LSB Industries, Inc. Annual Report 2007

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FY2007 Annual Report · LSB Industries, Inc.

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2007

$46,882

2006

$15,515

2003

$3,705

2005

$4,990

2004

$209

Net Income (thousands)

Climate Control Business
We are the U.S. market leader for geothermal and water source heat pumps and hydronic fan coils. We
also provide modular chillers, custom air-handlers, and execute large scale geothermal installations. Our
products are targeted to commercial, industrial and residential new-building construction, renovation of
existing buildings, and replacement of existing systems. Our innovative products are used by millions of
people every day in prestigious buildings and homes throughout North America and around the world. Our
technologically advanced and environmentally responsible “green” geothermal heat pumps reduce energy
consumption and greenhouse gas emissions.

Chemical Business
We manufacture high density, prilled ammonium nitrate, anhydrous ammonia, and liquid fertilizers which
are used to fertilize food crops, biofuel feedstock crops, pasture land for grazing livestock and forage
production. Our anhydrous ammonia is also used to reduce emissions from power plants. We are the
leading merchant marketer of nitric acid in the U.S., offering various concentrations of nitric acid, high-
grade mixed acids, and sulfuric acid for industrial markets. Our industrial acids are used to produce
dozens of products, from clothing and paper products to advanced athletic gear made from high impact
polyurethane. We manufacture and sell low-density (industrial-grade) ammonium nitrate which is used to
surface mine coal vital to meeting the world’s growing demand for energy, and other natural resources.

Engineered Products & Services
We market precision machine tools and design, engineer, specify and furnish world-class chemical and
industrial manufacturing facilities for international clients.

Financial Highlights

(thousands, except per share amounts)

Net Sales
Gross Proﬁ t
Operating Income
Net Income

2007

2006

2005

2004

2003

$586,407 $491,952 $397,115 $363,984 $317,026
51,166
8,794
3,705

132,593
59,011
46,882

66,766
14,853
4,990

90,862
27,139
15,515

52,622
2,083
209

Net income (loss) Applicable to Common Stock
Earnings (loss) per Diluted Share
Weighted Average Diluted Shares Outstanding

41,274
1.84
23,496

12,885
0.76
20,872

2,707
0.18
14,907

(2,113)
(0.16)
12,888

1,378
0.10
14,299

Total Assets
Shareholders’ Equity
Long-term Debt

307,554
94,283
121,064

219,927
43,634
86,113

188,963
14,861
105,036

167,568
9,915
101,674

161,813
8,862
71,645

Depreciation and Amortization

14,353

12,549

12,026

11,295

11,216

Note: The above ﬁ nancial information was taken directly from, and should be read in connection with, our
ﬁ nancial statements, including notes thereto, included in this report and prior reports ﬁ led with the SEC.

To Our Fellow Shareholders:

2007 was a landmark year for LSB Industries, Inc. It was a year of growth and
improvement. Among the highlights:

(cid:962) Consolidated total year sales were a record $586.4 million, up 19.2% over 2006’s
$492.0 million, with both our Climate Control and Chemical Businesses achieving
their best ever sales performance.

(cid:962) Consolidated operating income, also a record, increased 117.4% to $59.0 million,

up from $27.1 million in 2006.

(cid:962) Net income was $46.9 million, up 202.2% from $15.5 million in 2006.
(cid:962) Net income applicable to common stock was $41.3 million, up 220.3% from $12.9
million in 2006 resulting in diluted earnings per share of $1.84, or 142.1% ahead of
$.76 per share in 2006.

(cid:962) We replaced, under far more attractive terms, the $50 million term loan,

renegotiated our working capital revolver, and infused the balance sheet with an
additional $57 million in cash from the sale of 5.5% convertible notes.

(cid:962) We simpliﬁ ed our capital structure and strengthened our balance sheet, closing
the year with a debt to equity ratio of 1.30 to 1, improved from 2.24 to 1 the year
earlier.

(cid:962) LSB’s net worth more than doubled to $94.3 million from $43.6 million at 2006

year end.

(cid:962) Through exchanges, conversions and redemptions, we eliminated our Class C,
Series 2 Preferred shares outstanding. Future dividends and preferred stock
dividends in arrears on those securities have also been eliminated.

