 31st was approximately $50.3 million.

Although our total bookings during the second quarter were the highest since the first quarter 2011, the markets we serve continue to be soft. The commercial recovery has been slower than previously anticipated. The markets we serve for residential products have been severely impacted by low levels of construction and low levels of investments in existing homes. In addition, very low costs for natural gas which is used as a fuel for heating about 60% of the homes in the US have extended the payback period for our residential geothermal products in those markets that use natural gas. We believe this has impacted our sales of residential geothermal heat pumps. One bright spot is that we have maintained our leading market shares for geothermal and water source heat pumps and fan coils.

The next few pages of the power point deal with the market outlook for construction. On page 22 there’s a graph that shows McGraw Hill’s most recent construction forecast for certain commercial and institutional building types. These are the sectors that are the most important to us and comprise 61% of our total climate control sales in 2011. McGraw Hill is forecasting that in the aggregate they will decrease by approximately 3% in 2012 which is an about face from the 3% growth forecasted a quarter ago. This reflects the slowness in the economic recovery. These sectors are forecast to increase 77% through 2017. If this future growth materializes it should benefit all of our commercial and institutional product sales.

In addition to watching construction forecasts by sector we also track the Architectural Billings Index which is considered to be an indicator for non-residential construction spending nine to 12 months in the future. On page 23 is a graph of the ABI. An index score of 50 indicates that the architectural billings were approximately the same as the previous month. Any score above 50 indicates growth in billings while any score below 50 indicates a decline in billings.

This indicator was below 50 for most of 2011 finally breaking into positive ground in November. However, after five months in positive territory it dipped below 50 in April of this year and has remained there ever since. We believe the general consensus of most economist and construction industry experts is that the recovery in commercial and institutional new construction will be slower than previously forecasted. While new construction remains sluggish renovation and retrofit of existing commercial and institutional buildings has been and will continue to be an important market for us.

During the first half of 2012 18% of our Climate Control business were sales of geothermal heat pumps used in single family residential applications. Page 24 shows McGraw Hill’s forecast for single family residential construction starts. They are currently forecasting that housing starts will increase from about 413,000 in 2011 to 490,000 in 2012, a 19% increase and to over one million per year in 2015. If this future growth occurs it should be beneficial to our residential geothermal business.

Again, turning to page 25 we’ve listed our Climate Control business strategies and initiatives. Again, these are repeated from previous calls and I will not review them will you again at this time.

Before opening it up for questions, I would like to mention that Tony and I will be presenting at the Imperial Capital Global Opportunities Conference in New York City on September 19th. We hope to see some of you at this event. One more item and that is before I turn this over to the operator to poll for questions, I would really appreciate it since we usually have several questions and we want to get to everybody, if you’d try to limit your questions to three and if you have more just get back in line and we’ll come back to you after other people have a chance to get their questions in.

Operator, please open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Daniel Mannes – Avondale Partners.

Daniel Mannes – Avondale Partners

I want to ask real quickly if we can get a little more color on the ammonia converter replacement project. Can you just give us a little more color on the timing and how this at all corresponds, if at all, with the turnaround activity in the third quarter? If you could sort of walk us through the staging of the replacement?

Barry H. Golsen, J.D.

Right now what our plan is on just specific replacement is to actually have the new one constructed right where it’s going to operate which is in a different location but near where the old ones are, adjacent to it. We’ll basically have all that done and so there will be a very quick cut over. It will not be a situation where we’re going to stop and take the old ones down and replace it with the new one. Most of the work will be done while the old ones are still in operation. Right now we’re targeting sometime in early 2013 for that cut over.

Daniel Mannes – Avondale Partners

Have you already ordered this equipment and do you have any estimate of what that cost is going to be?

Barry H. Golsen, J.D.

Some of the equipment we already own, some of the equipment is on order and the work is being done, yes.

Jack E. Golsen

It’s in the planned spending we talked about but we think the total cost is going to be in the $6 to $7 million range.

Daniel Mannes – Avondale Partners

The last question and then I’ll hop back in queue, talking about your turnaround for the third quarter given the amount of downtime you’ve already had particularly at Pryor this year and contrasting to last year when you had a turnaround and then a lot of downtime, can you talk at all about what your plan is for the third quarter especially given what looks like a pretty strong environment at least for ammonia pricing?

