UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

Form 10-Q

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission file number 1-7677

LSB Industries, Inc.

Exact name of Registrant as specified in its charter

Delaware		73-1015226
State or other jurisdiction of		I.R.S. Employer Identification No.
incorporation or organization
16 South Pennsylvania Avenue, Oklahoma City, Oklahoma		73107
Address of principal executive offices		Zip Code

(405) 235-4546

None

changed since last report.

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

Indicate by check mark whether the Registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the Registrant was required to submit and post such files). þ Yes o No

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
				(Do not check if a smaller reporting company)

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Act). o Yes þ No

The number of shares outstanding of the Registrant’s voting common stock, as of October 31, 2011 was 22,289,813 shares, excluding 4,320,462 shares held as treasury stock.

 

 

FORM 10-Q OF LSB INDUSTRIES, INC.

TABLE OF CONTENTS

		Page
PART I — Financial Information
Item 1. Financial Statements			3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			30
Item 3. Quantitative and Qualitative Disclosures About Market Risk			48
Item 4. Controls and Procedures			49
Special Note Regarding Forward-Looking Statements			50
PART II — Other Information
Item 1. Legal Proceedings			51
Item 1A. Risk Factors			52
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			52
Item 3. Defaults Upon Senior Securities			52
Item 4. (Reserved)			52
Item 5. Other Information			52
Item 6. Exhibits			53
Exhibit 10.1
Exhibit 10.2
Exhibit 10.3
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2
EX-101 INSTANCE DOCUMENT
EX-101 SCHEMA DOCUMENT
EX-101 CALCULATION LINKBASE DOCUMENT
EX-101 LABELS LINKBASE DOCUMENT
EX-101 PRESENTATION LINKBASE DOCUMENT
EX-101 DEFINITION LINKBASE DOCUMENT

PART I
FINANCIAL INFORMATION

Item 1.		Financial Statements

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Information at September 30, 2011 is unaudited)

		September 30,				December 31,
		2011				2010
		(In Thousands)
Assets
Current assets:
Cash and cash equivalents		$	107,983			$	66,946
Restricted cash			512				31
Short-term investments			—				10,003
Accounts receivable, net			85,866				74,259
Inventories:
Finished goods			38,553				32,072
Work in process			4,367				2,981
Raw materials			31,277				25,053
Total inventories			74,197				60,106
Supplies, prepaid items and other:
Prepaid income taxes			3,467				—
Prepaid insurance			745				4,449
Precious metals			17,595				12,048
Supplies			7,866				6,802
Fair value of derivatives and other			7				1,454
Other			1,915				1,174
Total supplies, prepaid items and other			31,595				25,927
Deferred income taxes			6,064				5,396
Total current assets			306,217				242,668
Property, plant and equipment, net			154,621				135,755
Other assets:
Debt issuance costs, net			1,151				1,023
Investment in affiliate			3,168				4,016
Goodwill			1,724				1,724
Other, net			3,479				2,795
Total other assets			9,522				9,558
		$	470,360			$	387,981

(Continued on following page)

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS (continued)
(Information at September 30, 2011 is unaudited)

		September 30,				December 31,
		2011				2010
		(In Thousands)
Liabilities and Stockholders’ Equity
Current liabilities:
Accounts payable		$	57,512			$	51,025
Short-term financing			386				3,821
Accrued and other liabilities			32,977				31,507
Current portion of long-term debt			6,059				2,328
Total current liabilities			96,934				88,681
Long-term debt			77,245				93,064
Noncurrent accrued and other liabilities			14,882				12,605
Deferred income taxes			17,145				14,261
Commitments and contingencies (Note 10)
Stockholders’ equity:
Series B 12% cumulative, convertible preferred stock, $100 par value; 20,000 shares issued and outstanding			2,000				2,000
Series D 6% cumulative, convertible Class C preferred stock, no par value; 1,000,000 shares issued and outstanding			1,000				1,000
Common stock, $.10 par value; 75,000,000 shares authorized, 26,584,650 shares issued (25,476,534 at December 31, 2010)			2,658				2,548
Capital in excess of par value			160,970				131,845
Retained earnings			125,900				70,351
			292,528				207,744
Less treasury stock at cost:
Common stock, 4,320,462 shares			28,374				28,374
Total stockholders’ equity			264,154				179,370
		$	470,360			$	387,981

See accompanying notes.

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
Nine and Three Months Ended September 30, 2011 and 2010

		Nine Months								Three Months
		2011				2010				2011				2010
		(In Thousands, Except Per Share Amounts)
Net sales		$	589,892			$	437,750			$	176,780			$	138,948
Cost of sales			429,695				344,897				142,523				109,509
Gross profit			160,197				92,853				34,257				29,439
Selling, general and administrative expense			64,737				70,775				21,635				23,948
Provision for (recoveries of) losses on accounts receivable			160				(14	)			39				21
Other expense			2,532				575				149				273
Other income			(2,035	)			(4,179	)			(58	)			(3,273	)
Operating income			94,803				25,696				12,492				8,470
Interest expense			5,481				5,943				1,901				1,864
Losses on extinguishment of debt			136				52				—				—
Non-operating other expense (income), net			(3	)			(48	)			2				(10	)
Income from continuing operations before provisions for income taxes and equity in earnings of affiliate			89,189				19,749				10,589				6,616
Provisions for income taxes			33,582				8,821				4,433				2,930
Equity in earnings of affiliate			(375	)			(719	)			(168	)			(191	)
Income from continuing operations			55,982				11,647				6,324				3,877
Net loss from discontinued operations			128				122				18				79
Net income			55,854				11,525				6,306				3,798
Dividends on preferred stocks			305				305				—				—
Net income applicable to common stock		$	55,549			$	11,220			$	6,306			$	3,798
Weighted-average common shares:
Basic			21,851				21,182				22,241				21,094
Diluted			23,499				22,281				23,526				22,193
Income (loss) per common share:
Basic:
Income from continuing operations		$	2.55			$	.54			$	.28			$	.18
Net loss from discontinued operations			(.01	)			(.01	)			—				—
Net income		$	2.54			$	.53			$	.28			$	.18
Diluted:
Income from continuing operations		$	2.40			$	.53			$	.27			$	.17
Net loss from discontinued operations			(.01	)			(.01	)			—				—
Net income		$	2.39			$	.52			$	.27			$	.17

See accompanying notes.

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)

Nine Months Ended September 30, 2011

						Non-
		Common				Redeemable				Common				Capital in								Treasury
		Stock				Preferred				Stock Par				Excess of Par				Retained				Stock-
		Shares				Stock				Value				Value				Earnings				Common				Total
		(In Thousands)
Balance at December 31, 2010			25,477			$	3,000			$	2,548			$	131,845			$	70,351			$	(28,374	)		$	179,370
Net income																			55,854								55,854
Dividends paid on preferred stocks																			(305	)							(305	)
Stock-based compensation															761												761
Conversion of convertible debt to common stock			965								96				26,304												26,400
Exercise of stock options			143								14				960												974
Excess income tax benefit associated with stock-based compensation															1,100												1,100
Balance at September 30, 2011			26,585			$	3,000			$	2,658			$	160,970			$	125,900			$	(28,374	)		$	264,154

See accompanying notes.

