LSB Industries, Inc. (LXU) Q3 2015 Earnings Report, Transcript and Summary

Greetings and welcome to the LSB Industries third quarter 2015 conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ms. Kristy Carver, Treasurer. Thank you. You may begin.

Thank you, Donna. Please note that today's call will include forward-looking statements and because these statements are based on the company's current intent, expectations and projections, they are not guarantees of future performance and a variety of factors could cause actual results to differ materially. As this call will include references to non-GAAP result, please reference this morning's press release in the Investors section of lsbindustries.com for further information regarding forward-looking statements and reconciliations of non-GAAP result to GAAP result. At this time, I would like to go ahead and turn the call over to Dan for opening remarks.

Thank you, Kristy and good morning to everyone. Thank you for joining this morning's 2015 third quarter conference call. I will first review the management changes during the quarter and then provide further information on operating status of Pryor as well as an update on the El Dorado construction progress. I refer you to page three in our third quarter materials. This has been a transitional and transformational period for the company. The experienced active Board of Directors has focused on El Dorado completion, securing construction financing, increasing reliability and implementing enhanced governance practices. As we previously reported, the company's management team has undergone significant changes during the quarter. I am now serving as the Interim CEO and Richard Sanders has stepped up to serve as Interim Executive Vice President of Chemical Manufacturing. Richard has a very strong history of running world class nitrogen production facilities. He brings key operating discipline to our chemical facilities, construction and production activities. Additionally, we have restructured both the El Dorado construction responsibilities and the chemical manufacturing operations. We are implementing further positive changes throughout the company and driving accountability, a results oriented focus and a strong sense of urgency. We have begun initiatives on sales channel improvements for both the chemical and climate control businesses as well as reliability improvements for the chemical facilities. Pryor came back online in late September 2015 and has continued to operate very well since then. Cherokee and Baytown continue to have excellent performance. During the quarter we had several significant events that will position the company to improve going forward. First, we have secured key strategic financing to complete construction of our El Dorado expansion. While it's more expensive than we had anticipated, we hope to see improvements to our capital structure cost within 12 to 18 months as contributions from our El Dorado's new facilities generate significant cash flow. We have also completed a long-term offtake agreement for the excess ammonia when El Dorado ammonia plant becomes operational in the second quarter of 2016. This should bring steady monthly cash flow and profitability. In early September 2015, we initiated extensive engineering and cross reviews of the El Dorado construction project and were assisted by outside professional firms. As a result, we identified further cost increases to the project in the range of $108 million to $111 million. This range is related to the construction costs and does not include capitalized interest. Additionally, we have included a general contingency estimate of approximately $46 million. This represents approximately 20% to 25% of the remaining work to be completed for unforeseen, unanticipated, adverse weather, commissioning and startup complexities on the project. In order to accelerate the construction of the El Dorado facility, the company originally decided to bring experienced large bore pipe, defined as pipe greater than four inches in diameter, from the Donaldsonville, Louisiana location to El Dorado. The dismantling and relocation was completed in a manner that was not held for reassembly in El Dorado. Additionally, as a result of an initial poor quality piping subcontractor, significant costs were incurred for limited productivity and time was lost. As you likely know, in early July 2015, we replaced the poor performing piping subcontractor with two well-qualified high quality piping subcontractors. Further, the company's approach for the El Dorado expansion was to perform significant engineering work just in advance of construction activities in order to fast-track construction efforts. This meant the initial and subsequent cost estimates were not engineered estimates with a high degree of precision. We have painfully learned that fact. In early September 2015, we engaged Hatch Engineering to perform an independent detailed cost estimate study on the ammonia piping work. Those estimates are reflected in the revised costs we have provided today and are consistent with amounts forecasted by the current piping contractors. Additionally Hatch Engineering has been engaged to serve as our representative and has performed further comprehensive reviews of cost estimates, construction schedules and timelines as well as key project management activities. We believe these revised project cost estimates, along with the potential contingency amount will allow us to complete the project at or below $855 million. This additional cost overrun is extremely disappointing and we are driving the construction teams to complete the project without using any of the $46 million or contingency. Since early September, both Richard Sanders and I make frequent visits to El Dorado to monitor and assess the engineering work, construction progress and cost management. We will continue to provide intensive oversight until the project is completed, including commissioning and startup. Once completed, the El Dorado facility will be a state-of-the-art facility and will lead to significant profitability improvement since we will be producing ammonia as compared to purchasing ammonia for downstream nitric acid and ammonium nitrate production. We will also sell excess ammonia via the ammonia pipeline under a new three-year agreement with Coke Fertilizer. Turning to the third quarter results. Consolidated revenues decreased by approximately 8% due to the extended downtime at Pryor. Chemical revenues decreased by approximately 15% while climate control revenues increased by approximately 2%. Excluding the Carrier business and the climate control revenue comparisons, the year-over-year revenue increase for climate control was 5%. Referring to page four in our materials. We remain optimistic for nitrogen demand going into 2016, although the current demand is not as robust as we would like to see. Growers have been slower to purchase product in advance this year due to a variety of reasons, such as weather, softening of import prices, lower natural gas prices and lower corn futures. We do expect fill activity to pickup in the next several weeks. Industrial chemical sales remained steady while demand for low density ammonium nitrate for explosives remained soft given our cost disadvantage. Turning to page 5 in our materials. As I noted earlier, climate control sales excluding the Carrier impact increased 5% from a year ago quarter. We continue to see pricing pressure in the market, but we do have approximate $72 million of backlog. We are improving our rep network and hope to gain additional market presence as we go into 2016. We continue to focus on opportunities to consolidate manufacturing operations and back-office functions. We are initiating a detailed review of our go-to-market activities in climate control with the goal of expanding our product reach. We expect to see improvement in commercial and industrial new construction over the next few years. We believe the construction team will continue to focus on higher energy efficient green products. However, current low natural gas prices are having an impact on residential geothermal products. We are also keeping an eye on the residential energy efficiency property credit set to expire in 2016. At this time, I would like to turn the call over to Mark Behrman to discuss our financial results and our recent financing activities.

