| LSB INDUSTRIES INC ITEM 1A RISK FACTORS Risks Related to Us and Our Business Cost and availability of raw materials could materially affect our profitability and liquidity |
| Our Chemical Business’ sales and profits are heavily affected by the costs and availability of its primary raw materials |
| Anhydrous ammonia and natural gas, which are purchased from unrelated third parties, represent the primary raw material feedstocks in the production of most of the products of the Chemical Business |
| The primary material utilized in anhydrous ammonia production is natural gas, and fluctuations in the price of natural gas can have a significant effect on the cost of anhydrous ammonia |
| During 2005, there were substantial increases in the cost of anhydrous ammonia and natural gas, and in many instances we were unable to increase our sales prices to cover all of the higher anhydrous ammonia and natural gas costs incurred |
| Although our Chemical Business has begun a program to enter into contracts with certain customers that provide for the pass-through of raw material costs, we have a substantial amount of sales by the Chemical Business that do not provide for these pass-throughs |
| Thus, in the future, we may not be able to pass along to all of our customers the full amount of increases in anhydrous ammonia and natural gas costs |
| Then, as a result of the high cost of natural gas, our Chemical Business suspended ammonia production at the Cherokee Facility on December 20, 2005, until on or about January 12, 2006, and a customer of our Cherokee Facility who was taking approximately 8cmam000 tons of UAN per month temporarily suspended its obligations under the contract due to the high prices of natural gas from October until December 2005 when it agreed to resume taking a 17 ______________________________________________________________________ [56]Table of Contents [57]Index to Financial Statements limited amount of product as spot purchases as market conditions and the cost of natural gas permits |
| We could from time to time, suspend production at this facility due to, among other things, continuing high cost of its primary raw material, natural gas |
| Accordingly, our results of operations and financial condition have in the past been, and will in the future be, materially affected by cost increases of raw materials, including anhydrous ammonia and natural gas |
| In addition, our Climate Control Business depends on raw materials such as copper and steel, which have recently shown considerable price volatility |
| While we periodically enter into fixed-price contracts on copper to hedge against price increases, there can be no assurance that our Climate Control Business will effectively manage against price fluctuations in copper and other raw materials or that future price fluctuations in copper and other raw materials will not have an adverse effect on our financial condition, liquidity and results of operations |
| In recent years our Chemical Business has been unable to generate significant positive cash flows |
| Due, in part, to lower than optimum sales levels, margin problems and extensive capital expenditures, our Chemical Business has not generated significant positive cash flows in recent years |
| Continuing significant cash flow expenditures by this business could have a material adverse effect on our financial condition and liquidity |
| Our Climate Control Business and its customers are sensitive to economic cycles |
| Our Climate Control Business is affected by cyclical factors, such as interest rates, inflation and economic downturns |
| Our Climate Control Business depends on sales to customers in the commercial construction and renovation industries, which are particularly sensitive to these factors |
| A decline in the economic activity in the United States has in the past, and could in the future, have a material adverse effect on our customers in the commercial construction and renovation industries in which our Climate Control Business sells a substantial amount of its products |
| Such a decline could result in a decrease in revenues and profits, and an increase in bad debts, in our Climate Control Business |
| Weather conditions adversely affect our Chemical Business |
| The agricultural products produced and sold by our Chemical Business have in the past, and could continue in the future, to be materially affected by adverse weather conditions outside of our control (such as excessive rains or drought) in the primary markets for our fertilizer and related agricultural products |
| If any of these unusual weather events occur during the primary seasons for sales of our agricultural products (March-June and September-November), this could have a material adverse effect on the agricultural sales of our Chemical Business and our financial condition and results of operation |
| Environmental and regulatory matters entail significant risk for us |
| As discussed under “Environmental Matters” of Item 1, our Chemical Business is subject to numerous environmental laws and regulations |