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
Nine Months Ended September 30, 2011 and 2010

		2011				2010
		(In Thousands)
Cash flows from continuing operating activities:
Net income		$	55,854			$	11,525
Adjustments to reconcile net income to net cash provided by continuing operating activities:
Net loss from discontinued operations			128				122
Deferred income taxes			2,216				2,325
Losses on extinguishment of debt			136				52
Expense associated with modification of secured term loan			387				—
Expense associated with induced conversion of 5.5% convertible debentures			558				—
Net gain on carbon credits			(92	)			—
Losses on sales and disposals of property and equipment			996				508
Gain on property insurance recoveries associated with property, plant and equipment			—				(3,964	)
Depreciation of property, plant and equipment			13,861				12,880
Amortization			354				466
Stock-based compensation			761				752
Provision for (recovery of) losses on accounts receivable			160				(14	)
Provision for (realization of) losses on inventory			1,351				(86	)
Realization of losses on firm sales commitments			—				(337	)
Equity in earnings of affiliate			(375	)			(719	)
Distributions received from affiliate			1,223				425
Changes in fair value of commodities contracts			482				(141	)
Changes in fair value of interest rate contracts			635				344
Other			—				(10	)
Cash provided (used) by changes in assets and liabilities (net of effects of discontinued operations):
Accounts receivable			(11,777	)			(14,373	)
Inventories			(15,392	)			(1,967	)
Other supplies, prepaid items and other			(2,838	)			1,449
Accounts payable			3,744				6,635
Accrued payroll and benefits			(2,020	)			1,794
Accrued and prepaid income taxes			(7,538	)			319
Customer deposits			5,395				2,306
Other current and noncurrent liabilities			4,322				2,394
Net cash provided by continuing operating activities			52,531				22,685
Cash flows from continuing investing activities:
Capital expenditures			(31,145	)			(26,129	)
Proceeds from property insurance recoveries associated with property, plant and equipment			—				5,293
Proceeds from sales of property and equipment			190				44
Proceeds from short-term investments			10,012				20,053
Purchases of short-term investments			(9	)			(20,006	)
Deposits of restricted cash			(481	)			(167	)
Proceeds from sales of carbon credits			1,665				—
Payments on contractual obligations — carbon credits			(1,573	)			—
Other assets			(635	)			(427	)
Net cash used by continuing investing activities			(21,976	)			(21,339	)

(Continued on following page)

LSB INDUSTRIES, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
(Unaudited)
Nine Months Ended September 30, 2011 and 2010

		2011				2010
		(In Thousands)
Cash flows from continuing financing activities:
Proceeds from revolving debt facility		$	498,858			$	394,221
Payments on revolving debt facility			(498,858	)			(394,221	)
Proceeds from modification of secured term loan, net of fees			10,347				—
Proceeds from secured term loan, net of fees			14,766				—
Proceeds from other long-term debt, net of fees			—				47
Payments associated with induced conversion of 5.5% convertible debentures			(558	)			—
Acquisition of 5.5% convertible debentures			—				(2,494	)
Payments on other long-term debt			(12,001	)			(3,370	)
Payments on loans secured by cash value of life insurance policies			(84	)			(380	)
Payments of debt issuance costs			(112	)			—
Payments on short-term financing			(3,435	)			(3,017	)
Proceeds from exercise of stock options			974				347
Purchase of treasury stock			—				(2,421	)
Excess income tax benefit associated with stock-based compensation			1,100				212
Dividends paid on preferred stocks			(305	)			(305	)
Net cash provided (used) by continuing financing activities			10,692				(11,381	)
Cash flows of discontinued operations:
Operating cash flows			(210	)			(267	)
Net increase (decrease) in cash and cash equivalents			41,037				(10,302	)
Cash and cash equivalents at beginning of period			66,946				61,739
Cash and cash equivalents at end of period		$	107,983			$	51,437
Supplemental cash flow information:
Cash payments for income taxes, net of refunds		$	37,757			$	5,993
Noncash investing and financing activities:
Receivable associated with a property insurance claim		$	—			$	171
Accounts payable and long-term debt associated with property, plant and equipment		$	4,332			$	7,272
Debt issuance costs incurred associated with secured term loan		$	839			$	—
Debt issuance costs written off associated with 5.5% debentures		$	350			$	58
Accrued liabilities extinguished associated with 5.5% debentures		$	342			$	—
5.5% debentures converted to common stock		$	26,400			$	—

See accompanying notes.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Summary of Significant Accounting Policies

For a complete discussion of our significant accounting policies, refer to the notes to our audited consolidated financial statements included in our Form 10-K for the year ended December 31, 2010 (“2010 Form 10-K”), filed with the Securities and Exchange Commission (“SEC”) on March 3, 2011.

Basis of Consolidation and Presentation — LSB Industries, Inc. (“LSB”) and its subsidiaries (the “Company”, “We”, “Us”, or “Our”) are consolidated in the accompanying condensed consolidated financial statements. We are involved in manufacturing, marketing and engineering operations. We are primarily engaged in the manufacture and sale of geothermal and water source heat pumps and air handling products (the “Climate Control Business”) and the manufacture and sale of chemical products (the “Chemical Business”). LSB is a holding company with no significant operations or assets other than cash, cash equivalents, and investments in its subsidiaries. Entities that are 20% to 50% owned and for which we have significant influence are accounted for on the equity method. All material intercompany accounts and transactions have been eliminated.

In the opinion of management, the unaudited condensed consolidated financial statements of the Company as of September 30, 2011 and for the nine and three-month periods ended September 30, 2011 and 2010 include all adjustments and accruals, consisting of normal, recurring accrual adjustments which are necessary for a fair presentation of the results for the interim periods. These interim results are not necessarily indicative of results for a full year due, in part, to the seasonality of our sales of agricultural products and the timing of performing our major plant maintenance activities. Our selling seasons for agricultural products are primarily during the spring and fall planting seasons, which typically extend from March through June and from September through November.

Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles (“GAAP”) have been condensed or omitted in this Form 10-Q pursuant to the rules and regulations of the SEC. These condensed consolidated financial statements should be read in connection with our audited consolidated financial statements and notes thereto included in our 2010 Form 10-K.

Use of Estimates — The preparation of condensed consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Income per Common Share — Net income applicable to common stock is computed by adjusting net income by the amount of preferred stock dividends and dividend requirements, if applicable. Basic income per common share is based upon net income applicable to common stock and the weighted-average number of common shares outstanding during each year. Diluted income per share is based on net income applicable to common stock plus preferred stock dividends and dividend requirements on preferred stock assumed to be converted, if dilutive, and interest expense including amortization of debt issuance cost, net of income taxes, on convertible debt assumed to be converted, if dilutive, and the weighted-average number of common shares and dilutive common equivalent shares outstanding, and the assumed conversion of dilutive convertible securities outstanding.

Short-Term Investments — Investments, which consisted of certificates of deposit with an original maturity of 13 weeks, are considered short-term investments. These investments are carried at cost which approximates fair value. All of these investments were held by financial institutions within the United States (“U.S.”) and none of these investments were in excess of the federally insured limits.

Accounts Receivable — Our accounts receivable are stated at net realizable value. This value includes an appropriate allowance for estimated uncollectible accounts to reflect any loss anticipated on accounts receivable balances. Our estimate is based on historical experience and periodic assessment of outstanding accounts receivable, particularly those accounts which are past due (based upon the terms of the sale). Our periodic assessment of our accounts receivable is based on our best estimate of amounts that are not recoverable.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 1: Summary of Significant Accounting Policies (continued)

Inventories — Inventories are stated at the lower of cost (determined using the first-in, first-out (“FIFO”) basis) or market (net realizable value). Finished goods and work-in-process inventories include material, labor, and manufacturing overhead costs. Additionally, we review inventories and record inventory reserves for slow-moving inventory items.

Precious Metals — Precious metals are used as a catalyst in the Chemical Business manufacturing process. Precious metals are carried at cost, with cost being determined using the FIFO basis. Because some of the catalyst consumed in the production process cannot be readily recovered and the amount and timing of recoveries are not predictable, we follow the practice of expensing precious metals as they are consumed. Occasionally, during major maintenance or capital projects, we may be able to perform procedures to recover precious metals (previously expensed) which have accumulated over time within the manufacturing equipment. Recoveries of precious metals are recognized at historical FIFO costs. When we accumulate precious metals in excess of our production requirements, we may sell a portion of the excess metals.

Product Warranty — Our Climate Control Business sells equipment that has an expected life, under normal circumstances and use, which extends over several years. As such, we provide warranties after equipment shipment/start up covering defects in materials and workmanship.

Our accounting policy and methodology for warranty arrangements is to measure and recognize the expense and liability for such warranty obligations at the time of sale using a percentage of sales and cost per unit of equipment, based upon our historical and estimated future warranty costs. We also recognize the additional warranty expense and liability to cover atypical costs associated with a specific product, or component thereof, or project installation, when such costs are probable and reasonably estimable. It is reasonably possible that our estimated accrued warranty costs could change in the near term.

