Greetings. Welcome to LSB Industries 4Q '18 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] Please note that this conference is being recorded. I will now turn the conference over to your host, Kristy Carver, Senior Vice President and Treasurer. You may begin.

Thank you, Brock. Good morning, everyone. Joining me today on the call are Mark Behrman, our Chief Executive Officer; John Diesch, our Executive Vice President of Manufacturing; and Cheryl Maguire, our Chief Financial Officer. 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 results, please reference the press release in the Investors section of our website, lsbindustries.com, for further information regarding forward-looking statements and reconciliations of non-GAAP results to GAAP results. At this time, I'd like to go ahead and turn the call over to Mark for opening remarks.

Thank you, Kristy, and good morning, everyone. We're glad that you could participate in our call this morning and appreciate your interest in LSB Industries. Today, we will discuss our 2018 fourth quarter results and provide you with our current outlook for full year 2019. I'll begin with an overview of the fourth quarter, and then John will discuss our plant operations, followed by Cheryl, who will review our financial performance and capitalization in more detail. Then I'll return to provide you with our outlook for our markets and share our current thoughts around 2019 full year expectations for our business. As always, we'll take your questions after we conclude our prepared comments. Page 3 of the presentation provides highlights for the fourth quarter of 2018. 2018 was a successful year for LSB in several areas. First, we significantly improved our environmental, health and safety performance from the prior year for the deep commitment from our team as we push toward being best-in-class in our operations. We view and improved safety performance as a precursor to improve the operating performance. A continued focus on safety and on operational improvements translated into improved ammonia on-stream rates for Q4 2018, as we averaged approximately 95% on-stream across our three facilities for the quarter. Many thanks to all our employees for their efforts. Second, our financial performance for the quarter and year improved significantly. Our revenues for the fourth quarter of 2018 were $94.7 million, a 31% increase from the same quarter last year, after adjusting for the adoption of ASC 606 accounting. Our fourth quarter adjusted EBITDA was $23.3 million, which compares to $1 million of adjusted EBITDA for the fourth quarter of last year. The substantial year-over-year increase can be attributed to a material improvement in pricing for all of the…

Thank you, Mark, and good morning. As Mark mentioned earlier, the full year of 2018 was a significant improvement, especially given that the first half of the year was less than our expectations. The second half of the year improved significantly, particularly the operating rates of our ammonia plants, as the reliability and operations improvements we have been working on begin to make a difference. Please turn to page 6 of your slide deck. Overall for Q4, I was very pleased with our operating performance. The El Dorado ammonia plant had 98% on-stream time for the fourth quarter and 88% on-stream time for the year. We have continued to run well for the first quarter at daily rates well over our nameplate capacity. We are planning for a turnaround in August of this year, which will include mainly inspections, heat exchanger cleaning and catalyst changes with the next turnaround planned for 2022. Our nitric acid plants continue to run very well. The operators needed to meet our merchant nitric acid and ammonium nitrate sales commitments. On the project front, we are completing final engineering to increase capacity and improve reliability of our high density ammonium nitrate production facilities. We are also starting detail engineering on a $7.5 million project to replace the converter reactor in our sulfuric acid plant, which will not only improve the reliability of our plant, but also increase production capacity by approximately 20,000 tons annually. This project is scheduled to be completed in the fourth quarter of this year. Our Pryor facility ammonia plant had 97% on-stream time for the fourth quarter and 89% for the year. That is the highest annual on-stream rate for this plant since the restart at 2010. The ammonia plant has been operating very well so far this first quarter of…