Jack E. Golsen

Let me clarify one point, we’re going to do the Cherokee turnaround in the third quarter but Pryor is going to be in the fourth quarter and we’re doing that in conjunction with this converter installation. So there will be a turnaround in the fourth quarter for Pryor late in the quarter and the converter will be added at that same time. Hopefully we’ll have it in place early in 2013.

Operator

Your next question comes from Joe Mondillo - Sidoti & Company.

Joe Mondillo - Sidoti & Company

I thought I heard, it might have been Jack or Tony, I forgot who it might have been but did you say you were trying to increase capacity at Cherokee?

Jack E. Golsen

Yes.

Joe Mondillo - Sidoti & Company

Could you give some more color on that?

Jack E. Golsen

We’re adding a nitric acid plant. As you know we’re somewhat ammonia limited there but we do have a [inaudible] where we can increase ammonia capacity that way.

Joe Mondillo - Sidoti & Company

So this is going to increase your ag chemical production?

Jack E. Golsen

Potentially.

Joe Mondillo - Sidoti & Company

What is the timing on that?

Jack E. Golsen

Eight months.

Joe Mondillo - Sidoti & Company

How significant is that compared to the existing capacity?

Jack E. Golsen

About equal.

Joe Mondillo - Sidoti & Company

So double the capacity?

Jack E. Golsen

Yes, of nitric acid.

Joe Mondillo - Sidoti & Company

I guess if you look at the total sort of ag sales, what kind of addition is that going to be?

Jack E. Golsen

Probably what we’ll do there is that plant gives us a really good solid backup on the other acid plant there. It also gives us additional capacity that we can back up the other plants with nitric acid. We’ll have the ability to import ammonia for our industrial business which pays on a cost plus basis and divert more of our ammonia into the UAN there. That’s the plan.

Joe Mondillo - Sidoti & Company

In terms of UAN prices, I was just wondering if you could give us your thoughts on sort of the demand/supply dynamics, holding them down year-over-year despite sort of the drought pointing to another big planting season in 2013? I’m just wondering sort of your market thoughts on what’s going on, why ammonia prices are so high, why UAN prices are sort of tailoring down?

Jack E. Golsen

Well, I think if you look at what some of the other big fertilizer companies are saying there’s an awful lot of ammonia that was put down early this year because of the late season and because of the droughts right now I think people are hesitant to buy. But we believe the distribution and storage is pretty much stocked out now so UAN prices as usually where respond to where the demand kicks in so we think it’s probably a low point right now.

Tony M. Shelby

I think your question went to ammonia didn’t it?

Joe Mondillo - Sidoti & Company

Sort of both in general, just the market between ammonia and UAN?

Jack E. Golsen

Ammonia is very high right now.

Tony M. Shelby

Because we’re a net importer of ammonia.

Joe Mondillo - Sidoti & Company

I guess last question in terms of the climate control it seems like backlog has increased a couple of quarters here. It’s the highest level since first quarter ’11. I know you sort of said that market is still a little weak but do you sort of see a recovery slowly building or how are you looking at that business?

Barry H. Golsen, J.D.

I am reluctant at this point to be very aggressive about talking about recovery because we’ve been so disappointed over the last couple of years. The forecasters for construction that do this for a living have been missing this call and I don’t believe that I know anymore than they do. So I’m reluctant to do it. Anecdotally what we hear from the field is there is a lot of activity, there’s a lot of projects, there’s a lot on the boards but what we’re also seeing is that projects delay, that they rebid, that they rebid not only once but they rebid several times and the final decision to pull the trigger and go ahead just seems to be very procrastinated.

I wish I could give you a more definite answer as to what is going on out there but we just think that this recovery is going to be slower than what we thought it was going to be a year ago, or even slower than what we thought it was going to be six months ago.

Tony M. Shelby

I think one of the problems is the banks have tightened down on lending again and there’s very little project financing going on right now from the banks that is. They’re having to seek alternate sources of borrowing because the new law has kicked in and it’s having an effect on the banks.

Barry H. Golsen, J.D.

There are other factors that are affecting this and those who watch this closely, I mean I think we’ve kind of run through any residual affect that there was from the stimulus, that’s gone. We’ve seen much less governmental spending in the areas that we serve this year than the last couple of years and consumer spending is very tight. We’re optimistic about the long haul for this, I mean there’s pent up demand. They are forecasting long term growth that is pretty significant and we believe in the long term that that will probably happen.