Contingencies — Certain conditions may exist which may result in a loss, but which will only be resolved when future events occur. We and our legal counsel assess such contingent liabilities, and such assessment inherently involves an exercise of judgment. If the assessment of a contingency indicates that it is probable that a loss has been incurred, we would accrue for such contingent losses when such losses can be reasonably estimated. If the assessment indicates that a potentially material loss contingency is not probable but reasonably possible, or is probable but cannot be estimated, the nature of the contingent liability, together with an estimate of the range of possible loss if determinable and material, would be disclosed. Estimates of potential legal fees and other directly related costs associated with contingencies are not accrued but rather are expensed as incurred. Loss contingency liabilities are included in current and noncurrent accrued and other liabilities and are based on current estimates that may be revised in the near term. In addition, we recognize contingent gains when such gains are realized or realizable and earned.

Derivatives, Hedges, Financial Instruments and Carbon Credits — Derivatives are recognized in the balance sheet and are measured at fair value. Changes in fair value of derivatives are recorded in results of operations unless the normal purchase or sale exceptions apply or hedge accounting is elected.

Climate reserve tonnes (“carbon credits”) are recognized in the balance sheet and are measured at fair value. Changes in fair value of carbon credits are recorded in results of operations. Contractual obligations associated with carbon credits are recognized in the balance sheet and are measured at fair value unless we enter into a firm sales commitment to sell the associated carbon credits. When we enter into a firm sales commitment, the sales price, pursuant to the terms of the firm sales commitment, establishes the amount of the associated contractual obligation. Changes in fair value of contractual obligations associated with carbon credits are recorded in results of operations.

Income Taxes — We do not recognize a tax benefit unless we conclude that it is more-likely-than-not that the benefit will be sustained on audit by the taxing authority based solely on the technical merits of the associated tax position. If the recognition threshold is met, we recognize a tax benefit measured at the largest amount of the tax benefit that, in our judgment, is greater than 50% likely to be realized. We also record interest related to unrecognized tax positions in interest expense and penalties in operating other expense.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 1: Summary of Significant Accounting Policies (continued)

Income tax benefits associated with amounts that are deductible for income tax purposes but that do not affect earnings are credited to equity. These benefits are principally generated from exercises of non-qualified stock options.

Recognition of Insurance Recoveries — If an insurance claim relates to a recovery of our losses, we recognize the recovery when it is probable and reasonably estimable. If our insurance claim relates to a contingent gain, we recognize the recovery when it is realized or realizable and earned. Amounts recoverable from our insurance carriers, if any, are included in accounts receivable.

Recently Issued Accounting Pronouncements — In January 2010, the Financial Accounting Standards Board (“FASB”) issued an accounting standards update (“ASU”) requiring additional disclosures about an entity’s derivative and hedging activities for the purpose of improving the transparency of financial reporting. A portion of the new disclosure requirements became effective for us on January 1, 2010 and the remaining new disclosure requirements became effective for us on January 1, 2011. These disclosure requirements were applied prospectively. See Note 11 — Derivatives, Hedges, Financial Instruments and Carbon Credits.

In May 2011, the FASB issued an ASU clarifying how to measure and disclose fair value. The requirements under this ASU become effective for us on January 1, 2012 and are to be applied prospectively. We currently do not expect a significant impact from adopting this ASU.

In June 2011, the FASB issued an ASU amending current comprehensive income guidance. This ASU eliminates the option to present the components of other comprehensive income as part of the statement of stockholders’ equity. Instead, we must report comprehensive income in either a single continuous statement of comprehensive income which contains two sections, net income and other comprehensive income, or in two separate but consecutive statements. The requirements under this ASU become effective for us on January 1, 2012 and are to be applied retrospectively; however, the FASB is considering issuing an exposure draft to propose a deferral of certain requirements under this ASU. We currently expect the impact from adopting this ASU to change the format of our presentation.

In September 2011, the FASB issued an ASU amending current guidance for testing goodwill for impairment. This ASU added an option to first assess qualitative factors to determine if the current two-step impairment test is required. The assessment of qualitative factors is performed to determine whether the existence of events or circumstances leads to the determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Pursuant to the provisions of this ASU, we early adopted this ASU effective July 1, 2011, which provisions were applied prospectively. Our financial statements were not impacted from the adoption of this ASU.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 2: Income Per Common Share

The following table sets forth the computation of basic and diluted net income per common share:

(Dollars In Thousands, Except Per Share Amounts)

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Numerator:
Net income		$	55,854			$	11,525			$	6,306			$	3,798
Dividends on Series B Preferred			(240	)			(240	)			—				—
Dividends on Series D Preferred			(60	)			(60	)			—				—
Dividends on Noncumulative Preferred			(5	)			(5	)			—				—
Total dividends on preferred stocks			(305	)			(305	)			—				—
Numerator for basic net income per common share — net income applicable to common stock			55,549				11,220				6,306				3,798
Dividends on preferred stocks assumed to be converted, if dilutive			305				305				—				—
Interest expense including amortization of debt issuance costs, net of income taxes, on convertible debt assumed to be converted, if dilutive			298				—				8				—
Numerator for diluted net income per common share		$	56,152			$	11,525			$	6,314			$	3,798
Denominator:
Denominator for basic net income per common share — weighted-average shares			21,851,184				21,182,180				22,240,536				21,093,732
Effect of dilutive securities:
Convertible preferred stocks			935,540				937,080				935,366				936,536
Convertible notes payable			366,894				4,000				32,391				4,000
Stock options			345,245				157,682				317,420				158,886
Dilutive potential common shares			1,647,679				1,098,762				1,285,177				1,099,422
Denominator for diluted net income per common share — adjusted weighted-average shares and assumed conversions			23,498,863				22,280,942				23,525,713				22,193,154
Basic net income per common share		$	2.54			$	.53			$	.28			$	.18
Diluted net income per common share		$	2.39			$	.52			$	.27			$	.17

The following weighted-average shares of securities were not included in the computation of diluted net income per common share as their effect would have been antidilutive:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
Convertible notes payable			—				979,160				—				979,160
Stock options			—				365,659				5,000				350,000
			—				1,344,819				5,000				1,329,160

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 3: Accounts Receivable, net Our accounts receivables, net, consists of the following:

		September 30,				December 31,
		2011				2010
		(In Thousands)
Trade receivables		$	85,691			$	73,367
Other			946				1,528
			86,637				74,895
Allowance for doubtful accounts			(771	)			(636	)
		$	85,866			$	74,259

Note 4: Inventories At September 30, 2011 and December 31, 2010, inventory reserves for certain slow-moving inventory items (Climate Control products) were $1,984,000 and $1,616,000, respectively. In addition, because cost exceeded the net realizable value, inventory reserves for certain nitrogen-based inventories provided by our Chemical Business were $1,075,000 and $177,000 at September 30, 2011 and December 31, 2010, respectively.

Changes in our inventory reserves are as follows:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Balance at beginning of period		$	1,793			$	1,676			$	1,988			$	1,302
Provisions for (realization of) losses			1,351				(87	)			1,072				237
Write-offs and disposals			(85	)			(54	)			(1	)			(4	)
Balance at end of period		$	3,059			$	1,535			$	3,059			$	1,535

The provisions for (realization of) losses are included in cost of sales in the accompanying condensed consolidated statements of income.

Note 5: Precious Metals Precious metals are included in supplies, prepaid items and other in the accompanying condensed consolidated balance sheets. In addition, precious metals expense (recoveries), net, is included in cost of sales in the accompanying condensed consolidated statements of income.