(cid:962) We signiﬁ cantly expanded production capacity at our Climate Control Business

and made efﬁ ciency-enhancing improvements at our Chemical plants.
(cid:962) LSB was added to the Russell 2000 and 3000 Indexes and was named to

Business Week’s annual list of 100 Hot Growth Companies, published in the
June 4, 2007 issue.

(continued)

2007 Annual Report

Climate Control Business

(“HVAC”)
Our Climate Control Business is comprised of

two core companies as well as three newer

businesses. The core companies, market leaders

in their respective specialties, are ClimateMaster,

the world’s leading manufacturer of geothermal

and water source heat pumps, and International

Environmental, the leading U.S. producer of

hydronic fan coils.

In 2007, our Climate Control Business achieved

record sales of $286.4 million for a 29% year-over-

year improvement, principally due to our heat pump

and fan coil businesses, where sales rose 23% and

44%, respectively, compared to 2006. These gains

resulted in operating income of $34.2 million, a 34%

increase from the prior year, despite 2006’s $1.2

million gain due to the award of legal fees relating

to an arbitration case. Not only did we grow sales

and proﬁ ts, but our core products also gained market

share. Our heat pumps and fan coils captured 42%

and 41% of their respective markets, up from 38%

and 40% in 2006.

One of the most frequent questions asked by

investors is how the slowdown in construction,

residential construction in particular, impacts

our business. In answering that question, there

are several important points. First, single family

residential products represented approximately 5.4%

of LSB’s total 2007 sales. During 2007 our sales to

this market increased 7.5% despite the downturn in

housing starts. Some 6.4 million residential HVAC

systems of all types were sold in the U.S. during

2007, primarily for renovation and replacement, and

less than one percent of those were geothermal

systems. This represents signiﬁ cant growth

potential for our geothermal products. Finally,

the vast majority of our Climate Control sales are

for commercial and institutional installations for

construction, renovation and replacement. In 2007,

commercial and institutional sales represented

approximately 89% of total Climate Control sales

and about 74% of these sales were for ofﬁ ces,

hotels, educational facilities, health care and

retirement facilities, manufacturing and process

plants, apartments and condominiums.

During 2007, our Climate Control Business booked

$241.6 million in product orders, slightly ahead

of 2006’s product order levels. We closed 2007

with a backlog of $54.5 million, as compared to

$80.4 million at December 31, 2006. However,

2008 started on a strong note for bookings, and by

the end of the ﬁ rst quarter our backlog of product

orders had increased to $62.1 million. Aside from

bragging rights, excessive backlog is not good in

our business. For one, it has the unwanted effect

of reducing gross margin because our pricing at the

time an order is placed may not factor in intervening

material price increases at delivery time. In addition,

long lead times associated with large backlogs can

result in poor customer service. We’ve worked hard

to reduce our factory lead times, and most of 2007’s

$6.8 million capital spending for the Climate Control

Business was deployed to increase manufacturing

capacity and efﬁ ciency.

In 2007 ClimateMaster expanded and reconﬁ gured

its space, adding a 46,000 square foot warehouse

and a 110,000 square foot distribution center, which

resulted in 100% more manufacturing ﬂ oor space.

We installed fabrication equipment, additional

automated line testing, quality assurance systems,

and assembly lines, which allowed us to reduce

“A Year of Growth and Improvement”

delivery times. At International Environmental,

green developments are shaping up as one of the

we completed the reconﬁ guration of the assembly

strongest segments of the faltering housing market.”

area, added assembly lines, and made large

Not surprisingly, the green-building movement

strides toward our goal of doubling our total air coil

is migrating from the eco-chic luxury segment

production volume in order to bring all heat pump

into the mainstream. Corporate, institutional and

coil production in house. Over the past two years,

government sectors are making energy saving,

we invested in excess of $14 million in property,

environmentally friendly choices to obtain LEED

plant and equipment for our Climate Control

(Leadership in Energy and Environmental Design)

Business. In preparation for future growth, we are

certiﬁ cation, the national benchmark for high

acquiring 30 acres of land adjacent to our existing

performance buildings set forth by the U.S. Green

facilities to accommodate expansion as required.