What we’re iffy about and I think that most people probably are now is what will the real rate of that growth be and when will it really occur. Will it be according to the current forecast or will it push out again like it has the last few cycles, last couple of years.

Operator

Your next question comes from [Rob Longnecker – Joe Street Capital].

[Rob Longnecker – Joe Street Capital]

Could you provide a little more data on production at Pryor in the quarter?

Jack E. Golsen

What kind of data are you looking for?

[Rob Longnecker – Joe Street Capital]

Tons of ammonia and tons of UAN if there was any?

Jack E. Golsen

I think we mentioned that they didn’t produce any UAN during the quarter at Pryor and they produced about 41,000 tons of ammonia. Last year they produced 25,000 tons of ammonia and 62,000 tons of UAN. This year no UAN and 41,000 tons of ammonia. 25,000 tons is what they sold.

[Rob Longnecker – Joe Street Capital]

How much was produced in the quarter?

Jack E. Golsen

You had pretty much sales equal production this year as compared to last year where you were converting a lot of it to UAN.

[Rob Longnecker – Joe Street Capital]

You guys mentioned that the $100 million plant would be substantially covered by insurance. Do you have an estimate on how much you have to come out of pocket on that?

Tony M. Shelby

What we said before was we had a $1 million deductible on our damage policy.

[Rob Longnecker – Joe Street Capital]

And then everything else is covered?

Tony M. Shelby

At this time that is what we believe and that is what we hope.

[Rob Longnecker – Joe Street Capital]

When do you guys think you’ll be giving guidance on 2013 cap ex?

Tony M. Shelby

That will probably be either in the fourth quarter or in first quarter of next year.

Operator

(Operator Instructions) Your next question comes from R. Gregg Hillman – First Wilshire Securities.

R. Gregg Hillman – First Wilshire Securities

Could you talk about the cost and lead times to put in an ammonia producing facility in El Dorado?

Tony M. Shelby

You mean if we were to decide to put in an ammonia producing facility?

R. Gregg Hillman – First Wilshire Securities

Yes.

Jack E. Golsen

The thing about ammonia facilities are that the cost varies significantly depending on the capacity so that’s a very broad question and you really have to narrow it down more to be able to give an intelligent answer.

Tony M. Shelby

I can give you some guidelines. It’s a 36 month proposition more or less. Some people will say 30 months, some people will say 36 months from the time that you start. That includes engineering, the plant and building it. The cost will be anywhere from $200 to $300 million depending on the size of the plant. 700 tons a day would be in the range of $225 million, 1,000 tons a day would be in the range of $250 to $300 million and that’s inside battery limits.

R. Gregg Hillman – First Wilshire Securities

Do you have to get in queue with the manufacturer that makes the stuff? In other words like if you don’t decide in the next year or two could they get other customers and that would push you out to maybe five years? If you get the gist of my question?

Tony M. Shelby

It could happen.

R. Gregg Hillman – First Wilshire Securities

So there is a constraint in terms of the availability of the equipment necessary to build an ammonia plant.

Jack E. Golsen

It’s not only the equipment to build the ammonia plant it’s the number of qualified construction workers that are capable of working on these kinds of projects in a geographically logical area. Everybody knows the industry is already backed up based on some of the other announcements that have been made.

R. Gregg Hillman – First Wilshire Securities

Then just another question for Barry about the claims about geothermal heat pump between you and Water Furnace Industries, there seems to be a lot of claims going around who has the best gizmo. How can I make sense of all that or how do you make sense of all that?

Barry H. Golsen, J.D.

I’ll tell you what, there is a fellow who is a writer for Forbes who wrote a series of articles and I think ultimately he finally nailed it but here’s the way we view it. We announced our Trilogy Series which we said had approximately – when we announced it we said it had a 40 EER and approximately a 5 CLP. For those of you who aren’t familiar with these ratings the EER is a cooling efficiency rating and the CLP is the heating efficiency rating. This is a substantial increase over kind of the industry best previous which was approximately 30 EER, although some of the models in our lineup actually go as high as 42 EER.

In addition to that, our product is capable of producing hot water free as a byproduct 365 days a year whether the unit is being used for cooling or heating. Now, in a typical home, this is just an average number, about 75 of all the energy is used for cooling, heating, and the generation of hot water, about 60% for cooling and heating and about 15% for the generation of hot water.