Precious metals expense (recoveries), net, consists of the following:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Precious metals expense		$	6,101			$	4,508			$	1,591			$	1,047
Recoveries of precious metals			(4,654	)			(751	)			(2,012	)			(751	)
Gains on sales of precious metals			(33	)			(112	)			(33	)			—
Precious metals expense (recoveries), net		$	1,414			$	3,645			$	(454	)		$	296

Note 6: Investment in Affiliate Cepolk Holdings, Inc. (“CHI”), a subsidiary within the Climate Control Business, is a limited partner and has a 50% equity interest in Cepolk Limited Partnership (“Partnership”), which is accounted for on the equity method. The Partnership owns an energy savings project located at the Ft. Polk Army base in Louisiana. The income recognized from the Partnership is reported as equity in earnings of affiliate. During 2010, CHI filed a lawsuit against the general partner of the Partnership and subsequently, the general partner filed a lawsuit against CHI. During June 2011, these lawsuits involving the Partnership were settled through mediation. As the result of this settlement, our equity in earnings of affiliate decreased by approximately $480,000 for the nine months ended September 30, 2011. In addition, CHI will receive an increase of $74,000 in the quarterly distribution from the Partnership, which began during the third quarter of 2011.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 7: Current and Noncurrent Accrued and Other Liabilities Our current and noncurrent accrued and other liabilities consist of the following:

		September 30,				December 31,
		2011				2010
		(In Thousands)
Customer deposits		$	7,981			$	2,586
Deferred revenue on extended warranty contracts			6,250				5,675
Accrued warranty costs			4,993				3,996
Accrued payroll and benefits			4,722				6,742
Accrued death benefits			4,028				4,058
Accrued group health and workers’ compensation insurance claims			3,062				2,459
Fair value of derivatives and other			3,019				2,539
Accrued contractual manufacturing obligations			2,480				1,968
Deferred revenue on product sales			1,309				453
Accrued executive benefits			1,296				1,187
Accrued precious metals costs			1,206				449
Accrued general liability insurance claims			1,145				1,230
Accrued commissions			1,121				1,279
Accrued income taxes			764				4,835
Accrued interest			589				1,343
Other			3,894				3,313
			47,859				44,112
Less noncurrent portion			14,882				12,605
Current portion of accrued and other liabilities		$	32,977			$	31,507

Note 8: Accrued Warranty Costs Our Climate Control Business sells equipment that has an expected life, under normal circumstances and use, which extends over several years. As such, we provide warranties after equipment shipment/start up covering defects in materials and workmanship. Generally for commercial/institutional products, the base warranty coverage for most of the manufactured equipment in the Climate Control Business is limited to eighteen months from the date of shipment or twelve months from the date of start up, whichever is shorter, and to ninety days for spare parts. For residential products, the base warranty coverage for manufactured equipment in the Climate Control Business is limited to ten years from the date of shipment for material and to five years from the date of shipment for labor associated with the repair. The warranty provides that most equipment is required to be returned to the factory or an authorized representative and the warranty is limited to the repair and replacement of the defective product, with a maximum warranty of the refund of the purchase price. Furthermore, companies within the Climate Control Business generally disclaim and exclude warranties related to merchantability or fitness for any particular purpose and disclaim and exclude any liability for consequential or incidental damages. In some cases, the customer may purchase or a specific product may be sold with an extended warranty. The above discussion is generally applicable to such extended warranties, but variations do occur depending upon specific contractual obligations, certain system components, and local laws.

Changes in our product warranty obligation (accrued warranty costs) are as follows:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Balance at beginning of period		$	3,996			$	3,138			$	4,598			$	3,129
Charged to costs and expenses			4,870				2,669				1,636				1,026
Costs and expenses incurred			(3,873	)			(2,673	)			(1,241	)			(1,021	)
Balance at end of period		$	4,993			$	3,134			$	4,993			$	3,134

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 9: Long-Term Debt Our long-term debt consists of the following:

		September 30,				December 31,
		2011				2010
		(In Thousands)
Working Capital Revolver Loan due 2012 (A)		$	—			$	—
5.5% Convertible Senior Subordinated Notes due 2012 (B)			500				26,900
Secured Term Loan (C)			73,125				48,773
Other, with a current weighted-average interest rate of 6.56%, most of which is secured by machinery, equipment and real estate			9,679				19,719
			83,304				95,392
Less current portion of long-term debt			6,059				2,328
Long-term debt due after one year		$	77,245			$	93,064

(A)		Our wholly-owned subsidiary, ThermaClime, LLC (“ThermaClime”) and its subsidiaries (collectively, the “Borrowers”) are parties to a $50 million revolving credit facility (the “Working Capital Revolver Loan”) that provides for advances based on specified percentages of eligible accounts receivable and inventories for ThermaClime and its subsidiaries. The Working Capital Revolver Loan accrues interest at a base rate (generally equivalent to the prime rate) plus .50% or LIBOR plus 1.75% and matures on April 13, 2012. The interest rate at September 30, 2011 was 3.75%. Interest is paid monthly, if applicable.

The Working Capital Revolver Loan provides for up to $8.5 million of letters of credit. All letters of credit outstanding reduce availability under the Working Capital Revolver Loan. As of September 30, 2011, amounts available for borrowing under the Working Capital Revolver Loan were approximately $48.6 million. Under the Working Capital Revolver Loan, the lender also requires the Borrowers to pay a letter of credit fee equal to 1% per annum of the undrawn amount of all outstanding letters of credit, an unused line fee equal to .375% per annum for the excess amount available under the Working Capital Revolver Loan not drawn and various other audit, appraisal and valuation charges.

The lender may, upon an event of default, as defined, terminate the Working Capital Revolver Loan and make the balance outstanding, if any, due and payable in full. The Working Capital Revolver Loan is secured by the assets of all the ThermaClime entities other than El Dorado Nitric Company and its subsidiaries (“EDN”) but excluding the assets securing the secured term loan discussed in (C) below, certain production equipment and facilities utilized by the Climate Control Business, and certain distribution-related assets of El Dorado Chemical Company (“EDC”). In addition, EDN is neither a borrower under, nor guarantor of, the Working Capital Revolver Loan. The carrying value of the pledged assets is approximately $256 million at September 30, 2011.

The Working Capital Revolver Loan requires ThermaClime to meet certain financial covenants, including an EBITDA requirement of greater than $25 million; a minimum fixed charge coverage ratio of not less than 1.10 to 1; and a maximum senior leverage coverage ratio of not greater than 4.50 to 1. These requirements are measured quarterly on a trailing twelve-month basis and as defined in the agreement. ThermaClime was in compliance with those covenants for the twelve-month period ended September 30, 2011. The Working Capital Revolver Loan also contains covenants that, among other things, limit the Borrowers’ (which does not include LSB) ability, without consent of the lender and with certain exceptions, to:

•

incur additional indebtedness,

•

incur liens,

•

make restricted payments or loans to affiliates who are not Borrowers,

•

engage in mergers, consolidations or other forms of recapitalization, or

•

dispose assets.

The Working Capital Revolver Loan also requires all collections on accounts receivable be made through a bank account in the name of the lender or their agent.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 9: Long-Term Debt (continued)

(B)		In June 2007, we entered into a purchase agreement with each of twenty two qualified institutional buyers (“QIBs”), pursuant to which we sold $60 million aggregate principal amount of the debentures (the “2007 Debentures”) in a private placement to the QIBs pursuant to the exemptions from the registration requirements of the Securities Act of 1933, as amended (the “Act”), afforded by Section 4(2) of the Act and Regulation D promulgated under the Act.

The 2007 Debentures bear interest at the rate of 5.5% per year and mature on July 1, 2012. Interest is payable in arrears on January 1 and July 1 of each year.

In previous periods, we acquired a certain portion of the 2007 Debentures, with each purchase being negotiated, including $2.5 million during the nine months ended September 30, 2010. In March 2011, one of the holders converted $24.4 million principal amount of the 2007 Debentures into 888,160 shares of LSB common stock. For financial reporting purposes, the March 2011 transaction is considered an induced conversion.

In July 2011, Jack E. Golsen, our chairman of the board and chief executive officer (“CEO”), members of his immediate family (spouse and children), entities owned by them and trusts for which they possess voting or dispositive power as trustee (collectively, the “Golsen Group”) converted $2.0 million principal amount of the 2007 Debentures into 72,800 shares of LSB common stock in accordance with the terms of the 2007 Debentures as discussed in Note 16-Related Party Transactions. As a result of these acquisitions and conversions, only $0.5 million of the 2007 Debentures remain outstanding at September 30, 2011, all of which were converted into 18,200 shares of LSB common stock in October 2011.