Thanks, Dan. As Dan indicated, our second quarter results were disappointing compared to last year and what we expect going into the quarter. Page six of the presentation provides a consolidated summary statement of operations for the third quarter of 2015 and the first nine months of 2015. Total net sales were down for the quarter driven by lower chemical sales, which contributed to the lower gross profit and I will go into some detail in the next few slides. Overall, SG&A increase $4.2 million in the third quarter versus the third quarter of 2014. That increase was primarily driven by higher corporate expenses of approximately $2.5 million arising primarily from one-time severance costs for three senior executives, an increase in SG&A at our chemical business of approximately $1.2 million primarily from higher training expenses related to the incremental staff hired to run the new ammonia plant at El Dorado, increased railcar lease expenses related to low density ammonium nitrate sales and an increase in salary and wages at El Dorado for the ammonia plant staff hired, an increase in SG&A at our climate control business of approximately $400,000 related to higher warranty costs for specific claims and an increasing freight cost as a percentage of sales from a shift in product and customer mix, which was partially offset by lower personnel costs and advertising related expenses. One thing I do want to point out that included in the third quarter of 2015 is a $39.7 million write-down of our working interest in the Marcellus shale. This was caused by the continued reduction in natural gas prices and a push out of the timing of our true schedule causing slower well development and the movement of several wells from the producing category to the probable category, all causing a reduction in overall reserve value. Adjusted operating loss, adjusted net loss and adjusted EPS were all down for the quarter versus Q3 2014 due to the decrease in sales, gross profit margins and the increase in SG&A that I just discussed. Page seven provides a summary of the chemical businesses operating results for the third quarter of 2015 compared to the third quarter of 2014. Sales and gross profit were both down for the quarter, primarily as a result of the 45 days of unplanned downtime at Pryor's ammonia plant, which reduced production and sales of both ammonia and UAN, lower low-density ammonium nitrate production and sales versus the third quarter of 2014, when we were still under contract with Orica and they were required to pay for 60,000 tons per quarter irrespective of the amount they actually took, an increased operating costs largely related to the maintenance and repairs incurred at Pryor, increased depreciation at El Dorado and increased salary and wages, lower whereas natural gas prices and slower well development from a working interest in the Marcellus shale and overall lower fertilizer pricing which were partially offset by lower natural gas prices as feedstock at Cherokee and Pryor and of course higher onstream rates at Cherokee due to no scheduled turnaround in 2015. That combined with the increase in the SG&A discussed on the previous slide contributed to the increased adjusted operating loss for the quarter. From an operating standpoint, the Cherokee ammonia plant ran extremely well during the quarter with an onstream rate of approximately 100% and record production for the quarter. Pryor completed its scheduled turnaround successfully in the forecasted 25 days before the unplanned downtime incurred. Additionally, excluding plant turnarounds, the Cherokee ammonia plant's quarterly onstream rate has been 94% or higher for six out of the last second quarters. Turning to page eight. We provide a summary of climate control businesses operating results for the third quarter of 2015 compared to the third quarter of 2014. Sales increased approximately 2% driven by higher sales of our hydronic fan coil, custom air handler and construction services, partially offset by a reduction in sales of modular chillers and residential heat pumps. Gross profit and gross profit as a percent of sales decreased as a result of an unfavorable product mix of our commercial versus residential heat pump sales, which were more weighted towards commercial products in the third quarter of 2015 versus the third quarter of 2014. Commercial heat pump sales generally carry a lower gross profit margin versus residential heat pump sales. Additionally, we had an increase in sales of other products, primarily custom air handlers and those products tend to carry lower gross profit margin versus heat pumps and fan coils. As I discussed previously, SG&A increased approximately $400,000 and combined with lower gross profit that reduced operating income and EBITDA for the quarter. Page nine outlines our capital structure as of 9/30/15. Total cash and investments at the end of the quarter were approximately $39 million, of which $3 million is reserved for the operations of the Marcellus shale working interest, while total debt was approximately $496 million including $13.4 million drawn on our ABL facility and $15 million from the financing of the ammonia storage tank at El Dorado, which we closed in the third quarter of 2015. We are currently in discussions with a certain lender for the financing of the cogen facility being constructed as part of the El Dorado expansion project and hope to close on that loan in Q4 of 2015. As of 9/30, we had approximately $57.6 million availability on ABL facility and that decreased to approximately $54.2 million at the end of October. Moving to page 10, we outlined our free cash flow. The takeaway here is that until we complete the expansion at EDC, we will have negative free cash flow. That should change significantly when the expansion at EDC is completed and the ammonia plant is in operation in early Q2 2016. Since we are at the tail-end of the construction phase of our project, spending on the expansion project is at its highest levels. Page 11 outlines our expected capital spending for the remainder of 2015. As Dan outlined earlier, the overall cost of the expansion project at El Dorado has increased to a total of between $831 million and $855 million and he will go into much greater detail later in the presentation. Given our current project schedule that Dan will also discuss shortly, that means that the heavy CapEx spending should occur over the next four months. For the remainder of 2015, we expect CapEx to be between $210 million and $235 million with $70 million to $75 million of the remaining planned capital additions, all related to the El Dorado expansion projects to be spent in the early part of 2016. As of 9/30, our remaining spend to complete the expansion at El Dorado was between $267 million and $291 million. If you assume that an average monthly spend for Q3 was approximately $47 million and use that for October, that would leave our remaining spend as of November 1 to the project completion at between $220 million in $244 million including the $46 million of contingency that Dan alluded to earlier. So how will we finance that? If you turn to page 12, we will go into some detail. This morning, we announced in our earnings release that we executed a commitment for strategic investment of $260 million from security benefit and its affiliates. This investment will provide us with the necessary capital to complete the El Dorado facility expansion. Page 12 outlines the major terms of the financing. We will issue $50 million in senior secured notes and $210 million in nonconvertible preferred stock. Additionally, security benefit will receive the equivalent of 19.99% of the outstanding common stock before the closing of this transaction, holding rights equal to the same 19.99% of the outstanding common stock before the closing of this transaction and the right to appoint three nominees to the company's Board as replacements for three existing independent directors. We expect closing to occur on the $50 million of senior secured notes next week and the closing on the $210 million of preferred stock on or about November 20, but no later than the end of this year. We are happy to have found a partner who sees the value of the strategic plan that our Board and management team are executing. Now I will turn it back to Dan to discuss the status of our chemical operations and the status of the El Dorado expansion project.