| The manufacture and distribution of chemical products are activities which entail environmental risks and impose obligations under 18 ______________________________________________________________________ [58]Table of Contents [59]Index to Financial Statements environmental laws and regulations, many of which provide for substantial fines and potential criminal sanctions for violations |
| Our Chemical Business has in the past, and may in the future, be subject to fines, penalties and sanctions for violations of environmental laws and substantial expenditures for cleanup costs and other liabilities relating to the handling, manufacture, use, emission, discharge or disposal of pollutants or other substances at or from the Chemical Business’ facilities |
| Further, a number of our Chemical Business’ facilities are dependent on environmental permits to operate, the loss of which could have a material adverse effect on its operations and our financial condition |
| A substantial portion of our sales is dependent upon a limited number of customers |
| During 2005, five customers of our Chemical Business accounted for 53prca of its net sales and 31prca of our consolidated sales, and during 2005, our Climate Control Business had one customer that accounted for 18prca of its net sales and 7prca of our consolidated sales |
| The loss of, or a material reduction in purchase levels by, one or more of these customers could have a material adverse effect on our business and our results of operations, financial condition and liquidity if we are unable to replace a customer on substantially similar terms |
| Our working capital requirements fluctuate because of the seasonal nature of our Chemical Business’ agricultural products |
| Because of the seasonal nature of our Chemical Business’ agricultural products, our working capital requirements are significantly higher at certain times of the year due to increases in inventories of ammonium nitrate, UAN and other agricultural products prior to the beginning of each planting season |
| If additional working capital is required and not available under our revolving credit facility, this could have a negative impact on our other operations, including our Climate Control Business |
| There is intense competition in the Climate Control and Chemical industries |
| Substantially all of the markets in which we participate are highly competitive with respect to product quality, price, design innovations, distribution, service, warranties, reliability and efficiency |
| We compete with a number of established companies that have greater financial, marketing and other resources than we have and are less highly leveraged than we are |
| Competitive factors could require us to reduce prices or increase spending on product development, marketing and sales that would have a material adverse effect on our business, results of operation and financial condition |
| We are effectively controlled by the Golsen Group |
| As discussed under “Security Ownership of Certain Beneficial Owners” of Item 12, Jack E Golsen, our Chairman of the Board and Chief Executive Officer (“CEO”), members of his immediate family (spouse and children), including Barry H Golsen, our Vice Chairman and President, entities owned by them and trusts for which they possess voting or dispositive power as trustee (the “Golsen Group”) beneficially owned as of March 20, 2006, an aggregate of 4cmam845cmam288 shares of our common stock or 31dtta9prca, which includes 1cmam441cmam668 shares that the 19 ______________________________________________________________________ [60]Table of Contents [61]Index to Financial Statements Golsen Group has the right to acquire upon the conversion of preferred stock, stock options and a promissory note |
| Thus, the Golsen Group may be considered to effectively control us |
| As a result, the ability of other stockholders to influence our management and policies could be limited |
| Loss of key personnel could negatively affect our business |
| We believe that our performance has been and will continue to be dependent upon the efforts of our principal executive officers |
| We cannot promise you that our principal executive officers will continue to be available |
| Jack E Golsen has an employment agreement with us |
| No other principal executive has an employment agreement with us |
| The loss of some of our principal executive officers could have a material adverse effect on us |
| We believe that our future success will depend in large part on our continued ability to attract and retain highly skilled and qualified personnel |
| While we maintain liability insurance, including certain coverage for environmental contamination, it is subject to coverage limits and policies may exclude coverage for some types of damages |
| Although there may currently be sources from which such coverage may be obtained, it may not continue to be available to us on commercially reasonable terms or the possible types of liabilities that may be incurred by us may not be covered by our insurance |