(C)		On March 29, 2011, ThermaClime and certain of its subsidiaries entered into an amended and restated term loan agreement (the “Amended Agreement”), which amended ThermaClime’s existing term loan agreement (the “Original Agreement”), dated November 2, 2007, as previously amended. Pursuant to the terms of the Amended Agreement, the maximum principal amount of ThermaClime’s term loan facility (the “Secured Term Loan”) was increased from $50 million to $60 million. On May 26, 2011, the principal amount of the Secured Term Loan was increased an additional $15 million to $75 million pursuant to the terms of the Amended Agreement. The Amended Agreement also extended the maturity of the Secured Term Loan from November 2, 2012, to March 29, 2016. The Secured Term Loan continues to be guaranteed by LSB. For financial reporting purposes, this transaction is considered a non-substantial modification of the Original Agreement.

The Secured Term Loan requires quarterly principal payments of approximately $0.9 million, plus interest and a final balloon payment of $56.3 million due on March 29, 2016. At September 30, 2011, the stated interest rate on the Secured Term Loan includes a variable interest rate of approximately 3.36% on the principal amount of $48.7 million (the variable interest rate is based on three-month LIBOR plus 300 basis points, which rate is adjusted quarterly) and a fixed interest rate of 5.15% on the principal amount of $24.4 million. At September 30, 2011, the resulting weighted-average interest rate was approximately 3.96%.

The Secured Term Loan is secured by the real property and equipment located at our chemical production facilities located in El Dorado, Arkansas (the “El Dorado Facility”) and Cherokee, Alabama (the “Cherokee Facility”). The carrying value of the pledged assets is approximately $68 million at September 30, 2011.

The Secured Term Loan borrowers are subject to numerous covenants under the Amended Agreement including, but not limited to, limitation on the incurrence of certain additional indebtedness and liens; limitations on mergers, acquisitions, dissolution and sale of assets; and limitations on declaration of dividends and distributions to LSB, all with certain exceptions. At September 30, 2011, the carrying value of the restricted net assets of ThermaClime and its subsidiaries was approximately $84 million. As defined in the agreement, the Secured Term Loan borrowers are also subject to a minimum fixed charge coverage ratio of not less than 1.10 to 1 and a maximum leverage ratio of not greater than 4.50 to 1. Both of these requirements are measured quarterly on a trailing twelve-month basis. The Secured Term Loan borrowers were in compliance with these financial covenants for the twelve-month period ended September 30, 2011.

The maturity date of the Secured Term Loan can be accelerated by the lender upon the occurrence of a continuing event of default, as defined.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 9: Long-Term Debt (continued)

The Working Capital Revolver Loan agreement (discussed in (A) above) and the Secured Term Loan contain cross-default provisions. If ThermaClime fails to meet the financial covenants of either of these agreements, the lenders may declare an event of default.

A prepayment premium equal to 2.5% of the principal amount prepaid is due to the lenders should the borrowers elect to prepay on or prior to March 29, 2012. This premium is reduced to 1.0% during the following 24-month period and is eliminated thereafter.

Note 10: Commitments and Contingencies

Purchase Commitments — We entered into the following significant purchase commitments during the nine months ended September 30, 2011:

During the first nine months of 2011, certain subsidiaries within the Chemical Business entered into contracts to purchase natural gas for anticipated production needs at the Cherokee Facility and the chemical production facility located in Pryor, Oklahoma (the “Pryor Facility”). Since these contracts are considered normal purchases because they provide for the purchase of natural gas that will be delivered in quantities expected to be used over a reasonable period of time in the normal course of business and are documented as such, these contracts are exempt from the accounting and reporting requirements relating to derivatives. At September 30, 2011, our purchase commitments under these contracts were for approximately 1.2 million MMBtu of natural gas through December 2011 at the weighted-average cost of $4.14 per MMBtu ($5.1 million).

Legal Matters — Following is a summary of certain legal matters involving the Company.

A. Environmental Matters

Our operations are subject to numerous environmental laws (“Environmental Laws”) and to other federal, state and local laws regarding health and safety matters (“Health Laws”). In particular, the manufacture and distribution of chemical products are activities which entail environmental risks and impose obligations under the Environmental Laws and the Health Laws, many of which provide for certain performance obligations, substantial fines and criminal sanctions for violations. There can be no assurance that we will not incur material costs or liabilities in complying with such laws or in paying fines or penalties for violation of such laws. The Environmental Laws and Health Laws and enforcement policies thereunder relating to our Chemical Business have in the past resulted, and could in the future result, in compliance expenses, cleanup costs, penalties or other liabilities relating to the handling, manufacture, use, emission, discharge or disposal of effluents at or from our facilities or the use or disposal of certain of its chemical products. Historically, significant expenditures have been incurred by subsidiaries within our Chemical Business in order to comply with the Environmental Laws and Health Laws and are reasonably expected to be incurred in the future.

We will recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. We are obligated to monitor certain discharge water outlets at our Chemical Business facilities should we discontinue the operations of a facility. We are also contractually obligated to pay a portion of the operating costs of a municipally owned wastewater pipeline currently being constructed, which will serve the El Dorado Facility through at least December 2053. Additionally, we have certain facilities in our Chemical Business that contain asbestos insulation around certain piping and heated surfaces, which we plan to maintain or replace, as needed, with non-asbestos insulation through our standard repair and maintenance activities to prevent deterioration. Currently, there is insufficient information to estimate the fair value for most of our asset retirement obligations. In addition, we currently have no plans to discontinue the use of these facilities and the remaining life of the facilities is indeterminable. As a result, no asset retirement obligations have been recognized except for $75,000 to retire an injection well at the Pryor Facility. However, we will continue to review these obligations and record a liability when a reasonable estimate of the fair value can be made.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 10: Commitments and Contingencies (continued)

1. Discharge Water Matters

The El Dorado Facility owned by EDC generates process wastewater, which includes cooling tower and boiler blowdowns, contact storm water (rain water inside the facility area which picks up contaminants) and miscellaneous spills and leaks from process equipment. The process water discharge, storm-water runoff and miscellaneous spills and leaks are governed by a state National Pollutant Discharge Elimination System (“NPDES”) discharge water permit issued by the Arkansas Department of Environmental Quality (“ADEQ”), which permit is generally required to be renewed every five years. The El Dorado Facility is currently operating under a NPDES discharge water permit, which became effective in 2004 (“2004 NPDES permit”). In November 2010, a preliminary draft of a discharge water permit renewal, which contains more restrictive ammonia limits, was issued by the ADEQ for EDC’s review. EDC submitted comments to the ADEQ on the draft permit in December 2010.

The El Dorado Facility has generally demonstrated its ability to comply with applicable ammonia and nitrate permit limits, and believes that if it is required to meet the more restrictive dissolved minerals permit levels, it should be able to do so. However, as part of our long-term compliance plan, EDC is pursuing a rulemaking and permit modification with the ADEQ. The ADEQ approved a rule change, but on August 31, 2011, the United States Environmental Protection Agency (“EPA”) formally disapproved the rule change. EDC has filed an appeal of the EPA’s decision in Federal District Court in El Dorado, Arkansas. EDC has intermittently failed the more restrictive dissolved minerals permit limits while the rulemaking has been pursued. However, we do not believe that the occasional noncompliance will have a material adverse impact on EDC. While we are hopeful that EDC will prevail in the appeal, it is unknown how the Court will rule. We do not believe this matter regarding the dissolved minerals will be an issue once the pipeline is operational as discussed below.

During January 2010, EDC received an Administrative Order from the EPA noting certain violations of the 2004 NPDES permit and requesting EDC to demonstrate compliance with the permit or provide a plan and schedule for returning to compliance. EDC has provided the EPA a response which states that the El Dorado Facility is now in compliance with the permit, that the El Dorado Facility expects to maintain compliance and that a majority of the alleged violations were resolved through a consent administrative order with the ADEQ. In June 2011, EDC received an Administrative Complaint from the EPA acknowledging EDC had achieved compliance with the 2004 NPDES permit but has assessed a penalty of $124,000 for past violations of the permit. EDC has met, and continues to meet, with the EPA to explain its objections against the proposed penalty. However, a liability of $124,000 has been established at September 30, 2011 as a result of the Administrative Complaint.