After we announced ours Water Furnace announced another one that I think they announced a 41 rating on their efficiencies approximately, let’s say it’s a point or two higher. But theirs is not capable of generating as a free byproduct the generation of hot water year round. So when we designed ours we looked at the possibility of designing a higher EER. We could have been capable of hitting a higher EER at a certain point.

However, to do that it would not have been optimum for also including the heating capability. So we looked at it holistically and we said, “What’s more important to the consumer? Getting an extra point of EER or two or having this capability of generating the heat year round?” I think if you look at the net energy savings that’s generated at ours versus the Water Furnace unit you’ll find that over the course of a typical 12 months period our users save substantially more energy and that’s what we think counts not whether at any given point we’re hitting a slightly higher mark on one rating point.

Operator

Your next question comes from Joe Mondillo - Sidoti & Company.

Joe Mondillo - Sidoti & Company

Just a couple of follow up questions. One, just regarding sort of the increased capacity not only did you say at Cherokee but I thought you mentioned El Dorado as well so I just wanted to clarify is that anything other than replacing the DSN plant or are you planning on something else?

Jack E. Golsen

As we are going through the engineering process and the planning process for that plant we’re looking at and we’re considering the possible expansion of some capacity there. We have not completely finalized that and we’re not sure what that level will be and when we get farther along and we have something more definite we’ll let you know.

Joe Mondillo - Sidoti & Company

In terms of Pryor I know you have been benefitting from the low nat gas prices, I was wondering what kind of gross margin you’re realizing at Pryor?

Tony M. Shelby

We really don’t disclose gross margin on a plant-by-plant basis.

Jack E. Golsen

But we’ve been through this before, you know what the sales price of UAN is and you know how much gas is in a ton of UAN.

Joe Mondillo - Sidoti & Company

Then just lastly, could you talk about the cash flow in the quarter? You saw a pretty big increase year-over-year in your operations cash flow despite all the issues you had at El Dorado and Pryor. I’m just wondering what’s sort of driving that?

Jack E. Golsen

That $25 million that we talked about that was not year-over-year that was from March 31st forward to June 30th and typically that’s a seasonal boost to your cash flow because your inventories are down and your seasons are down and you’re ready to start building inventory again.

Joe Mondillo - Sidoti & Company

You did $25 million last June, didn’t you?

Jack E. Golsen

We had net cash increase $25 million for the second quarter of ’12.

Joe Mondillo - Sidoti & Company

So it was $25 million in second quarter of ’12?

Jack E. Golsen

For the second quarter ’12.

Joe Mondillo - Sidoti & Company

So it’s sort of comparable to last year?

Jack E. Golsen

Yes, and you can look in the Q for the six month number. If you look at the cash flow in the Q on page seven you have $56 million net cash provided by operations for six months, $45 million of that came in the second quarter.

Joe Mondillo - Sidoti & Company

So you did see $45 in the second quarter?

Tony M. Shelby

Yes, but some of it was spent.

Jack E. Golsen

Net cash provided by operations for six months of $56 million and $45 of that was in the second quarter.

Tony M. Shelby

But that’s just cash flow.

Jack E. Golsen

Remember we said out of that came $17 million for cap ex and $3 million for debt reduction and a $25 million increase.

Joe Mondillo - Sidoti & Company

So I guess my question was you did $45 million of operation cash flow in the second quarter of this year. You did $25 last year so I was just wondering in terms of your operational cash flow what was driving the higher amount?

Jack E. Golsen

I don’t have last years in front of me except for the six months last year it was $41 million for six months.

Tony M. Shelby

I think the difference will be in receivables and inventory.

Operator

Your next question comes from Daniel Mannes – Avondale Partners.

Daniel Mannes – Avondale Partners

I just wanted to follow up real quickly on the insurance side, when would you anticipate getting the property insurance on El Dorado and how does that phase in with the timing of the big rebuild project?

Tony M. Shelby

I’ll tell you how that works. First of all the insurance company has to come in and they’re in already, they’ve been in, and get their own engineering firm to determine whether or not it should be rebuilt and they’ll pay for a rebuild or they’ll pay for new. We’ve already determined that it’s going to cost as much for a rebuild as it is for new. They have to satisfy themselves on that. When they do, then we’ll set up the procedure for them paying it over the period probably – I don’t how that works whether they give it to us all at once or they give it to us as we spend the money.