Building Council. We are delighted to note that

geothermal systems deliver many of the required

Because of its timeliness in the face of escalating

points to achieve LEED certiﬁ cation. We are poised

energy costs, the quest for energy independence

to take advantage of this potential.

and the green movement, we would like to discuss

the geothermal part of our business. As mentioned,

During 2007 we reorganized our geothermal sales

we are the market leader in this area, and although

and marketing program, with the intent of improving

geothermal sales are still a relatively small part of

awareness about these products and further

our overall business, we believe this is a product

increasing our market penetration.

for our times. These systems, which work in all

climates, provide heat and cooling, utilizing the

The newer companies within our Climate Control

sun’s renewable energy that is stored in the earth.

Business are:

These ultra high efﬁ ciency, non-ozone depleting

systems save up to 60% on utility bills, have

ClimateCraft, which engineers and produces large

estimated life spans of up to three times that of

custom air handling units for environmentally-

conventional systems, operate nearly noise free,

sensitive applications, such as semiconductor and

and greatly reduce greenhouse gas emissions. As

pharmaceutical manufacturing facilities and surgical

an added beneﬁ t, geothermal systems can generate

suites, where air temperature, humidity and purity

free domestic hot water. The U.S. House of

are mission critical.

Representatives recently passed legislation which,

if also passed by the U.S. Senate and enacted into

ClimaCool, which produces modular water chillers

law, should further encourage geothermal sales.

that may be connected to each other to form larger

capacity chillers used in central air-conditioning

According to the November 7, 2007 issue of

systems. Individual chiller modules ﬁ t through

Barron’s, “The green-building market is expected

standard doorways and passenger elevators,

to grow from $7.6 billion in 2005 to $39 billion in

avoiding the demolition and expensive installation

2010. It is now one of the hottest segments of

costs associated with replacing large one-piece

luxury buildings. In many parts of the country,

chillers.

2007 Annual Report

Trison Construction, which offers design,

When LSB entered the Chemical Business in 1984,

engineering and construction services, specializes in

sales were predominantly to agricultural markets.

large scale geothermal installations.

Over the years, the sales mix has evolved, and in

2007, about 40% was to the agricultural sector,

Climate Control’s 2007 operating income was

with the remainder sold to industrial and mining

reduced by about $2.6 million due to these newer

customers. As compared to agricultural related

enterprises, which have excellent potential. One of

sales, the industrial and mining parts of our business

the most promising developments of the past year

are quite predictable and less subject to seasonality,

took place in the fall when ClimateCraft was selected

weather and natural gas price ﬂ uctuations. That is

by one of the nation’s largest health care providers

because, for the most part, we have agreements in

to be one of two suppliers of large custom air

place which enable us to pass through certain key

handlers. While potentially valuable in its own right,

costs, including the cost of raw material feedstocks,

this arrangement is also a door opener to other large

to those customers.

organizations in this and related sectors.

Chemical Business
We manufacture ammonium nitrate and urea

ammonium nitrate, agrochemicals that are used

to produce fertilizers for food crops and pasture

land. Our Industrial Chemical Business remains

the largest merchant marketer of concentrated nitric

acid in North America. It is also a large marketer

of all grades of nitric acid used to produce various

specialty chemicals including polyurethane, ﬂ ame

resistant ﬁ bers, and carbon ﬁ bers, while the

specialty blends and the mixed acids we produce

are used for metal treatment, diesel fuel additives,

herbicides, ordnance, and pharmaceuticals. We

also produce sulfuric acid used for pulp and paper

production, water treatment, metals processing, and

a variety of other uses. Our industrial ammonium

nitrate is required for the production of commercial

explosives for coal, iron and copper surface mining,

road construction and quarrying. Our anhydrous

ammonia is used to abate harmful emissions from

power plants.

In 2007, our Chemical Business grew sales by 11%

to $288.8 million. Operating income increased more

than 350% to $35 million as compared to 2006. The

improved results were driven by substantially higher

sales prices for our fertilizer products, and slightly

better pricing for our mining products and industrial

acids, as well as continued improved plant production

performance. Additionally, during 2007, the

proﬁ tability of the Chemical Business was improved

by a $3.3 million litigation settlement and a $3.8

million business Interruption Insurance recovery.

The outlook for our fertilizer business is good

due to favorable supply-demand fundamentals.