Thanks, Mark. I am referring you to the chemical facilities operational status on page 13. In El Dorado, the new nitric acid concentrator is completed and began initial production in June 2015. The new nitric acid plant is starting initial production next week and will ramp up to full rates in the near-term. The ammonia plant construction is progressing well for mechanical completion at the end of January 2016 and the ammonia production is planned to commence early in the second quarter of 2016. At Pryor, the ammonia plant is running at full rates of approximately 700 tons per day. Cherokee's ammonia production is running at approximately 515 tons per day. These levels of production are historical highs. Baytown continues to run at plant rates with excellent safety results. Turning to the El Dorado construction timeline on page 14. We have included a construction timeline on the ammonia plant, which indicates that we plan to be mechanically complete at the end of January 2016. We plan on producing ammonia in the second quarter of 2016. Page 15 shows aerial shots of the facility. Turning to page 16, the El Dorado expansion capital spending. As I noted earlier, the project engineering work was performed just in advance of the construction teams and the ability to accurately estimate and manage cost was limited. We believe we have resolved both of those issues with the assistance of Hatch Engineering, Performance Contractors and ParFab Contractors. The additional cost increases without the owners contingency amount of $46 million totaled approximately $111 million. The summarized categories of cost increases consist of the following, piping and mechanical labor and materials $70 million, engineering and project management $14 million, scaffolding and crane rentals $11 million, electrical installation $5 million and additional equipment, weather delays and other miscellaneous costs $11 million, which aggregate to the $111 million. We are working aggressively to reduce these costs and bring the project to completion with limited or no use of the contingency amounts. We believe the completion of this project will provide significant value creation for shareholders. Referring to page 17, remaining El Dorado project costs. This page only includes construction costs and does not include the general contingency of $46 million or capitalized interest. Costs incurred to-date aggregate to $531 million. From October 2015 through project completion in the second quarter of 2016, we expect to spend between $201 million and $224 million. The majority of the work to be completed consists of labor and materials associated with piping and mechanical activities. Page 18 provides a volume outlook for the fourth quarter of 2015 for our chemical business. Page 19 shows key aspects that we are focused on to create value for our shareholders. We believe with strong Board support and focused management, we can accomplish meaningful change in the remainder of 2015 and beyond. That concludes our prepared comments. And now, I would like to open it up for -and-answers. Donna?