Thanks, John, and good morning, everyone. I'm pleased to be taking part in this call for the first time as LSB's CFO. As many of you know, I've been in the Company's finance area since the fourth quarter of 2015, with most of my time since then, in the role of Vice President of Finance. As a result, I've taken part in much of the significant progress we have made with respect to our operations and financial results. I'm now excited to be in a more external-facing role, and I'm looking forward to speaking with and meeting many of you in the quarters and years to come. So, turning to our fourth quarter and full year results. Page 9 of the presentation provides a consolidated summary statement of operations for the fourth quarter of 2018, as compared to the fourth quarter of 2017 along with a year-to-date comparison. As discussed during the last several calls, beginning in Q1 2018, we adopted the new FASB revenue recognition standards. We along with many public companies have chosen not to go back and restate our prior year financials for its impact. For us, the biggest change resulting from the implementation of the new revenue recognition standards, is that sales and cost of sales from our Baytown facility will no longer be grossed up on our income statement. This has no impact to our EBITDA. As you know, we manage the Baytown facility for Covestro, and as such, going forward, revenue and costs will be recognized more in line with how we view this arrangement. From our perspective, this is a good change as it represents the true economic earnings and margin of that business. Beginning in Q1 2019 results will be presented on a comparative basis. Turning to our results for the full…

Thank you, Cheryl. As I stated earlier in the call, we expect 2019 to be a growth year for LSB as a result of year-over-year pricing improvement, coupled with higher production and sales volumes, driven by operating rates generally consistent with the strong performance of our facilities delivered in the second half of 2018. Turning to Page 17, as Cheryl just discussed, product pricing was a tailwind for us for the second half of 2018. On the ag side, higher prices were driven by diminishing supply as domestic capacity that came online during 2017 was absorbed by the market in addition to reduced volumes of low priced product being sold into the U.S. by China and others. More recently, however, U.S. nitrogen prices have trended downward due primarily to the impact of a weak fall ammonia application season as many farmers simply didn't have the ability to apply ammonia due to a very wet and then cold last few months of 2018 across the U.S. As I mentioned earlier, the early part of 2019 hasn't been much better with the ground in our key geographic markets either frozen and snow covered or cold and extremely wet, both not conducive to applying ammonia for pre-plant or for the sales of HDAN, UAN, urea and other fertilizers. Not surprisingly, U.S. inventories of ammonia and other fertilizer products are now quite high, leading to selling price pressure in most of these products. Specifically, the Tampa Ammonia price dropped from $355 per metric ton in October to $285 per metric ton for January and has stayed there for February, while urea prices have trended down approximately $60 per ton during that same time. The good news is that we believe this is a short-term dynamic as ultimately the weather will likely improve, and at…

Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question today comes from Joe Mondillo of Sidoti & Company. Please go ahead.

So my first question just on the on-stream rates, looking at 2019 versus 2018, you mentioned that the fourth quarter was a $9 million contribution relative to the improved on-stream rates. Considering relative to the 94% rates that you're expecting across the three plants, is there any way you can quantify like you did in the fourth quarter, sort of what that contribution would be to improve profitability for 2019, if you hit that 94% relative to what you did in 2018?

Yes, I think, Joe, we don't give out guidance, and so, in particular, we're not going to really split out how much is price and how much is improvement from operating rates.

Okay. I assume there is -- maybe some upside to that 94%, especially maybe Cherokee, Cherokee has run almost consistently above 94%. Is that a possibility? And then also looking at EDC, EDC has run sort of below 90 the last couple of year, I believe. Any -- are you optimistic that you can get better productivity at EDC as well?

Yes. So, I mean the 94% is an average of all three facilities. So as we've talked about on previous calls, and I think John even talked about earlier in his comments, we would expect Cherokee and EDC to have higher operating rates than prior. I think we're still making, we're making a lot of progress at Pryor. I don't think we're there yet, and we wouldn't expect that Pryor would be on par with the other two facilities. As John did mentioned though, we have an extensive turnaround scheduled for later on this year, and we think getting through that turnaround and the work that we're doing will set us up for Pryor to run close to what our expectations would be for the other two facilities in 2020.

All right. And are you surprised that what you've, I guess, in the fourth quarter, and I guess, it seems like currently Pryor is running really good. Are you surprised at all of the production that you're getting out of that plant before finally replacing that urea reactor?

No, I think, a big focus of the Pryor, as John mentioned, really has been the ammonia plant. Everything starts with ammonia, right. If we don't make ammonia, we can't make downstream products, we can't sell products. So I think the team has done a great job over the last couple of years really focusing on the reliability of the ammonia plant, and we're pretty comfortable that we can run certainly at 90-plus-percent out of that plant for the full year. And we'll see as we improve throughout the year and certainly after the turnaround. So, no, I don't think we're surprised. I think that's the plan that was put in place. And as John mentioned, after our focus of the ammonia plant, we're still continuing to do work there. The focus then will turn more toward the nitric acid plants and in particular the urea plant. So we feel comfortable, as I said, that we're making progress up at Pryor. It's always slower than you expect, but a little by little.