Global grain stocks are at very low levels. At the

same time, world-wide demand has increased

substantially and commodity prices for most crops

are up. Increases in demand are a result of grain

consumption to produce biofuels (e.g. ethanol) as

well as increased demand for higher protein diets in

growing middle class income groups in developing

countries, such as China and India, which also

requires increased grain production.

“A Year of Growth and Improvement”

With the increase in both 2007 sales volumes and

that initial annual plant capacity would approximate

pricing of agricultural grade nitrogen fertilizer for

325,000 tons of UAN plus an additional 50,000 tons

corn, a feedstock for ethanol, and other crops that

of anhydrous ammonia, with the ability to increase

require nitrogen fertilizer, we have been asked

the output, if required.

by investors why we haven’t sought an even

higher proportion of agricultural sales. Long-term

shareholders may recall that in 2006 and prior

years, sales of agricultural chemicals declined due

to a serious drought in our marketing area. We

have found that customer and market diversiﬁ cation

makes business sense over the long haul.

That said, we have every intention of being

opportunistic while avoiding a ‘bet the farm’ risk.

We expect to optimize our agrochemical sales while

maintaining our strong foothold in the industrial

sectors we service. Market data indicates continued

strong demand for nitrogen fertilizers required by

increased grain production as a result of lower

grain inventories in general, plus higher demand

for forage crops. Our marketing strategy focuses

on growing our non-seasonal industrial customer

base with an emphasis on customers that accept

the risk inherent with raw material cost ﬂ uctuations,

while maintaining a strong presence in the seasonal

agricultural sector. Our manufacturing strategy, as

always, is to emphasize cost reduction and operate

our plants at full rates thereby lowering the ﬁ xed

cost of each unit of production. We have the ability

to reallocate portions of our capacity to nitrogen-

based fertilizer when the markets indicate favorable

volumes and margins. We are also taking initial

steps that could allow us to start-up an idled urea

ammonium nitrate plant (UAN) in Pryor, Oklahoma.

While a ﬁ nal decision to reopen the plant in Pryor

has not been made, we have applied for permits and

estimate that if we decide to proceed, project lead

time could be 12 to 15 months. We also estimate

Other Business
In addition to our two core businesses, we have

a small, self-sufﬁ cient and proﬁ table Engineered

Products and Services business that is classiﬁ ed

as “Other” sales. This refers primarily to Summit

Machine Tool which markets standard and

computer numerical control precision machine

tools required in many metalworking manufacturing

operations and tool and die shops. We also

provide design and construction services for metal

manufacturing and chemical facilities.

Our Balance Sheet: Stronger,

Cleaner and Ready for Action
In 2007, our balance sheet and capital structure

underwent a transformation. In addition to the

highlights noted in the introduction to this letter,

speciﬁ c transactions and loan agreements are

set forth in our 2007 10-K. In summary, LSB now

has a balance sheet that not only supports current

operations, but gives us the ﬂ exibility to pursue

sound new business initiatives within our core

competencies.

At December 31, 2007, our total interest bearing

debt was $122.1 million, up $24.4 million compared

to year-end 2006. We also had cash and cash

equivalents on our books of $58.2 million, an

increase of $56 million from year-end 2006. Total

long-term debt at year-end 2007 included various

mortgages and equipment loans of $12.1 million and

a new $50 million secured term loan due 2012 which

(continued)

2007 Annual Report

replaced a previous loan of the same amount, under

products continues to grow. Our industrial chemical

far better terms and conditions. The ﬁ nal component

products are essential for many uses and our

of long-term debt, $60 million of 5.5% Convertible

agrochemicals are in high demand.

Debentures due 2012 placed mid-year 2007,

enabled us to redeem Class C, Series 2 Preferred

Since investors generally look at comparable quarter

Stock, repay certain mortgages and equipment

performance, we would like to point out that LSB’s

loans, and pay accrued and unpaid dividends on two

2007 effective tax rate was fairly insigniﬁ cant due to

classes of Preferred Stock.

the reversal of the valuation allowances on the net

operating loss carryforwards and other deferred tax

While funding operations and growth is our top

assets. The strong earnings of 2007 allowed us to

priority for cash, in the ﬁ rst quarter of 2008 our

utilize all but $2.9 million of our federal net operating

Board of Directors authorized management to

loss carryforward. We anticipate fully utilizing the

repurchase LSB shares, depending upon share

federal net operating loss carryforwards in 2008, and

price, alternate use of funds for other needs such as

we expect to pay federal income taxes at regular tax

business growth, capital investment, credit markets,

rates.