Jack E. Golsen

The way we’re expecting it to happen is [inaudible] replacement cost so as we spend the money we submit periodic claims and periodically we expect them to pay us.

Daniel Mannes – Avondale Partners

There may be a little out-of-pocket every time then?

Jack E. Golsen

There will be a time lag there and there will also be some due diligence on their part but if things work the way they should that’ll be the way it will work.

Daniel Mannes – Avondale Partners

This may be an off the wall question but for $100 million and I realize this is insured, will you get an attractive rate of return given the contract for this $100 million? I guess I’m trying to get my arms around that, it was a lot larger dollars than we were expecting.

Jack E. Golsen

This will be a much more efficient acid plant than the DSN plant because of the current technologies, so yes. The customers that we service from this give us a good margin.

Daniel Mannes – Avondale Partners

Switching topics real quick going to the Climate segment, we’ve seen some mergers and acquisition activity particularly in the geothermal heat pumps side, have you seen any change to the competitive environment or are you anticipating any?

Barry H. Golsen, J.D.

No, we’ve seen no significant change on the competitive environment. As far as anticipating any we don’t see anything happening on the horizon and that was as of yesterday because I don’t know what announcements occurred today while I was getting ready for the conference call. But, we don’t see anything that we think will move the needle in any way, that we know of.

Daniel Mannes – Avondale Partners

We were looking at Geofinity got bought out, which was a smaller player, and obviously we’re seeing Water Furnace is doing some expansion internationally and I wasn’t sure if that was interesting to you for instance?

Barry H. Golsen, J.D.

Well, it’s interesting but that wasn’t what your question was. Your question was did we see it changing the competitive environment and the answer was not anything that we know of at this time.

Daniel Mannes – Avondale Partners

One other quick question, it wouldn’t be a call if someone didn’t ask, I know you sort of have an ongoing review but have you given any further thought or any other incremental thoughts on the potential for a MLP of some of your assets?

Barry H. Golsen, J.D.

We’ve looked at the MLPs that are out there and we’ve looked at the MLP structure and we’ve looked at several of the positive aspects of MLPs and we’ve looked at some of the cons that are related to MLPs as well, so we’ve looked at this. Right now currently we don’t have a plan to do an MLP.

Daniel Mannes – Avondale Partners

Understood but is that a definitive answer or is this something that is continually reevaluated?

Barry H. Golsen, J.D.

Right now at this time we have no plans to do an MLP.

Tony M. Shelby

When you’re in business you have to keep looking at everything and that’s what we do but we can’t say we’re not always looking at what’s going on out there in the market.

Barry H. Golsen, J.D.

We’re always evaluating everything.

Jack E. Golsen

If we had a need for some serious cash that could affect our decision but at this point, as you know, we have a very strong balance sheet and are very liquid.

Operator

Your next question comes from [Rob Longnecker – Joe Street Capital].

[Rob Longnecker – Joe Street Capital]

In the press release you guys gave on the plant explosion I think you said that 29% of Q1 chemical operating income came from El Dorado. I’m wondering if you could provide a similar percentage for this quarter?

Jack E. Golsen

In this press release we said we estimate the event reduced chemical operating income for the second quarter by approximately $7 million.

Tony M. Shelby

That was the reduction. What he’s asking is what was the operating income out of El Dorado during the period and we haven’t really disclosed that so we don’t have that in front of us at the moment and that’s probably not a number we’re going to disclose.

Jack E. Golsen

But the disclosure we made will give you a pretty good idea of the impact.

Tony M. Shelby

Generally speaking we’re not disclosing profit on a plant-by-plant basis. The only exception historically we made to that was with Pryor because it was a new start up plant. On a going forward basis we’re probably not going to disclose profit on a plant-by-plant basis. We felt at the time of the explosion that it was necessary to put in perspective what El Dorado meant to the big picture and our chemical business and so as a onetime special disclosure we broke that out but we probably going forward will not do that.

[Rob Longnecker – Joe Street Capital]

In the Q there was some commentary about a insurance claim receivable of $13.5 million is that what you think is now due to you by the insurance company just on the property damage or what is that number pertaining to?