The city of El Dorado, Arkansas received approval to construct a pipeline for disposal of wastewater generated by the city and by certain companies in the El Dorado area. The companies intending to use the pipeline will contribute to the cost of construction and operation of the pipeline. Although EDC believes it can comply with the more restrictive permit limits without the pipeline, EDC will participate in the construction of the pipeline that will be owned by the city in order to ensure that EDC will be able to comply with future permit limits. During April 2011, certain companies, including EDC, and the City entered into a funding agreement and operating agreement, pursuant to which each party to the agreements has agreed to contribute to the cost of construction and the annual operating costs of the pipeline. EDC anticipates its capital cost in connection with the construction of the pipeline including EDC’s right to use the pipeline to dispose of its wastewater will be approximately $4.0 million, of which $0.4 million has been capitalized as of September 30, 2011. The City plans to complete the construction of the pipeline in 2013. Once the pipeline is completed, EDC’s estimated share of the annual operating costs is to be $100,000 to $150,000. The initial term of the operating agreement is through December 2053.

In addition, the El Dorado Facility is currently operating under a consent administrative order (“2006 CAO”) that recognizes the presence of nitrate contamination in the shallow groundwater. The 2006 CAO required EDC to continue semi-annual groundwater monitoring, to continue operation of a groundwater recovery system and to submit a human health and ecological risk assessment to the ADEQ relating to the El Dorado Facility. The final remedy for shallow groundwater contamination, should any remediation be required, will be selected pursuant to a new consent administrative order and based upon the risk assessment. The cost of any additional remediation that may be required will be determined based on the results of the investigation and risk assessment, which costs (or range of costs) cannot currently be reasonably estimated. Therefore, no liability has been established at September 30, 2011, in connection with this matter.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 10: Commitments and Contingencies (continued)

2. Air Matters

The EPA has sent information requests to most, if not all, of the operators of nitric acid plants in the United States, including our El Dorado and Cherokee Facilities and the Baytown, Texas nitric acid plant operated by EDN (the “Baytown Facility”) under Section 114 of the Clean Air Act as to construction and modification activities at each of these facilities over a period of years. These information requests will enable the EPA to determine whether these facilities are in compliance with certain provisions of the Clean Air Act. In connection with a review by our Chemical Business of these facilities in obtaining information for the EPA pursuant to the EPA’s request, our Chemical Business management believes, subject to further review, investigation and discussion with the EPA, that certain facilities within our Chemical Business may be required to make certain capital improvements to certain emission equipment in order to comply with the requirements of the Clean Air Act. If changes to the production equipment at these facilities are required in order to bring this equipment into compliance with the Clean Air Act, the type of emission control equipment that might be required is unknown and, as a result, the amount of capital expenditures necessary in order to bring the equipment into compliance is unknown at this time but could be substantial.

Further, if it is determined that the equipment at any of our chemical facilities has not met the requirements of the Clean Air Act, our Chemical Business could be subject to penalties in an amount not to exceed $27,500 per day as to each facility not in compliance and be required to retrofit each facility with the “best available control technology.” We are currently unable to determine the amount (or range of amounts) of any penalties that may be assessed by the EPA. Therefore no liability has been established at September 30, 2011, in connection with this matter.

3. Other Environmental Matters

In 2002, two subsidiaries within our Chemical Business, sold substantially all of their operating assets relating to a Kansas chemical facility (“Hallowell Facility”) but retained ownership of the real property. At December 31, 2002, even though we continued to own the real property, we did not assess our continuing involvement with our former Hallowell Facility to be significant and therefore accounted for the sale as discontinued operations. In connection with this sale, our subsidiary leased the real property to the buyer under a triple net long-term lease agreement. However, our subsidiary retained the obligation to be responsible for, and perform the activities under, a previously executed consent order to investigate the surface and subsurface contamination at the real property and a corrective action strategy based on the investigation. In addition, certain of our subsidiaries agreed to indemnify the buyer of such assets for these environmental matters. Based on the assessment discussed above, we account for transactions associated with the Hallowell Facility as discontinued operations.

The successor (“Chevron”) of a prior owner of the Hallowell Facility has agreed in writing, within certain limitations, to pay and has been paying one-half of the costs of the interim measures relating to this matter as approved by the Kansas Department of Environmental Quality, subject to reallocation.

Our subsidiary and Chevron are pursuing a course with the state of Kansas of long-term surface and groundwater monitoring to track the natural decline in contamination. Currently, our subsidiary and Chevron are in the process of performing additional surface and groundwater testing. We have accrued for our allocable portion of costs for the additional testing, monitoring and risk assessments that could be reasonably estimated.

In addition, the Kansas Department of Health and Environment (“KDHE”) notified our subsidiary and Chevron that the Hallowell Facility has been referred to the KDHE’s Natural Resources Trustee, who is to consider and recommend restoration, replacement and/or whether to seek compensation. KDHE will consider the recommendations in their evaluation.

Currently, it is unknown what damages, if any, the KDHE would claim, if any. The ultimate required remediation, if any, is unknown. The nature and extent of a portion of the requirements are not currently defined and the associated costs (or range of costs) are not reasonably estimable.

At September 30, 2011, our estimated allocable portion of the total estimated liability (which is included in current accrued and other liabilities) related to the Hallowell Facility is $165,000. The estimated amount is not discounted to its present value. It is reasonably possible that a change in the estimate of our liability could occur in the near term.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 10: Commitments and Contingencies (continued)

B. Other Pending, Threatened or Settled Litigation

The Jayhawk Group

In November 2006, we entered into an agreement with Jayhawk Capital Management, LLC, Jayhawk Investments, L.P., Jayhawk Institutional Partners, L.P. and Kent McCarthy, the manager and sole member of Jayhawk Capital, (collectively, the “Jayhawk Group”), in which the Jayhawk Group agreed, among other things, that if we undertook, in our sole discretion, within one year from the date of agreement a tender offer for our Series 2 $3.25 convertible exchangeable Class C preferred stock (“Series 2 Preferred”) or to issue our common stock for a portion of our Series 2 Preferred pursuant to a private exchange, that they would tender or exchange an aggregate of no more than 180,450 shares of the 340,900 shares of the Series 2 Preferred beneficially owned by the Jayhawk Group, subject to, among other things, the entities owned and controlled by Jack E. Golsen, our chairman and chief executive officer (“Golsen”), and his immediate family, that beneficially own Series 2 Preferred only being able to exchange or tender approximately the same percentage of shares of Series 2 Preferred beneficially owned by them as the Jayhawk Group was able to tender or exchange under the terms of the agreement.

During 2007, we made a tender offer for our outstanding Series 2 Preferred at the rate of 7.4 shares of our common stock for each share of Series 2 Preferred so tendered. In July 2007, we redeemed the balance of our outstanding shares of Series 2 Preferred. Pursuant to its terms, the Series 2 Preferred was convertible into 4.329 shares of our common stock for each share of Series 2 Preferred. As a result of the redemption, the Jayhawk Group converted the balance of its Series 2 Preferred pursuant to the terms of the Series 2 Preferred in lieu of having its shares redeemed.

The Jayhawk Group has filed suit against us and Golsen alleging that the Jayhawk Group should have been able to tender all of its Series 2 Preferred pursuant to the tender offer, notwithstanding the above-described agreement, based on the following claims against us and Golsen:

•

fraudulent inducement and fraud,

•

violation of 10(b) of the Exchange Act and Rule 10b-5,

•

violation of 17-12A501 of the Kansas Uniform Securities Act, and

•

breach of contract.

The Jayhawk Group seeks damages up to $12 million based on the additional number of common shares it allegedly would have received on conversion of all of its Series 2 Preferred through the February 2007 tender offer, plus punitive damages. In May 2008, the General Counsel for the Jayhawk Group offered to settle its claims against us and Golsen in return for a payment of $100,000, representing the approximate legal fees it had incurred investigating the claims at that time. Through counsel, we verbally agreed to the settlement offer and confirmed the agreement by e-mail. Afterward, the Jayhawk Group’s General Counsel purported to withdraw the settlement offer, and asserted that Jayhawk is not bound by any settlement agreement. We contend that the settlement agreement is binding on the Jayhawk Group. We intend to contest the lawsuit vigorously, and have asserted that Jayhawk is bound by an agreement to settle the claims for $100,000. On April 28, 2011, the court granted Golsen’s summary judgment motion, and dismissed all claims against Golsen. During September 2011, this case was tried before the court in the United States District Court for the District of Kansas. We are awaiting the court’s decision in this matter. Our insurer, Chartis, a subsidiary of AIG, has agreed to defend this lawsuit on our behalf and on behalf of Golsen and to indemnify under a reservation of rights to deny liability under certain conditions. We have incurred expenses associated with this matter up to our insurance deductible of $250,000, and our insurer is paying defense costs in excess of our deductible in this matter. Although our insurer is defending this matter under a reservation of rights, we are not currently aware of any material issue in this case that would result in our insurer denying coverage. Therefore, no liability has been established at September 30, 2011 as a result of this matter.