general economic outlook and other pertinent factors

at the time. 200,000 shares were repurchased

On behalf of the Board of Directors, we thank all

before the buying window closed, two weeks before

of those responsible for making 2007 the best

the end of the ﬁ rst quarter.

year in our history, especially our employees. The

Future Outlook
As LSB’s senior management and large

accomplishments of 2007 are due to consistently

ﬁ ne work of our entire team. We also appreciate the

support and cooperation of our fellow shareholders,

shareholders, we remain conﬁ dent in our Company’s

backed by their investment, in LSB.

future prospects, and we remain committed to its

long-term proﬁ table growth. We believe that we

are in the right place with the right climate control

products which address some of the major issues

of our times, mainly energy conservation and

environmental concerns. We dominate the niche

markets we serve, and our market share of key

Sincerely,

Jack E. Golsen
Chairman of the Board
& CEO

Barry H. Golsen
Vice Chairman of the
Board, President & COO

This letter contains certain forward-looking statements, including, but not limited to, signiﬁ cant growth potential for our geothermal products,
seasonal patterns of our Climate Control business, acquisition of additional land for expansion of our Climate Control business, new busi-
nesses within our Climate Control business, our Climate Control business is poised to take advantage of the geothermal market, expect to
optimize our sales within our Chemical business, market demands within our Chemical business, expansion of our Chemical business through
potential start up of an idled plant, future outlook and prospects for our company and fully utilizing our net operating loss in 2008. Please read
“A Special Note Regarding Forward-Looking Statements” contained in our 2007 Form 10-K for a discussion of a variety of factors which could
cause the future outcome to differ materially from the forward-looking statements contained in this letter.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

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

For the transition period from __________ to __________

Commission File Number: 1-7677

LSB INDUSTRIES, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware
(State of Incorporation)

16 South Pennsylvania Avenue
Oklahoma City, Oklahoma
(Address of Principal Executive Offices)

73-1015226
(I.R.S. Employer)
Identification No.)

73107
(Zip Code)

Registrant's Telephone Number, Including Area Code: (405) 235-4546

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class
Common Stock, Par Value $.10

Name of Each Exchange
On Which Registered
American Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act: Preferred Share Purchase Rights

(Facing Sheet Continued)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act. [ ] Yes [X] No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. [ ] Yes [X] No

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

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K
is not contained herein, and will not be contained, to the best of Registrant's knowledge, in
definitive proxy or information statements incorporated by reference in Part III of this Form 10-
K or any amendment to this Form 10-K. [ ]

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

Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]

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

The aggregate market value of the Registrant’s voting common equity held by non-affiliates of
the Registrant, computed by reference to the price at which the voting common stock was last
sold as of June 29, 2007, was approximately $272 million. As a result, the Registrant is an
accelerated filer as of December 31, 2007. For purposes of this computation, shares of the
Registrant’s common stock beneficially owned by each executive officer and director of the
Registrant and by Jayhawk Capital Management, L.L.C. and its affiliates were deemed to be
owned by affiliates of the Registrant as of June 29, 2007. Such determination should not be
deemed an admission that such executive officers, directors and other beneficial owners of our
common stock are, in fact, affiliates of the Registrant or affiliates as of the date of this Form 10-
K.

As of March 7, 2008 the Registrant had 21,106,292 shares of common stock outstanding
(excluding 3,448,518 shares of common stock held as treasury stock).

FORM 10-K OF LSB INDUSTRIES, INC.

TABLE OF CONTENTS

PART I

Item 1.

Business

Item 1A.

Risk Factors

Item 1B.

Unresolved Staff Comments

Item 2.

Properties

Item 3.

Legal Proceedings

Item 4.

Submission of Matters to a Vote of Security Holders

Item 4A.

Executive Officers of the Registrant

PART II

Item 5.

Market for Registrant’s Common Equity and Related Stockholder Matters

Item 6.

Selected Financial Data

Item 7.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 7A.

Quantitative and Qualitative Disclosures About Market Risk

Item 8.

Financial Statements and Supplementary Data

Item 9.