Jack E. Golsen

What we’ve done there is we’ve taken assets that have been destroyed and cost of repairing what’s already been damaged and set that up as a receivable. Then when we collect the replacement cost of assets and recovery on insurance procedures that will go against that. So basically what we’ve said is we’ve got some of these assets on the books for X, that will be a receivable. We’ve spent so much cleaning up and putting together three acid plants back into operation so we’ve just accrued costs that we think are reimbursable by the insurance company.

[Rob Longnecker – Joe Street Capital]

Then just following up on the question on the $100 million, I was also surprised at the size of that number. If there weren’t insurance proceeds coming into play here would it make business sense for you guys to spend $100 million on that plant as a Greenfield? In other words would you get the returns you would want to get on a $100 million investment on that plant?

Jack E. Golsen

That’s a little bit hypothetical for today. $100 million without replacement cost insurance I couldn’t answer that off my head I’d have to look at it closely.

Barry H. Golsen, J.D.

We have one of our major customers that take the production out of this plant.

[Rob Longnecker – Joe Street Capital]

What are those guys going to do for production for the next two years?

Barry H. Golsen, J.D.

We’ve been keeping them going. We’ve been squeezing our other operations for product. We’ve been acquiring product on the market. We’ve been keeping them going during this period.

Jack E. Golsen

Keep in mind we’re only about 20% short right now on acids so we can bring acid in and allocate some of our other customers.

Tony M. Shelby

I think you’ve got a good question and we would not proceed with the rebuild with a replacement if we didn’t think it was economically feasible. We look for pay back.

[Rob Longnecker – Joe Street Capital]

You mean exclusive or inclusive of insurance money?

Tony M. Shelby

Either way.

Jack E. Golsen

Yes, either way.

[Rob Longnecker – Joe Street Capital]

So if you hadn’t had this plant in the first place and you saw the business opportunity right now you’d be comfortable spending $100 million of your own money to build that plant?

Barry H. Golsen, J.D.

The answer is yes. I think there’s another thing that you have to look at, you can’t start – when you look at a whole complex of our whole chemical business, all four plants, all four facilities, and all the different plants within those facilities and you look at the mix of products that we have, and you look at the fact that it’s necessary to get a product balance and to be able to shift back and forth and to be able to serve different customers at different times in different seasons and as the demand wanes and flows and the different sectors that we serve having this as part of the overall complex has a significant value to us in addition to looking at it as an isolated plant. So you have to look at the big picture and you have to look at it holistically.

Operator

Your next question comes from [Eli Nushan – Core Share].

[Eli Nushan – Core Share]

I just have a couple of quick ones, first on prior the $10 million in reduced profit that you’ve flagged in the press release, is that net of the increase of anhydrous ammonia?

Jack E. Golsen

Yes. We looked at what market was available for us on UAN that we lost and then we looked at what we were able to generate in the way of ammonia sales. Keep in mind we didn’t have ammonia production for the entire quarter and compared the margin on that to the margin we would have and there were some other costs in there as well, some embedded costs so that was based on with and without the UAN production.

[Eli Nushan – Core Share]

Then sort of the follow up to that, I think in the prepared remarks you guys mentioned one shouldn’t annualize or run rate this quarter’s results. I’m curious just for you to explain that a little bit in terms of are we talking the $1.11 that you reported or should we not run rate $1.60 which is what you would have done if you make the two adjustments on the chemical side?

Tony M. Shelby

We’re not going to really talk $1.11 or $1.60 or anything. What Jack was really referring to was the fact that we do have most of our turnarounds that occur in the third quarter. We just wanted to draw that to your attention so that those of you who are trying to do out some expectations we were reminding you that we do have those turnarounds.

Jack E. Golsen

And it’s in the low part of the ag season in the third quarter.

[Eli Nushan – Core Share]

The last question is you guys have a balance sheet that is strong and getting stronger as you generate cash. Now, I think you have $3 a share of net cash on the balance sheet, I’m curious what the plans would be and if you have plans of what you’re going to do as you build more cash?

Barry H. Golsen, J.D.

As you can see by Tony’s discussion of cap ex that the chemical business has some significant capital requirements so of course some of that cash will be used for some of those projects. There’s other opportunities that we haven’t discussed that we look at all the time. We’re always looking at cases of different ways to improve the operations, to debottleneck them, to add to capacity so there’s growth opportunities there. They aren’t definite plans at this point but they’re things that we consider and they’re sort of opportunities to grow that business.