[Operator Instructions]. Our first question is coming from Roger Spitz of Bank of America. Please proceed with your question.

Hi. Thank you. Good morning.

Good morning, Roger.

Good morning.

Regarding the 12% $50 million secured notes of 2019, will they be trying to pursue with the first lien, the 7.75%, the first liens of 2019, meaning will they be secured by exactly the same collateral?

Yes. They will.

And will there be any differences in the incurrence covenants from those 7.75%? Or will there be any maintenance covenants in those notes?

No. None at all. They will be the same.

Okay. The same. And, presumably you had incurred that under the $50 million, these bonds under the basket and current liens under the $50 million general debt incurrence basket. So if that's true, I am assuming that that basket is done. Does that mean the only other basket in current liens at all would be the, say, $60 million liens related to the capital leases, though that would not be on any collateral?

Yes.

Perfect. In the past you talked about the $21 million related to the El Dorado cogen facility. Has that been separately financed yet? Or is included in what you are talking about today?

No. Roger, as I mentioned earlier, we have a commitment from a lender. So we do expect to close that this quarter.

Okay. Would that then be under that capital lease carve out?

Yes.

And lastly for me, the preferred stock, the 14% cumulative preferred stock, can that be paid in cash or not be paid in cash at the Board's sole discretion? And if not paid in cash, if cumulative, would they be paid at some point in the future, if they are to be paid? Or would they at that level or would they pick up?

Yes. So the Board has an option to pay in cash or in kind. And they will elect that every six months. And if for some reason the Board elects to not pay anything, then they will just be cumulative and they would be compounding, if it's not paid.

They would be picking. It would be picking.

Yes. Effectively, yes.

Okay. I am sorry. One last one. Just so I have got this trade, the Q4 2015 CapEx and 2016 CapEx?

Yes. So if we go back to page 11 in the presentation, so the Q4, as I said, should be $210 million to $235 million in total.

In Q4.

Yes.

Okay.

And then there is $70 million to $75 million of EDC project costs that will come in the first half of 2016, mostly in the first quarter.

In first quarter. What would be the total 2016 CapEx expectation guidance?

We haven't come out with that yet.

Thank you very much.

Thank you. Our next question is coming from David Deterding of Wells Fargo. Please proceed with your question.

Hi guys. Thanks for taking my question. Just on El Dorado, you were talking about Pryor and Cherokee running at record rates. I think last quarter you told us that you would expect EBITDA negative until you guys got the new ammonia plant up and running at El Dorado. Is that still your expectation?

Yes. It is.