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A.

Controls and Procedures

Item 9B.

Other Information

Item 10.

Directors, Executive Officers and Corporate Governance

Item 11.

Executive Compensation

PART III

Page

FORM 10-K OF LSB INDUSTRIES, INC.

TABLE OF CONTENTS

Item 12.

Security Ownership of Certain Beneficial Owners and Management and Related
Stockholder Matters

Item 13.

Certain Relationships and Related Transactions, and Director Independence

Item 14.

Principal Accountant Fees and Services

Item 15.

Exhibits and Financial Statement Schedules

PART IV

Page

100

106

110

112

PART I

ITEM 1. BUSINESS

General

LSB Industries, Inc. (the "Company", “Registrant”, “LSB”, "We", "Us", or "Our") was formed in
1968 as an Oklahoma corporation, and became a Delaware corporation in 1977. We are a
diversified holding
Inc.
(“ThermaClime”) through its subsidiaries, owns substantially all of our core businesses
consisting of the:

company. Our wholly-owned

subsidiary, ThermaClime,

• Climate Control Business engaged in the manufacturing and selling of a broad range of
heating, ventilation and air conditioning (“HVAC”) products for the niche markets we
serve. These products are used in commercial and residential new building construction,
renovation of existing buildings and replacement of existing systems.

• Chemical Business engaged in the manufacturing and selling of chemical products
produced from plants in Texas, Arkansas and Alabama for the industrial, mining and
agricultural markets.

Certain statements contained in this Part I may be deemed to be forward-looking statements. See
"Special Note Regarding Forward-Looking Statements."

We believe our Climate Control Business has developed leadership positions in niche markets by
offering extensive product lines, customized products and improved technologies. Under this
focused strategy, we have developed what we believe to be the most extensive line of water
source heat pumps and hydronic fan coils in the United States. Further, we were a pioneer in the
use of geothermal technology in the climate control industry and have used it to create what we
believe to be the most energy efficient climate control systems commercially available today. We
employ highly flexible production capabilities that allow us to custom design units for new
construction markets and for the retrofit and replacement markets. Our products are currently
installed in some of the most recognizable commercial developments in the country, including
Prudential Tower, Rockefeller Plaza, Trump Tower, and Time Warner Center, and are slated to
be in a number of developments currently under construction. In addition, we have a significant
presence in the lodging industry with installations in numerous Hyatt, Marriott, Four Seasons,
Starwood, Ritz Carlton and Hilton hotels. We also have a substantial share of resort destinations
in Las Vegas where we have units installed in over 70,000 rooms for a number of premier
properties, including the MGM Grand, Luxor, Venetian, Treasure Island, Bellagio, Mandalay
Bay, Caesar’s Palace, Monte Carlo, Mirage, Golden Nugget, Hard Rock, Wynn resorts, and
many others.

Our Chemical Business has three chemical production facilities located in Baytown, Texas (the
“Baytown Facility”), El Dorado, Arkansas (the “El Dorado Facility”) and Cherokee, Alabama
(the “Cherokee Facility”). Our Chemical Business is a supplier to some of the world’s leading
chemical and industrial companies. By focusing on specific geographic areas, we have developed
freight and distribution advantages over many of our competitors, and we believe our Chemical
Business has established leading regional market positions, a key element in the success of this

business. The primary raw material feedstocks (natural gas, anhydrous ammonia and sulfur) of
the Chemical Business are commodities, subject to price fluctuations and are purchased at prices
in effect at time of purchase.

The Baytown Facility consumes approximately 125,000 tons of purchased anhydrous ammonia
per year. The majority of the Baytown Facility’s production is sold pursuant to a long-term
contract that provides for a pass-through of certain costs, including the anhydrous ammonia
costs, plus a profit.

The El Dorado Facility purchases approximately 220,000 tons of anhydrous ammonia and
40,000 tons of sulfur annually and produces and sells approximately 455,000 tons of nitrogen-
based products and approximately 120,000 tons of sulfuric acid per year. The anhydrous
ammonia is purchased pursuant to a supply agreement whereby the El Dorado Facility secures
the majority of its requirements of anhydrous ammonia from one supplier. Although anhydrous
ammonia is produced from natural gas, the price does not necessarily follow the spot-price of
natural gas in the U.S. because anhydrous ammonia is an internationally traded commodity and
the relative price is set in the world market while natural gas is primarily a nationally traded
commodity. The ammonia supply to the El Dorado Facility is transported from the Gulf of
Mexico by pipeline. Our cost of anhydrous ammonia is based upon formulas indexed to
published industry prices, primarily tied to import prices. Historically, the sulfur costs have been
relatively stable; however, the recent world sulfur shortages have led to significant increase in
the cost of this raw material.