| In addition, our insurance carriers may not be able to meet their obligations under the policies or the dollar amount of the liabilities may exceed our policy limits |
| Even a partially uninsured claim, if successful and of significant magnitude, could have a material adverse effect on our business, results of operations, financial condition and liquidity |
| Our warranty claims are not generally covered by our insurance |
| The development, manufacture, sale and use of products by our Climate Control Business involve a risk of warranty and product liability claims |
| Warranty claims are not generally covered by our product liability insurance and there may be types of product liability claims that are not covered by our product liability insurance |
| A successful warranty or product liability claim not covered by our insurance could have a material adverse effect on our business, results of operations, financial condition and liquidity |
| We have not declared or paid dividends on our outstanding common stock in many years and have a substantial amount of accrued and unpaid dividends on our outstanding series of cumulative preferred stock |
| We have not paid cash dividends on our outstanding common stock in many years, and since January 1, 1999, through December 31, 2005, we did not pay any accrued dividends on our outstanding cumulative preferred stock |
| As of December 31, 2005, there was approximately dlra14dtta5 million of accrued and unpaid dividends on our outstanding cumulative preferred stock |
| We intend to retain most of our future earnings, if any, to provide funds for our operations and/or expansion of our businesses |
| However, on January 17, 2006, our Board of Directors declared nominal dividends, payable March 15, 2006, to holders of record as of February 15, 2006, on 20 ______________________________________________________________________ [62]Table of Contents [63]Index to Financial Statements certain outstanding series of our preferred stock, as follows: $ |
| 10 per share on our outstanding dlra3dtta25 Convertible Exchangeable Class C, Series 2, which has 623cmam550 shares outstanding, $ |
| 37 on our outstanding Series B 12prca Cumulative Convertible Preferred, which has 20cmam000 shares outstanding, and $ |
| 31 a share on our outstanding Non-Cumulative Preferred, which has 871 shares outstanding |
| These dividends are not for the full amount of the required quarterly dividends pursuant to the terms of all of our outstanding series of preferred stock |
| As a result, the amount of accrued and unpaid dividends on our outstanding cumulative preferred stock increased to approximately dlra14dtta9 million as of March 15, 2006 |
| There are no assurances that we will in the future pay any additional quarterly dividends on any of our outstanding shares of preferred stock |
| We do not anticipate paying cash dividends on our outstanding common stock in the foreseeable future, and until all accrued and unpaid dividends are paid on our outstanding cumulative preferred stock, no dividends may be paid on our common stock |
| In the event of our liquidation, winding up or dissolution, there can be no distributions on our common stock until all of the liquidation preference and stated value amounts of our outstanding preferred stock and all accrued and unpaid dividends due on our outstanding cumulative preferred stock are paid in full |
| Further, not paying all of cumulative accrued dividends on our outstanding preferred stock could adversely affect the marketability of our common stock and our ability to raise additional equity capital |
| Terrorist attacks and other acts of violence or war, including the military conflict in Iraq and natural disasters (such as hurricanes), have and could negatively impact the US and foreign companies, the financial markets, the industries where we operate, our operations and profitability |
| Terrorist attacks and natural disasters (such as hurricanes) have in the past, and can in the future, negatively affect our operations |
| We cannot promise that there will be no further terrorist attacks and natural disasters in the United States and elsewhere |
| These attacks or natural disasters have contributed economic instability in the United States and elsewhere, and further acts of terrorism, violence, war or natural disasters could further affect the industries where we operate, our ability to purchase raw materials, our business, results of operations and financial condition |
| In addition, terrorist attacks and natural disasters may directly impact our physical facilities, especially our chemical facilities, or those of our suppliers or customers and could impact our sales, our production capability and our ability to deliver products to our customers |
| As a result of Hurricane Katrina, the natural gas pipeline to our Cherokee Facility was damaged causing us to shutdown this facility for several weeks in September and October 2005 |
| Although we resumed production at the Cherokee Facility in October 2005, the damaged pipeline was not repaired, resulting, in part, in this facility operating at less than full capacity from October 2005, until we suspended production at this facility on December 20, 2005, due to high cost of natural gas |