And sticking with Pryor, I guess, natural gas prices, I believe, have been very favorable, particularly at Pryor due to, I guess, some supply issues and not being able to get that natural gas out of the Permian. Is that dynamic consistent to what you saw in 2018, and will that change at all in 2019?

Yes, it will change. I think for a good part of 2018, we saw significant basis differential, so basis advantage with gas up at Pryor. A lot of that had to do with no takeaway capacity. Those dynamics have changed slightly. There are some pipelines that are being built up out of the SCOOP and STACK area which is where they're pulling gas, but also LNG is becoming much more prevalent, right. I mean, everyone's talking about LNG and exporting LNG. So those producers up in the SCOOP/STACK region of Oklahoma are also able to move gas down the pipeline to the Gulf. So LNG will have some impact on their ability to get gas out as well. All of that really translates into a basis differential, that's probably narrowing a little bit. We still will enjoy a basis differential, a positive basis differential out of Pryor versus our other two facilities, but it probably narrowed a little bit.

Okay. And in terms of the turnarounds, I believe you called out, on this call, you called out $10 million of costs in the third quarter of '18, and I believe on the third quarter call last year, you called out about $5 million of cost absorption. So call it about $15 million headwind in the third quarter of '18. You called out for this third quarter in terms of the turnarounds $8 million of cost. Is there any way to at least compare if not quantify the cost absorption in third quarter, the effects there relative to that $5 million that you saw in the third quarter of '18?

Well, I would tell you that with prices up year-over-year, then the $5 million impact from cost absorption is going to be higher this year than it would be, than it was last year. So, that $15 million impact in the third quarter of last year will be higher this year.

Okay, great. And then I wanted to ask about SG&A. The SG&A, even if you exclude the severance costs, SG&A was up, and you called out the fact that it was because, largely because of legal costs. The guidance for SG&A suggests that these legal costs will go away, assumingly, I guess. Is that the right way to think about that? Do you expect any more legal costs related to this sub-contractor issue?

Yes. I mean, I think the incurrence of legal costs related to this issue has principally been incurred. It is possible that we will see some additional legal costs, but I don't think it will be as material as it was in 2018.

Okay. And regarding sort of the recovery here, I guess could you quantify how much costs you have expensed related to this issue, and what's the total cost that the whole, the legal costs and the issues related to the whole issue, what would that total cost be so we can get an idea of, you said you're hoping to get all of it back, but obviously maybe you won't, any idea about that?

Yes, I don't think we've really quantified what that cost is, so I'm certainly not going to, yes, probably not in a position to discuss it right now.

Okay. And then in terms of pricing, I guess, especially for the first quarter, I understand that volumes, maybe a little lower due to these delay of sales, but in terms of pricing, relative to spot, have you sold forward at all those attractive prices that we saw in the back half of '18 or how can we think about forward versus spot realization in the first half for the first quarter?

Yes, I think it's as both Cheryl and I pointed out on UAN, we're principally sold out for the first quarter, and we have taken some orders in the second quarter. So we have some forward sales. I think, we feel really comfortable with the price. I mean, I think, Cheryl talked about first quarter pricing for UAN at about $200 a ton or higher. So, we like the pricing. For ammonia, we've got a forward order book as well, that's certainly takes us out for the rest of this quarter and into some in the fourth quarter as well. We've got some ability to take some additional spot orders into this, in this third quarter for when the market opens. And we think that the pricing is pretty attractive. We're seeing relative to NOLA pricing or to Tampa pricing, we're seeing inland premiums for ammonia sold as fertilizer. So, you know, we're happy with the pricing. On HDAN, I think we've got a pretty healthy and solid forward order book there. And so, we're just waiting for the weather to allow the movement of product, and so that should take us certainly through this quarter and into the second quarter.

Okay. So, fourth quarter, it looks like you saw a discount in NOLA prices, especially on UAN, you think that will essentially reverse and you should see sort of a premium in the first quarter?