Okay. And then the last one I had is just, in the press release you said, we are still pursuing previously disclosed strategic alternatives. Does that mean that you guys are still, once you get this thing up and running, strategic alternatives and meaning potentially splitting or selling one of these businesses?

Well, I think you said it correctly. Our primary focus is to get it up and running. So that's our number one, number two and number three objective, is the same. I think the Board wants us to and the Board will continue to look at the value creation opportunities for shareholders and will consider all types of different options.

Great. Thank you, guys.

Thank you. Our next question is coming from Dan Mannes of Avondale Partners. Please proceed with your question.

Thanks. Good morning, guys.

Good morning, Dan.

So I guess this is mostly for Dan. I was hoping maybe to back a little bit more over the timeline as it relates to the cost increases. I guess my question is, you highlighted some of the challenges in terms of the reengineering plan, but that wasn't new, that's not something you guys learned about now. I mean that's been the case since this project originally embarked. And I guess maybe I had thought that you guys already hired Hatch at the time when you put out the Q2 cost increase. So I wondered if you can go back through the schedule and help me out on those two topics, because again, I think myself and obviously everyone else is a little bit surprised by another increase here.

Sure. I mean, we had hired Hatch earlier. They were originally hired to help with commissioning activities. Part of their scope was expanded in July to include some other project management activities, but when I came on September 1, I engaged them specifically to do detailed cost studies and activities surrounding the overall project costs. The did do very detailed cost studies, P&ID looks, all the cost estimates and then they went through and scrubbed all the other areas of the contractors and timelines, project management, things like that. So when I came onboard, we engaged them to do a very detailed piece of work. Prior to that, it wasn't that detailed.

So then how did the July cost, where was the estimating coming from for that? Because again, I would like to go back through the exact script, but it was certainly indicated there were a lot of third party resources that were engaged in order to make that estimation. So I guess I am trying to understand why these consultants are better than those consultants? It's a little bit troubling from the outside?

Well, keep in mind, when, I think in the last, around July 1, we had terminated one of the piping contractors that was not performing. And on July 1, we brought on two new piping contractors, Performance and ParFab. At that point in time, the detail engineering wasn't done and they were making, I would say, their best estimates at that time based on the information they had. And we had not engaged Hatch to do that detail cost study. So those cost estimates at that time were based upon Leidos' information as a general contractor and with the new guys, ParFab and Performance just coming onsite, been onsite less than a month and probably didn't have as detailed information as they could have. We subsequently in September launched on that to get very detailed estimates to go down to the individual pipe runs, estimate each individual pipe run and a much more detailed and thorough cost review was done in very early September.

Okay. Maybe I will take it offline, because I feel like we are missing a step. But I guess the other thing I will ask is, I mean since you guys have been on the Board for over a year, was there a recognition of may be the challenges with the engineering plan, which it sounds like, in hindsight, was pretty obviously wasn't going to work, but was that something you guys were aware of earlier and I guess I am wondering why it wasn't addressed until more recently?

Well, I think we were aware of it, certainly when we had the initial $50 million cost increase, the Board was aware of it. We were certainly aware of the July increase and the effort that around that. I think the level of detail that we recognized was not there in the August estimates. The Board was not comfortable with that and clearly as a result we made changes to the management, the senior management and I immediately launched on detailed cost estimate work. So that's the sequence of events and that's what occurred.

Okay. Following up briefly on the El Dorado and the current operations, I think in your press release you said it was about $15 million drag on the quarter. Can you break that out, how much of that, if at all, relates to training expenses and things like that for the expansion versus the under absorption, given the lower production levels currently?

Yes. I would say, about $0.5 million is training and then there is probably another $0.5 million related to the staff that we put brought on related to the ammonia plant. And then we had probably another $500,000 to $600,000 of additional railcar lease expense, as I talked about last quarter and that's just going to carry through every quarter. And then we had probably lower, high-density ammonium nitrate sales and selling prices was probably another $800,000 with about $4.5 million of the loss related to low-density ammonium nitrate tons that we sold versus last year when we had the Orica contract.

So the $15 million year-on-year, is that the absolute loss of the facility?

No. I am talking year-over-year.

Okay. I guess I am just trying to find out how much of a get back we have, just by having even breakeven production where the ammonia nitrate actually covers the cost of the ammonium nitrate plant and you are basically able to get the ammonia margin. I guess I am wondering what the get back is versus where we are right now. You have talked about the $80 million to $90 million on El Dorado, but that doesn't count just the recovery of the current losses. And I want to make sure we understand that point as well.