In the Climate Control business we’re expanding a facility this year, we’re adding research and development, expanding our research and development facilities. There’s expansion requirements as we get growth in the future in certain specific areas and we’re also looking for the right kind of acquisitions in that business. So there are all kinds of opportunities and so those are things we will use part of our cash for but right now as Tony mentioned, we feel given that some of the global uncertainty, it really behooves us to keep our powder dry and to have more cash than you would normally have in what would be more normal times.

Tony M. Shelby

You brought up a good subject which we discuss all the time, what’s the proper amount of cash for an $800 million sales company to have? All kinds of things happen, you can’t run dry you’ve got to make sure you can always pay your bills. I mean, $100 million is not considered excess for that size company just with the ebb and flow of seasonal business and things that happen that are not forecast that you have to be able to take care of. People look at it like it’s a lot of cash and why don’t we do something with it, well we’re protecting what they have and helping what they have grow is what we’re doing.

Jack E. Golsen

Plus we’re positioning ourselves to take advantage of any opportunities that might arise.

Operator

Your next question comes from R. Gregg Hillman – First Wilshire Securities.

R. Gregg Hillman – First Wilshire Securities

I wanted to ask you about that permit you got for Pryor for 60,000 tons additional ammonia. How much does it cost to bring that up and when will that be up?

Tony M. Shelby

We’ve said before and I think we said in our prepared comments but maybe we went over that very quickly, that we weren’t putting a specific time frame on that but that our expectation was that it would be up by the end of the year.

Jack E. Golsen

We have planned a little over $6 million in cap ex for that, for those 60,000 tons. Keep in mind that’s a plant sitting there, we’re bringing one up that’s already existing.

Operator

We have no further questions in queue at this time. I would like to turn the floor back over to management for closing remarks.

Tony M. Shelby

At this time we’d like to thank you and we’d like to turn the meeting over to Carol Oden and she is going to make some important remarks regarding forward-looking statements we might have made during the discussion today.

Carol Oden

Thanks again for listening in today. The comments today contained certain forward-looking statements. All statements other than statements of historical fact are forward-looking statements. Statements that include the words expect, intend, plan, believe, project, anticipate, estimate, and similar statements of a future or forward-looking statement nature identify forward-looking statements including, but not limited to, all statements about or any references to the Architectural Billing Index or any McGraw Hill forecast including those pertaining to commercial, institutional, and residential building increases or industry growth.

The forward-looking statements include, but are not limited to, the following statements: we expect production at Pryor to be below targeted rates until we replace the converter in the main ammonia plant and make certain other modifications; we expect these modifications to be completed early in 2013; the sulfuric acid plant repairs are expected to occur during the fourth quarter of 2012; we believe the outlook for LSB for the balance of 2012 and forward for 2013 is positive; we have substantially more potential to develop the company until we replace approximately 20% of El Dorado’s asset capacity; El Dorado’s future earnings will be adversely affected; conventional wisdom is that natural gas will remain low for sometime; outlook for the chemical markets we serve are favorable; positive fundamentals of the ag business should continue; the drought should have little or no affect on demand for our products in the third quarter; we expect increased ammonia production at Pryor by the end of the year; we plan to install a single larger and more current design Kellogg converter early in 2013; measures should allow us to achieve our targeted ammonia production rates at Pryor; plan is to install the larger converter next to the old while they are running and have a quick cut over with minimal disruption of production; and the new acid plant and the concentrator will take at least two years to fabricate and install.

You should not rely on forward-looking statements because actual events or results may differ materially from those indicated by these forward-looking statements as a result of a number of important factors. We incorporate the risks and uncertainties being discussed under the heading special note regarding forward-looking statements in our annual report Form 10K for the fiscal year ended December 31, 2011 and Form 10Q for the periods ending March 31, 2012 and June 30, 2012.

We undertake no duty to update the information contained in this conference call. The term EBITDA is used in this presentation is net income plus interest expense, depreciation, amortization, income taxes, and certain non-cash charges unless otherwise described. EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative to GAAP measurements. We will post on our website reconciliation to GAAP of any EBITDA numbers discussed during this conference call.

Thank you and that ends our conference call.

Operator

Ladies and gentlemen this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!