Yes, I don't, I can't tell you what -- I don't remember what the NOLA UAN price was in the fourth quarter. I can just tell you that where our pricing is and we're seeing that north of -- for UAN north of $200 a ton today.

Okay. And the ammonia prices in terms of NOLA, you expect that also to be sort of favorable in terms of NOLA prices?

Yes.

Okay. You also mentioned the procurement and logistics that you talked a lot about at the Investor Day last year. I believe you were thinking potential savings of $5 million or maybe more. Is that baked into your SG&A guidance? Is there upside to those savings throughout this year? Could you just talk about what's going on there? And I know there's a lot of different dynamics just given free and potentially barge prices. Could you just sort of address how you're thinking about the benefits from what you're doing there?

Yes, sure. So, I think we spoke in our Investor Day and I think we even spoke in some conference calls of about $3 million to $5 million of annual cash savings, primarily from procurement as opposed to logistics, and there will be some on the logistics side. Like we realized between $2.5 million to $3 million of annual savings and we put it in place starting for 2019, most of that's going to not be in SG&A, it's going to be in cost of sales. So, it's really plant expenses which rose up the cost of sales. So, I think there is still some more upside. I think, we can probably capture another $2 million, as I said, $3 million to $5 million over the next 12 months to 18 months. First you attack the low hanging fruit, and then you go after some other opportunities. So, I think we'll still be able to realize some of that.

Okay. And last question from me, just regarding -- there's a lot of, I guess, puts and takes with the working capital. It sounded like you're going to see some recovery in some of the receivables about $10 million in the first half of the year. How can we think about working capital needs or uses for 2019?

Hey, Joe. This is Cheryl. As you know, we typically build inventory going into the spring season and we sell that inventory down in the first half of the year. So, working capital is generally at its lowest in the summer months. Once the cooler temperatures come around in the fall, we'll start building up inventory again in the October to December time frame to get ready for spring season. The only other thing I'd mention is, we've talked about this recently that were thinking differently about our summer sale and our fall sale requirements, and that could mean restore more inventory in the low season. So, we can sell it at higher prices in season.

But, you're probably talking about anywhere from $5 million to now more than $10 million of additional working capital for that temporary period of time.

But looking across the year, is it sort of too early to sort of tell how that would fall into place in terms of what the year looks like, or do you think you're positioned to maybe generate cash for working capital, or does it depend on how the market to translate and how much inventory you are building in the back half of the year that kind of thing?

Well, I mean, I think, we definitely expect to generate cash. It's way too early to determine how much cash we generate. Just, a lot of it will depend…

On a working cap basis, I'm referring to.

Yes, I think, it's too early to tell. A lot will depend on the pricing and the, you know, the summer field program and what our strategy is as far as positioning product.

Okay. Okay. Appreciate it. Thanks for taking my questions.

Thank you.

The next question is from Karl Blunden of Goldman Sachs. Please, go ahead.

Hi. Good morning, guys. Thanks for the time. Regarding a little bit there at the end, regarding cash flow and capital allocation over time, you mentioned some, you'd explore opportunities to gain scale, interested in your thoughts on what those could be, what kind of size you're contemplating. Obviously, it's a bit of a longer-term question, but just wanted to understand what you're focused on?

Sure. I think, we said on the last couple of calls that we believe that there should be further consolidation within the fertilizer space. This industry in North America is really dominated by three of our main competitors, and then there are a number of other smaller competitors, including ourselves. I think scale is important in this industry for lots of various reasons, just sheer financial strength is one, the ability to move product, diversity of products, logistics and procurement opportunities. So, you know, we will look to see if we can be part of or lead that consolidation. But, I don't want to discount us doing anything on the industrial side of our business. We have a small sulfuric acid plant out of El Dorado. We know that business well. We've been in the business for a long period of time. So, if there are opportunities to combine or merge or acquire with other sulfuric plants or assets or companies, we'd certainly be open to doing that. The same on the nitric acid side, we are the largest merchant marketer of nitric acid in North America. We know that business. We're known in the industry to be the leader in that business. So, we'd love to have the ability to acquire or merge with some other assets there as well. So, I think we'll be open minded as we look around and see what opportunities might make sense. I mean at the end of the day, they've got to really make sense and they've got to be accretive to shareholder value or scale is not worth doing just for the sake of scale.