Yes. I would say, you are right. So we talked about $90 million, which was really a comparison of 2014, when we had Orica versus 2017. And so if you look at 2015 versus 2017, that $90 million probably goes to about $130. We end up at the same place, but we are starting from bit deeper in the hole.

Got it. That's helpful. And then lastly, you mentioned on the climate side some of the pricing pressures. On the other side, you should be getting some tailwinds on the raw side. We are seeing lower steel, lower copper, all kinds of lower raws. Is that maybe contributing to the pricing side? And are you able to maintain margin? Or is there something else going on we should be thinking about?

No. I think it's just a very competitive market. Yes, we are getting benefits of raw material decreases but I think it is a very competitive market out there and all manufacturers are looking for the additional effort. I think the weakness in geothermal sales for the homeowners, it has maybe a small our result of that, but it's just competition.

And what's the pacing as it relates to margin enhancement in that? And that will be my final question. Because you guys laid out a longer term plan to get to 15% EBITDA margins at climate and we saw some sequential improvement, but can you maybe walk me through any steps that have been taken or where we are in that process?

Sure. There is several. We are intensifying our OpEx with our OpEx plan and hitting that harder. In addition to that, we are bringing in some folks, some outside help to look at our sales channel and our go-to-market process. So I think we are looking both on the manufacturing side and on the sales and distribution side of how we can enhance those margins and what we can do to A, add more reps and B, look at our go-to-market activities and see what changes may or may not be needed there.

Okay. Thank you.

Thank you. Our next question is coming from Joe Mondilo of Sidoti & Company. Please proceed with your question.

Good morning, guys. Dan, you have been on the Board for over a year now. You have been in the CEO spot for a few months. Can you just give us a sense of the changes going on in upper level management and how we can be a little more confident on this story going forward, just considering the numerous missteps over the last couple of years?

Well, I mean, look I think there has been a significant change at the Board level initiated the last year with Bill Murdy and myself and Richard Sanders coming on the board. Both Richard and I have significant nitrogen experience, him from the operational side, me more from the financial and business side and then Bill Murdy came on with extensive experience in the HVAC business. And then this past year, there were five new members who came on the Board, all with the significant experience. Two of those from the nitrogen and fertilizer space and one other from the chemical space and then two other highly qualified Directors. I think when you see the quality of the new Directors that have been added over the last the year and change, you have got a significantly enhanced Board and a very, very active and thoughtful Board. In addition to that, we have changed quite a few of our governance practices. We have tighten those up. And you have, what I call, an energetic, highly involved and very helpful Board. I think you will continue to see that as Mark pointed out in our release today, Security Benefit is going to get three Board seats. So they will have high-quality folks on the Board as well. And so we are looking forward to them joining this Board. So from a Board perspective, I think you have got good things in place. From transitioning the CEO position and other senior executive positions, I think the Board took a look at where we thought the business needs to go, what we need to do to drive accountability, to drive performance improvements and to drive a sense of urgency. And I have been tasked with that along with Richard Sanders and Mark to drive all those activities and I think here in very short order, while the cost increases are very, very disappointing, I think we have put process in place that we probably should had in place earlier and it wasn't as robust as we would have expected. So we have tackled that. We are tackling reliability issues head on. We are tackling go-to-market activities. And we are looking at the financing. Mark has driven the financing process very, very well here and in tight, tight circumstances. And we have a very good partner in Security Benefit. We have built a good relationship with them in a short period. They are long-term focused. They believe in the opportunity for value creation, once the El Dorado plant is completed and they like the strengthened management team and the Board team that they saw. They like our value creation story and we are looking forward to them as a valuable partner. So I think summing it up, you have a very engaged Board, a highly energetic Board. You have, I call it, a quicker step, a faster step in the management team, higher expectations from the Board placed on the management team and that's something we intend to deliver. And I think in this very short period of time, we have delivered a heck of a lot to move this company forward and position it for growth and for increased shareholder value.

Okay. What is the risk of closing on the deal with Security Is that pretty much a done deal?

We have a full commitment lever. So it's just completion of docs, as Mark said, I believe, we expect the $50 million to be closed today and likely funded very early next week. And then on the preferred, we just have to get the definitive document. There is probably some HSR, hopefully get early termination of HSR and that should fund very shortly after that, but no later than December 31. So there are no contingencies out there other than HSR review that really could hold us up on it.