| We resumed production at the Cherokee Facility on or about January 12, 2006 |
| The effect of the damaged pipeline on this facility until it is repaired is unknown |
| The consequences of any terrorist attacks or hostilities or natural disasters are unpredictable, and we may not be able to foresee events that could have an adverse effect on our operations |
| 21 ______________________________________________________________________ [64]Table of Contents [65]Index to Financial Statements Our net loss carryovers are subject to various limitations and have not been approved by the Internal Revenue Service |
| Our net loss carryovers have resulted from certain losses, and we anticipate they may be used to reduce the federal income tax payments which we would otherwise be required to make with respect to income, if any, generated in future years |
| We had available regular-tax net operating loss carryovers of approximately dlra67 million at December 31, 2005 |
| The use of the net operating loss carryovers is, however, subject to certain limitations and will expire to the extent not utilized by the years 2009 through 2021 |
| In addition, the amount of these carryovers has not been audited or approved by the Internal Revenue Service, and, accordingly, we cannot promise that such carryovers will not be reduced as a result of audits in the future |
| Recent restatements and amendments to our 2004 audited financial statements and certain matters related to our disclosure controls and procedures may present a risk of future restatements and could in turn lead to legal exposure |
| As a result of comments from the SEC, our 2004 Form 10-K and other changes we made internally, we have recently restated and amended our 2004 audited financial statements and filed a Form 10-K/A (Amendment Nodtta 1) for year ended December 31, 2004 |
| As a result of the restatement and amendments to our 2004 audited financial statements and SEC comments, we also filed an amended Form 10-Q/A for each of the quarters ended March 31, 2005 and June 30, 2005 |
| As a result of this restatement to our 2004 financial statements, we also revised our 2004 Form 10-K and first two quarters 2005 Form 10-Qs to provide that our disclosure controls and procedures were not effective as of December 31, 2004, March 31, 2005 and June 30, 2005, in our Form 10-K/A and Forms 10-Q/A, as a result of assessing that the change from the LIFO method to the FIFO method of accounting was not material resulting in the decision at the time of the change not to disclose and not to restate the prior years financial statements |
| We believe that during December 2005, we corrected the weakness to our disclosure controls and procedures by, among other things, establishing a Disclosure Committee to maintain oversight activities and to examine and reevaluate our policies, procedures and criteria to determine materiality of items relative to our financial statements taken as a whole |
| Restatements by others have, in some cases, resulted in the filing of class action lawsuits against such companies and their management |
| Any similar lawsuit against us could result in substantial defense and/or liability costs and would likely consume a material amount of management’s attention that might otherwise be applied to our business |
| Under certain circumstances, these costs might not be covered by, or might exceed the limits of, our insurance coverage |
| We are subject to a variety of factors that could discourage other parties from attempting to acquire us |
| Our certificate of incorporation provides for a staggered board of directors and, except in limited circumstances, a two-thirds vote of outstanding voting shares to approve a merger, consolidation or sale of all, or substantially all, of our assets |
| In addition, we have entered into severance agreements with our executive officers and some of the executive officers of our 22 ______________________________________________________________________ [66]Table of Contents [67]Index to Financial Statements subsidiaries that provide, among other things, that if, within a specified period of time after the occurrence of a change in control of our company, these officers are terminated, other than for cause, or the officer terminates his employment for good reason, we must pay such officer an amount equal to 2dtta9 times the officer’s average annual gross salary for the last five years preceding the change in control |
| We have authorized and unissued (including shares held in treasury) 61cmam239cmam342 shares of common stock and 3cmam398cmam541 shares of preferred stock as of December 31, 2005 |
| These unissued shares could be used by our management to make it more difficult, and thereby discourage an attempt to acquire control of us |
| We have further adopted a preferred share purchase plan, which is designed to ensure that all of our stockholders receive fair and equal treatment in the event of a proposed takeover or abusive tender offer |