Pryor Chemical Company

A subsidiary within our Chemical Business, Pryor Chemical Company (“PCC”) has filed lawsuits against certain vendors of PCC related to work performed during the start-up of the Pryor Facility. The claims allege certain damages resulting from improperly performed work by the vendors and for lost profits and other costs due to delays in restarting the Pryor Facility. The total amount for damages and lost profits claimed is substantial but the amount and timing of the ultimate recovery is uncertain. As a result, any recovery from litigation or settlement of these claims is a gain contingency and will be recognized if, and when, realized or realizable and earned.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 10: Commitments and Contingencies (continued)

Other Claims and Legal Actions

We are also involved in various other claims and legal actions including claims for damages resulting from water leaks related to our Climate Control products and other product liability occurrences. Most of the product liability claims are covered by our general liability insurance, which generally includes a deductible of $250,000 per claim. For any claims or legal actions that we have assessed the likelihood of our liability as probable, we have recognized our estimated liability up to the applicable deductible. At September 30, 2011, our accrued general liability insurance claims were $1,145,000 and are included in accrued and other liabilities. It is possible that the actual development of claims could be different than our estimates but, after consultation with legal counsel, if those general liability insurance claims for which we have not recognized a liability were determined adversely to us, it would not have a material effect on our business, financial condition or results of operations.

Note 11: Derivatives, Hedges, Financial Instruments and Carbon Credits We have three classes of contracts that are accounted for on a fair value basis, which are commodities futures/forward contracts (“commodities contracts”), foreign exchange contracts and interest rate contracts as discussed below. All of these contracts are used as economic hedges for risk management purposes but are not designated as hedging instruments. In addition as discussed below, periodically we are issued carbon credits, which a certain portion of the carbon credits are to be sold and the proceeds given to Bayer Material Science LLC (“Bayer”). The carbon credits are accounted for on a fair value basis as discussed below. Also the contractual obligations associated with these carbon credits are accounted for on a fair value basis (as discussed below) unless we enter into a firm sales commitment to sell the carbon credits as discussed in Note 1 — Summary of Significant Accounting Policies. The valuations of these assets and liabilities were determined based on quoted market prices or, in instances where market quotes are not available, other valuation techniques or models used to estimate fair values.

The valuations of contracts classified as Level 1 are based on quoted prices in active markets for identical contracts. The valuations of contracts classified as Level 2 are based on quoted prices for similar contracts and valuation inputs other than quoted prices that are observable for these contracts. At September 30, 2011, the valuations of contracts classified as Level 2 related to interest rate swap contracts. For interest rate swap contracts, we utilize valuation software and market data from a third-party provider. These interest rate contracts are valued using a discounted cash flow model that calculates the present value of future cash flows pursuant to the terms of the contracts and using market information for forward interest-rate yield curves. The valuation inputs included the total contractual weighted-average pay rate of 3.29% and the total estimated market weighted-average receive rate of 1.06%. No valuation input adjustments were considered necessary relating to nonperformance risk for the contracts. The valuations of assets and liabilities classified as Level 3 are based on prices or valuation techniques that require inputs that are both unobservable and significant to the overall fair value measurement. At September 30, 2011, the valuations ($1.50 per carbon credit) of the carbon credits and the contractual obligations associated with these carbon credits are classified as Level 3 and are based on the range of ask/bid prices ($1.50 to $3.00) per carbon credit obtained from a broker involved in this low volume market, pricing terms included in sales agreements entered into during the first nine months of 2011, and inquiries from market participants concerning our listed ask price through a broker. The valuations are using undiscounted cash flows based on management’s assumption that the carbon credits would be sold and the associated contractual obligations would be extinguished in the near term.

In addition, no valuation input adjustments were considered necessary relating to nonperformance risk for the carbon credits and associated contractual obligations. At December 31, 2010, the valuations ($3.25 per carbon credit) of contracts classified as Level 3 related to carbon credits and contractual obligations associated with these carbon credits.

Commodities Contracts

Raw materials for use in our manufacturing processes include copper used by our Climate Control Business and anhydrous ammonia and natural gas used by our Chemical Business. As part of our raw material price risk management, we periodically enter into futures/forward contracts for these materials, which contracts are generally accounted for on a mark-to-market basis. At December 31, 2010, our futures/forward copper contracts were for 750,000 pounds of copper through May 2011 at a weighted-average cost of $3.75 per pound. At September 30, 2011, our futures/forward copper contracts were for 375,000 pounds of copper through December 2011 at a weighted-average cost of $4.44 per pound. At December 31, 2010, our futures/forward natural gas contracts were for 800,000 MMBtu of natural gas through February 2011 at a weighted-average cost of $4.10 per MMBtu. At September 30, 2011, we did not have any futures/forward natural gas contracts. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 11: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

Foreign Exchange Contracts

One of our business operations purchases industrial machinery and related components from vendors outside of the United States. As part of our foreign currency risk management, we periodically enter into foreign exchange contracts, which set the U.S. Dollar/Euro exchange rates. These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. At December 31, 2010, our foreign exchange contracts were for the receipt of approximately 783,000 Euros through June 2011 and for the payment of approximately 110,000 Euros through March 2011, at the total contractual weighted-average exchange rate of 1.26 (U.S. Dollar/Euro). At September 30, 2011, we did not have any foreign exchange contracts. The cash flows relating to these contracts are included in cash flows from continuing operating activities.

Interest Rate Contracts

As part of our interest rate risk management, we periodically purchase and/or enter into various interest rate contracts. In April 2008, we entered into an interest rate swap at no cost, which sets a fixed three-month LIBOR rate of 3.24% on $25 million and matures in April 2012. In September 2008, we acquired an interest rate swap at a cost basis of $0.4 million, which sets a fixed three-month LIBOR rate of 3.595% on $25 million and matures in April 2012. In February 2011, we entered into an interest rate swap at no cost, which sets a fixed three-month LIBOR rate of 3.23% on a declining balance (from $23.8 million to $18.8 million) for the period beginning in April 2012 through March 2016.

These contracts are free-standing derivatives and are accounted for on a mark-to-market basis. During the nine months ended September 30, 2011 and 2010, no cash flows occurred relating to the purchase or sale of interest rate contracts. The cash flows associated with the interest rate swap payments are included in cash flows from continuing operating activities.

Carbon Credits and Associated Contractual Obligation

During December 2010 and May 2011, we were issued carbon credits by the Climate Action Reserve in relation to a greenhouse gas reduction project (“Project”) performed at the Baytown Facility. Pursuant to the terms of the agreement with Bayer (the “Bayer Agreement”), a certain portion of the carbon credits are to be used to recover the costs of the Project, and any balance thereafter to be allocated between Bayer and EDN. We have no obligation to reimburse Bayer for their costs associated with the Project, except through the transfer or sale of the carbon credits when such credits are issued to us. The carbon credits are accounted for on a fair value basis and the contractual obligations associated with these carbon credits are also accounted for on a fair value basis (unless we enter into a firm sales commitment to sell the carbon credits). At December 31, 2010, we had approximately 198,000 carbon credits, all of which were subject to contractual obligations. At September 30, 2011, we had a minimal amount of carbon credits, all of which were subject to contractual obligations. The cash flows associated with the carbon credits and the associated contractual obligations are included in cash flows from continuing investing activities.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 11: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

The following details our assets and liabilities that are measured at fair value on a recurring basis at September 30, 2011 and December 31, 2010:

						Fair Value Measurements at
						September 30, 2011 Using
						Quoted Prices				Significant
		Total Fair				in Active				Other				Significant				Total Fair
		Value at				Markets for				Observable				Unobservable				Value at
		September 30,				Identical Assets				Inputs				Inputs				December 31,
Description		2011				(Level 1)				(Level 2)				(Level 3)				2010
		(In Thousands)
Assets — Supplies, prepaid items and other:
Commodities contracts		$	—			$	—			$	—			$	—			$	761
Carbon credits			7				—				—				7				644
Foreign exchange contracts			—				—				—				—				49
Total		$	7			$	—			$	—			$	7			$	1,454
Liabilities — Current and noncurrent accrued and other liabilities:
Commodities contracts		$	482			$	482			$	—			$	—			$	—
Contractual obligations — carbon credits			7				—				—				7				644
Interest rate contracts			2,530				—				2,530				—				1,895
Total		$	3,019			$	482			$	2,530			$	7			$	2,539

During the nine months ended September 30, 2011 and 2010, none of our assets or liabilities measured at fair value on a recurring basis transferred between Level 1 and Level 2 classifications. In addition, the following is a reconciliation of the beginning and ending balances for assets and liabilities measured at fair value on a recurring basis using significant unobservable inputs (Level 3) during the nine and three months ended September 30, 2011 (not applicable for the nine and three months ended September 30, 2010):

		Nine Months Ended								Three Months Ended
		September 30, 2011								September 30, 2011
		Assets				Liabilities				Assets				Liabilities
		(In Thousands)
Beginning balance		$	644			$	(644	)		$	9			$	(7	)
Transfers into Level 3			—				—				—				—
Transfers out of Level 3			—				—				—				—
Total realized and unrealized gain (loss) included in earnings			1,028				(936	)			(2	)			—
Purchases			—				—				—				—
Issuances			—				—				—				—
Sales			(1,665	)			—				—				—
Settlements			—				1,573				—				—
Ending balance		$	7			$	(7	)		$	7			$	(7	)

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 11: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

Realized and unrealized net losses included in earnings and the income statement classifications are as follows:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Total net gains (losses) included in earnings:
Cost of sales — Commodities contracts		$	(624	)		$	(764	)		$	(430	)		$	140
Cost of sales — Foreign exchange contracts			46				42				—				66
Other income — Carbon credits			1,028				—				(2	)			—
Other expense — Contractual obligations relating to carbon credits			(936	)			—				—				—
Interest expense — Interest rate contracts			(1,825	)			(1,512	)			(799	)			(375	)
		$	(2,311	)		$	(2,234	)		$	(1,231	)		$	(169	)

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Change in unrealized gains (losses) relating to contracts still held at period end:
Cost of sales — Commodities contracts		$	(482	)		$	141			$	(430	)		$	342
Other income — Carbon credits			7				66				(2	)			66
Other expense — Contractual obligations relating to carbon credits			(7	)			—				—				—
Interest expense — Interest rate contracts			(635	)			(344	)			(395	)			4
		$	(1,117	)		$	(137	)		$	(827	)		$	412

The following discussion of fair values is not indicative of the overall fair value of our assets and liabilities since it does not include all assets, including intangibles.

Our long-term debt agreements are the only financial instruments with fair values significantly different from their carrying amounts. At September 30, 2011 and December 31, 2010, the fair value for variable interest rate debt (excluding the secured term loan at December 31, 2010) is believed to approximate their carrying value. At December 31, 2010, the estimated fair value of the secured term loan is based on defined LIBOR rates plus 6% utilizing information obtained from the lender. The fair values of fixed interest rate borrowings, other than the 2007 Debentures, are estimated using a discounted cash flow analysis that applies interest rates currently being offered on borrowings of similar amounts and terms to those currently outstanding while also taking into consideration our current credit worthiness. At September 30, 2011, the estimated fair value of the 2007 Debentures is based on the conversion rate and market price of LSB common stock. At December 31, 2010, the estimated fair value of the 2007 Debentures is based on quoted prices obtained from a broker for these debentures.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 11: Derivatives, Hedges, Financial Instruments and Carbon Credits (continued)

The estimated fair value and carrying value of our long-term debt are as follows:

		September 30, 2011								December 31, 2010
		Estimated				Carrying				Estimated				Carrying
		Fair Value				Value				Fair Value				Value
		(In Thousands)
Variable Interest Rate:
Secured Term Loan (1)		$	73,125			$	73,125			$	26,721			$	48,773
Working Capital Revolver Loan			—				—				—				—
Other debt (2)			—				—				2,437				2,437
Fixed Interest Rate:
5.5% Convertible Senior Subordinated Notes			522				500				27,976				26,900
Other bank debt and equipment financing			9,631				9,679				17,251				17,282
		$	83,278			$	83,304			$	74,385			$	95,392

(1)		Includes a fixed interest rate of 5.15% on the principal amount of $24.4 million at September 30, 2011.
(2)		At December 31, 2010, the balance includes a variable interest rate debt agreement with a minimum interest rate of 6%, which interest rate was 6%.

Note 12: Income Taxes Provisions for income taxes are as follows:

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Current:
Federal		$	24,497			$	5,059			$	2,583			$	586
State			6,869				1,437				1,200				263
Total current provisions		$	31,366			$	6,496			$	3,783			$	849
Deferred:
Federal		$	1,932			$	2,026			$	554			$	1,800
State			284				299				96				281
Total deferred provisions			2,216				2,325				650				2,081
Provisions for income taxes		$	33,582			$	8,821			$	4,433			$	2,930

For the nine and three months ended September 30, 2011 and 2010, the current provision for federal income taxes shown above includes regular federal income tax after the consideration of permanent and temporary differences between income for GAAP and tax purposes. For the nine and three months ended September 30, 2011 and 2010, the current provision for state income taxes shown above includes regular state income tax and provisions for uncertain state income tax positions. At December 31, 2010, we have remaining state tax net operating loss (“NOL”) carryforwards of approximately $7,200,000 that begin expiring in 2011.

Our annual estimated effective tax rate for 2011 includes the impact of permanent tax differences, such as the domestic manufacturer’s deduction, the advanced energy credit and other permanent items.

During June 2010, we determined that certain nondeductible expenses had not been properly identified relating to the 2007-2009 provisions for income taxes. As a result, we recorded an additional income tax provision of approximately $800,000 for the nine months ended September 30, 2010. For the nine months ended September 30, 2010, the effect of this adjustment decreased basic and diluted net income per share by $.04. Management of the Company evaluated the impact of this accounting error and concluded the effect of this adjustment was immaterial to our 2007-2010 consolidated financial statements.

LSB INDUSTRIES, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (continued)
(Unaudited)

Note 12: Income Taxes (continued)

The tax provision for the nine months ended September 30, 2011 and 2010 was $33,582,000 (37% of pre-tax income) and $8,821,000 (43% of pre-tax income), respectively.

We had approximately $764,000 and $700,000 accrued for uncertain tax liabilities at September 30, 2011 and December 31, 2010, respectively, which are included in current and noncurrent accrued and other liabilities.

LSB and certain of its subsidiaries file income tax returns in the U.S. federal jurisdiction and various state jurisdictions. With few exceptions, the 2008-2010 years remain open for all purposes of examination by the U.S. Internal Revenue Service (“IRS”) and other major tax jurisdictions. Currently we are under examination by the IRS and certain state tax authorities for the tax years 2007-2010.

Note 13: Other Expense, Other Income and Non-Operating Other Income (Expense), net

		Nine Months Ended								Three Months Ended
		September 30,								September 30,
		2011				2010				2011				2010
		(In Thousands)
Other expense:
Losses on sales and disposals of property and equipment		$	996			$	508			$	101			$	249
Loss on contractual obligations associated with carbon credits			936				—				—				—
Other miscellaneous expense (1)			600				67				48				24
Total other expense		$	2,532			$	575			$	149			$	273
Other income:
Gain on carbon credits		$	1,028			$	—			$	(2	)		$	—
Settlements of litigation and potential litigation (2)			757				—				—				—
Property insurance recoveries in excess of losses incurred (3)			—				3,982				—				3,243
Miscellaneous income (1)			250				197				60				30
Total other income		$	2,035			$	4,179			$	58			$	3,273
Non-operating other income (expense), net:
Interest income		$	61			$	107			$	20			$	30
Miscellaneous income (1)			—				1				—				1
Miscellaneous expense (1)			(58	)			(60	)			(22	)			(21	)
Total non-operating other income (expense), net		$	3			$	48			$	(2	)		$	10