Joe, there were no due diligence else or anything like that. It's a firm commitment, just subject to final documentation.

Okay. And I know Dan asked several questions. I know you gave some prepared commentary. Just a little unclear regarding the last four months. How this thing sort of spun out of control? Several different increases in estimates of the total value of this project. I am not a construction guy. I am not an EPC analyst. Just trying to get a better idea of how hundreds of millions of dollars have gotten lost in the estimation? Who is at fault here? I know you had some problems with the subcontractor. Is it largely that? Is it more so prior management? Any color on this in addition, would be helpful, because obviously, it's very frustrating.

Sure. And I understand your frustration. Let me step back a minute and talk about, when we originally put this project cost estimates together, that was not an engineered estimate. And what I mean by that, is the engineering work really, you have a very, very high level engineering work. The detail engineering work wasn't there. It was not a plus or minus 10% estimate. Okay. It was not. I think we probably didn't do as good a job as we should have or could have on that and the cost should have been probably a plus or minus 50% estimate at that time with the level of engineering work that was done. Now let's take that piece and move to the next piece. We decided to bring the large bore piping. We decided to bring a large bore piping up from Donaldson. That was dismantled, as I said in my prepared remarks, in a manner that did not allow efficient reinstallation at the new facility. And so what has occurred is a significant amount of additional labor, materials, scaffolding cost, manpower candidly to reassemble that pipe. And that's something that we clearly did not anticipate in these cost estimates early on. We anticipated some of it in the August estimate, but the fact of that matter is, it's taken us significantly more time. I think early on the project there were a lot of weather delays. We talked about that earlier. And then clearly the contractor. Just that point on the engineering, of not having an engineered estimate. If you look at the components in our materials and we talked about the ammonia plant, the nitric acid plant and concentrator and then you will recall the OSBL or outside battery limits work and you look at that nitric acid plant construction, the concentrator, that was a fully engineered detailed project that was built, that was completed and pretty well on budget. And so we did have good success with that project that was engineered upfront at a detailed level. All that was taken care of and the installation and construction went very well. So I think it points to the fact that when you have high quality engineering, a thorough and complete engineering, it sure as heck reduces your construction risk profile and we have painfully learned that. So I think what we have done since the two earlier cost estimates, is in late August or mid to late August, we began as a Board to get uncomfortable with where we were on this project and as I said, we made some management changes and then immediately I initiated a full detailed cost reviews and cost studies to get our arms around this thing and we have and we have changed significant management, we have change responsibility of the construction, responsibility of reporting. We have a clear line of sight to it. We are down there frequently, every week and we participate in all those management activities for that plant, the construction, commissioning and startup. So in my view, we have done the things we need to do now. The news was unfortunate. We have our arms around it. And our focus is getting this plant completed and up and running. And that is, as I said on the call, number one, number two and number three focus is get that plant up and running. And Mark has been able to raise the funding to do that and it's more expensive than we had hoped, but we have it. We are going to get the plant running. And it is going to be a world-class plant and it's going to generate significant cash flow for the company. So yes, we have cost overrun. We are going to work ourselves through that and get that up and then once we do that, I think you will see significant value creation for shareholders.

Okay. Thank you for that. And then in terms of cash flow regarding once you get the plant up and running and dealing with the balance sheet and everything, how do you tackle off of that? Are you planning on paying back the preferred stock immediately? Is that the plan in terms of cash flow and winding down the leverage on everything? Would that be where you start? Or walk us through what the plan is on a cash flow basis over the next year or two on the balance sheet?

Yes. So I think I will answer that two ways. Any excess cash flow that we have, I think we have looked to try and delever. And so that would be the primary focus. But as Dan alluded to in his prepared comments about improving the capital structure over the next 12 to 18 months, the reality is when the plant is up and running and producing in the way we think it can produce, our first call date in our senior notes is August of next year. and we also have the ability to call the preferred at any point in time at par plus accrued and unpaid dividends. So I think it's very likely that we when we get to the end of next year, you would see us refinance all the debt assuming that the debt markets are acceptable and open to that.

Okay. That does it for me. Actually, one last question. The Coke agreement, is that a similar agreement that you have with the Pryor plant?

It's a different agreement. Obviously we are not going to talk about the pricing, but no, it's a totally different agreement in the way the product is priced.

So it's contracted by price then and not just volume?