I mean that all makes sense. It sounds like, some of the things you mentioned there would require some cash, some potentially not, in the sense of a merger. When you're thinking about use of cash and your priorities there, how does that growth or tuck-in acquisitions, how would that, how would you prioritize that relative to the reduction or reduction of the preferred outstanding?

Well, I mean, I think, you have to look at returns. That's probably the most important thing. Clearly, we've got a preferred stock that's outstanding that is relatively expensive. And I don't think we've been shy historically about talking about our desire to try and redeem that and reduce that or ultimately replace it. So, I don't think that's changed. But, as opportunities come up, I think you have to at least explore them and see if they really makes sense. And so we'll do that, and if there is an opportunity that comes up that we think is, ultimately is an increase of shareholder value, then we'll have to weigh the different options in the use of capital.

Okay. Thanks very much.

The next question is from JP Geygan of Global Value. Please, go ahead.

Hey, good morning and congratulations on a good quarter. Your plant operations have improved and you talked about a number of factors that led to that, including leadership changes, capital investments and maintenance procedures. Page 7 of your deck provides a nice overview on your progress on a multi-year plan, but I was hoping you might provide a little color around this checklist of seven items assess where you are in this process, what sort of incremental improvement we might expect? And as you begin to focus on downstream production versus the ammonia production, how that might affect your financial results, particularly margin?

Well, I mean, again, as we've probably talked about a number of different times, everything starts with ammonia, right. So, the one good thing about nitrogen facilities is all along the manufacturing chain you have ability to make and sell each product individually. So, the only reason really to upgrade to a downstream product is because you're going to have a greater margin, otherwise we would just sell straight ammonia. So, I think, when we look at this and we look at it all the time, we call it product balance. We really look at our ability in some cases on the industrial side and the mining side, specifically, we've got contracts, and those are longer-term contracts and we have got commitments with those contracts. So, we certainly can't switch product around, where we won't deliver on those contracts. But, where we don't, where we have the ability to move product around, we continually look at that and see where our best margins are. So, I don't think anything really changes by having better or more reliable operations. I mean, it gives us more product for sale or potential product for sale, but the same thought process that we have today, we will continue going forward.

Recognizing that this is an ongoing process that at a certain level will never end, how far along are you in terms of between where you've come from and where you'd like to be?

Yes. So, I get the question all the time. I guess, the way I would categorize it, I use baseball terminology. We're in the top of the seventh inning. So, we've made a lot of progress, but I don't think we're there yet clearly. And so, we've got a bit more work to do. We've talked about, you know, over the last year and a half, really revamping our maintenance management system and work order process system, and some of the other operational initiatives that we had, but we are embarking on kind of a next level of initiatives that John alluded to, and so that's an ongoing process, when you're talking about training and you're talking about changing operational behavior, that goes on and on and on, as you said, it's continuous. And so that program itself, the specific program is probably a 2 year, 2.5 year program that we're investing, and it's really an investment in people, more than it is in equipment. Certainly we need to invest the appropriate amount of capital, but we feel that the investment in our people is just as important, and so we'll continue to do that. So top of the seventh inning, we hope that we make significant progress and believe that we can make significant progress throughout this year, and that's why I alluded to the fact that I think particularly at Pryor, we'll have a lot of improvement and we expect a lot of improvement this year, so that we can run that facility in that ammonia plant at higher operating rates and certainly the ammonia plant, more toward the mid-90s operating rate.

Okay. Natural gas prices spiked late in the year, which you talked about, can you shed some light on how you'd prepare hedge or pass these costs through?

Yes. So historically, we're at certainly the last two years, I'll talk about the last couple of years. We were buying natural gas to match forward sales. So that's a pure hedge, where we can lock in our margin. We have not typically going forward just gas purchases without having a sale. Clearly, we and others will probably shake in a little bit in the spike that we saw, the significant spike that we saw in the fourth quarter. So as we sit here today, strategy really hasn't changed that much, but we did lock in about 75% of our gas for February and for March in addition to the forward sales that we had at prices that I think Cheryl alluded to, around $3. Actually thinking about it, we really locked in at EDC and at Cherokee, we did not lock in at Pryor.