| The foregoing provisions and agreements are designed to discourage a tender offer or proxy contest for control of us and could have the effect of making it more difficult to remove incumbent management |
| Delaware has adopted an anti-takeover law which, among other things, will delay for three years business combinations with acquirers of 15prca or more of the outstanding voting stock of publicly-held companies (such as us), unless (1) the acquirer owned at least 85prca of the outstanding voting stock of such company prior to commencement of the transaction, or (2) two-thirds of the stockholders, other than the acquirer, vote to approve the business combination after approval thereof by the board of directors, and (3) the stockholders decide to opt out of the statute |
| We are a holding company and depend, in large part, on receiving funds from our subsidiaries to fund our indebtedness |
| Because we are a holding company and operations are conducted through our subsidiaries, principally ThermaClime and its subsidiaries, our ability to make scheduled payments of principal and interest on our indebtedness depend on operating performance and cash flows of our subsidiaries and the ability of our subsidiaries to make distributions and pay dividends to us |
| Under its loan agreements, ThermaClime and its subsidiaries may only make distributions and pay dividends to us under limited circumstances and in limited amounts |
| If ThermaClime is unable to make distributions or pay dividends to us, or the amounts of such distributions or dividends are not sufficient for us to service our debts, we may not be able to pay the principal or interest, or both, due on our indebtedness |
| We are highly leveraged, which could affect our ability to pay our indebtedness |
| At December 31, 2005, after giving effect to the sale of dlra18 million in convertible senior subordinated debentures that we completed in March 2006, and the application of the net proceeds thereof, our aggregate consolidated debt was approximately dlra113dtta6 resulting in total debt as a percentage of total capitalization of 89dtta2prca |
| 23 ______________________________________________________________________ [68]Table of Contents [69]Index to Financial Statements The degree to which we are leveraged could have important consequences to us, including the following: • our ability to obtain additional financing in the future for refinancing indebtedness, acquisitions, working capital, capital expenditures or other purposes may be impaired; • funds available to us for our operations and general corporate purposes or for capital expenditures will be reduced because a substantial portion of our consolidated cash flow from operations could be dedicated to the payment of the principal and interest on our indebtedness; • we may be more highly leveraged than some of our competitors, which may place us at a competitive disadvantage; • the agreements governing our long-term indebtedness, including indebtedness under the debentures, and those of our subsidiaries (including indebtedness under the debentures) and bank loans contain certain restrictive financial and operating covenants; • an event of default, which is not cured or waived, under financial and operating covenants contained in these debt instruments could occur and have a material adverse effect on us; and • we may be more vulnerable to a downturn in general economic conditions |
| Our ability to make principal and interest payments, or to refinance indebtedness, will depend on our future operating performance and cash flow, which are subject to prevailing economic conditions and other factors affecting us, many of which are beyond our control |
| Future issuance or potential issuance of our common stock could adversely affect the price of our common stock, our ability to raise funds in new stock offerings and dilute your percentage interest in our common stock |
| At March 20, 2006, we had outstanding dlra18 million in debentures and had outstanding various series of preferred stock, all of which are convertible into an aggregate of approximately 5dtta8 million shares of our common stock, subject to adjustment from time to time |
| In addition, we may, at our option, pay the redemption price of the debentures in shares of common stock under certain conditions, and we may also pay up to one-half of the debentures at maturity in our common stock under certain conditions |
| We also have outstanding warrants and options that are exercisable into approximately 2 million shares of our common stock, subject to adjustment |
| The issuance or potential issuance of these shares of common stock could adversely affect the prevailing market price of our common stock and could impair our ability to raise capital through offerings of equity or equity related securities |
| Future issuance of our common stock in connection with our outstanding debentures, preferred stock and exercise of our outstanding warrants and options will also significantly reduce the percentage ownership of our existing common stockholders |