Yes. There is a minimum volume in the contract and is a negotiated pricing formula that as Dan said, we are not going to get into the pricing, but it is for all excess ammonia that's produced at that plant.

Right. But just looking at the spot markets in ammonia, if we are looking at those spot prices next year, are we going to be able to think about where your pricing falls in?

Well, I mean I think I am going to give a general comment. Typically Tampa is often referenced in price contracts and that's at least a starting point. It maybe some pricing formula we have. I don't know. I just don't want to go into the detail of the pricing.

You said, get competitive pricing now relative to spot markets.

Yes. We will get market based pricing.

Okay. And then just lastly, the El Dorado plant for the fourth quarter. Should we expect those losses to decline in the fourth quarter relative to the third, just given seasonality of demand or I know prices have come down, but natural gas prices have come down also? So how do we think about the losses in the fourth quarter at El Dorado relative to the third quarter?

I would tell you that I would think that they would be the same.

Okay.

Keep in mind, we aren't producing ammonia there in the fourth quarter. So natural gas prices have no impact on --

Right. You are right. Okay. All right. Thanks.

Thank you. Our next question is coming from Gregg Hillman of First Wilshire Securities. Please proceed with your question.

Good morning, gentlemen. Mark, when you were picking a financing partner, did you use an investment banker and like bidded it off to look at multiple ones? Or how did you arrive at Security Benefit Corporation?

As you probably know, we have worked with CS on multiple occasions over the past two years and so we did work with CS and there was a process that was run and we did have a number of people that were interested and I think we ran an efficient process to try and figure out what were the best terms for us and ultimately we decided that these were the most appropriate terms that management and the Board were comfortable with and we were extremely comfortable, as Dan said, with Security Benefit as a partner.

Okay. Did they have the best, I was just wondering, could you have gone all debt? Why did you have to bring in that the equity piece? Was there somebody willing to go all debt with you?

If there were someone willing to do it, we would have done it.

Okay. So you feel this is the best deal you have that was on the table? There wasn't a better deal available to you at this time? You didn't just pick them because of relationship? Well, I guess, on what basis did you chose Security?

Look, they had a combination of three things. Number one, they came with a total financing package which in our mind and the Board's mind was an important component and then they put the two components together with us that we thought served as a good basis, either individually or in the aggregate they were very competitive and we did that. We went out and we looked at, as Mark said, Credit Suisse went our and helped us look at multiple different sources. So number one, the total package was the best total package and that was something that we were looking for and they quite frankly came late in the process. But it was a good package. So that was number one. Number two, they believe in the opportunity and the value creation for the company and that was attractive to them. So they showed a strong interest in wanting to participate. And number three, we look at them as long-term focus partners and during the process of their due intelligentsia, they visited every single location and had discussions with plant management and the like. So we just felt like that, that was the type of long-term financing partner that we wanted to have and their rates were the most competitive when you look at it on a total package basis.

Okay. And then just also Mark, in terms of just any other equity dilution that's out there? You mentioned the warrants from Security. But what other warrants or management options are there at this point that would result in further equity dilution?

Well, there is nothing other out there in the form of warrants other than what we have disclosed this morning.

Okay.

There are management options that are out there that have been issued and are outstanding and that's outlined in our public filings. And so there is nothing significant that has changed this quarter. So you will be able to see that.

Okay. That's fine. And just from the top of your head, what are management options right now? What's the average exercise price?

They are in the 30s.

Okay. And what's the number of them?

You can look at our public filings. They are out there available in the public filings on the most recent 10-Q. They are having [indiscernible].

Yes, I wouldn't know off the top of my head, the exact number.

Okay. That's fine. Thank you.

Thank you. At this time, I would like to turn the floor back over to management for any additional or closing comments.

Great. Thank you, Donna. Well, first of all, thanks for everyone for participating in this morning's conference call. I think we have outlined things and tried to provide as much clarity as we can. We are optimistic about completing the project. The construction schedule at El Dorado is progressing very, very well and we are pleased with the weekly progress they make. We measure it on a weekly basis at a detailed level on every area. We have a robust process around that. I think the financing that we have secured is going to put us in a good position to complete that construction. As Mark and I both indicated, we look to improve our capital structure cost as soon as we possibly can. And we will focus on that. And then again, the Board is also focused on creating the best shareholder value for the shareholders. And that's something that we will contribute to do and something we are actually looking forward to delivering. So once again, I appreciate your time and have a good day.