Okay. And my final question is on the Baytown and Covestro relationship, you briefly touched on an expansion that was going on what you plan to undertake there, can you give us a sense of the scale of that expansion?

No, I really can't. I feel uncomfortable talking about sort of the relationship down in Baytown with Covestro. They have announced publicly that they're going to do a pretty substantial expansion of their own facility down in Baytown, that's public knowledge. So clearly if they do expansion, which is on the MDI side, they're going to need more nitric acid. So we are in conversations with them, as you would expect, and the different options that they have and how we might fulfill the needs of additional nitric acid.

Great. Thank you for your time.

The next question is from Brian DiRubbio of William Blair. Please go ahead.

Great, thank you for the time. Just a couple of housekeeping questions. I know we're running late, so I'll try to keep this quick. You mentioned during the script in the release, there were -- you delivered project -- product to several customers with extended short-term payment terms, which means optimizing inventory storage capacity. Can you quantify how much that was?

How many tons?

No, dollar amount.

I would probably say, it was in the neighborhood of $5 million.

Okay. And that was sales that would normally be in the first quarter that you just sort of put forward a little bit?

No. Actually it was sales that were in the fourth quarter, but we extended the payment terms a little bit to work with our customers.

Got it. And with inventory at current levels, and obviously given the slow start to the planting season, do you have to lower operating rates to sort of manage inventory at your storage levels?

Well, we really haven't had to do much of that at all so far. We're lucky in that. We've got pretty decent ammonia storage at all three facilities. Unfortunately, what we have had to do, and that was a decision, you always have that decision, right. You can turn down operating rates, if you fill up and you can sell the product, where you can move product between facilities, and so we were able to, we've got very large storage capabilities down at El Dorado, and so we were able to move products, particularly out of Pryor, down to El Dorado into their storage facilities. The bad part is you incur freight when you do that. So there were some costs related to that.

Okay. And as we think about just the weather right now, is there, how should we think, the weather forecast for next 40 days still indicate very cold weather, is there sort of a period in time where plantings just don't get done or is it all just put into the second quarter?

Well, generally speaking, farmers insurance doesn't kick in until April 1st anyhow. So they've got until April 1st to plant. Our expectation or our hope anyhow, would be that the weather breaks before then. But I can't predict, I mean, none of us can predict the weather, so I think it's just more of a waiting out period.

Understood. And just final question, the vendor settlements you had that was $4.4 million, that was considered a reduction in COGS if I saw the notes correctly?

Yes, that's correct. When we originally incurred those costs, they were in cost of goods sold. And so the recovery goes against the cost of goods sold.

Okay. So, sort of on a go-forward basis, if we sort of try to level set this fourth quarter to next fourth quarter, we're really thinking about no more than $18.5 million, $19 million EBITDA number sort of a true comp number, as we think about fourth quarter of '19?

Well, I guess on the pure numbers, I would agree with that. I mean, I would hope that we didn't, we truncated fall ammonia application season, which we hadn't seen in a while. We don't have again. So I guess it depends on how you look at that internally. We took about a $5 million hit in the fourth quarter for having a very shortened ammonia application season. So the $4.4 million principally offset that. So we would hope not to see that again.

Okay. And just one final question, you mentioned, you still have high cost of inventory in the system. As a percentage of your inventory, is that pretty much all the $29 million of inventories that all high cost, should we all consider that high cost?

No, the way that I would look at it is, we generally run about 2.4 million of MMBtus of gas a month, and gas in the fourth quarter, actually in December, if you think about it on a 30-day turn, gas is about a buck higher, a dollar higher, so $1 on $2.4 million is probably your impact that you should see in the first quarter.

Very good. Thank you so much.

There are no further questions. I will now turn the conference back over to Mark Behrman for closing remarks.

Well, we appreciate everyone's interest in LSB Industries, and hope to deliver continued good results and improving results in the quarters to come. Thank you so much.

This concludes today's conference. You may now disconnect your lines at this time. Thank you for your participation.