The Cherokee Facility normally consumes 4 to 6 million MMBtu’s of natural gas annually and
produces and sells approximately 305,000 tons of nitrogen-based products per year. Natural gas
is a primary raw material for anhydrous ammonia. Natural gas costs continue to exhibit
volatility. In 2007 daily spot prices per MMBtu, excluding transportation, ranged from $5.30 to
$10.59.

Due to the uncertainty of the sales prices of our products in relation to the cost of sulfur,
anhydrous ammonia and natural gas, our Chemical Business has pursued a strategy of
developing customers that purchase substantial quantities of products pursuant to sales
agreements and/or pricing arrangements that provide for the pass through of these raw material
costs. These pricing arrangements help mitigate the commodity risk inherent in the raw material
feedstocks of natural gas, anhydrous ammonia and sulfur. For 2007, approximately 60% of the
Chemical Business’ sales were made pursuant to sales agreements and/or pricing arrangements
that pass-through the cost of these raw materials. The remaining sales are primarily into
agricultural markets at the price in effect at time of shipment. The sales prices of our agricultural
products have only a moderate correlation to the anhydrous ammonia and natural gas feedstock
costs and reflect market conditions for like and competing nitrogen sources. This can
compromise our ability to recover our full cost to produce the product in this market.
Additionally, the lack of sufficient non-seasonal sales volume to operate our manufacturing
facilities at optimum levels can preclude the Chemical Business from reaching full performance
potential. Our primary efforts to improve the results of our Chemical Business include
maintaining the current level of non-seasonal sales volumes with an emphasis on customers that
will accept the commodity risk inherent with natural gas and anhydrous ammonia, while
maintaining a strong presence in the agricultural sector.

Segment Information and Foreign and Domestic Operations and Export Sales

Schedules of the amounts of net sales, gross profit, operating income (loss) and identifiable
assets attributable to each of our lines of business and of the amount of our export sales in the
aggregate and by major geographic area for each of the last three years appear in Note 20 of the
Notes to Consolidated Financial Statements included elsewhere in this report.

Climate Control Business

General

Our Climate Control Business manufactures and sells a broad range of standard and custom
designed geothermal and water source heat pumps and hydronic fan coils as well as other
products for the niche markets we serve. These products are for use in commercial and
residential HVAC systems, including large custom air handlers and modular chiller systems. The
construction of commercial, institutional and residential buildings including multi and single-
family homes, the renovation of existing buildings and the replacement of existing HVAC
systems drive the demand for our Climate Control products. Our Climate Control commercial
products are used in a wide variety of buildings, such as hotels, motels, office buildings, schools,
universities, apartments, condominiums, hospitals, nursing homes, extended care facilities,
industrial and high tech manufacturing facilities, food and chemical processing facilities, and
pharmaceutical manufacturing facilities. We target many of our products to meet increasingly
stringent indoor air quality and energy efficiency standards.

The following table summarizes net sales information relating to our products of the Climate
Control Business:

Percentage of net sales of the Climate Control Business:

Geothermal and water source heat pumps
Hydronic fan coils
Other HVAC products

Percentage of our consolidated net sales:

Geothermal and water source heat pumps
Hydronic fan coils
Other HVAC products

Geothermal and Water Source Heat Pumps

2007

2006

2005

58 %
30 %
12 %
100 %

28 %
15 %
6 %
49 %

61 %
27 %
12 %
100 %

27 %
12 %
6 %
45 %

54 %
34 %
12 %
100 %

21 %
13 %
5 %
39 %

We believe we are a leading provider of geothermal and water source heat pumps to the
commercial construction and renovation markets in the United States. Water source heat pumps
are highly efficient heating and cooling products, which enable individual room climate control
through the transfer of heat through a water pipe system, which is connected to a centralized
cooling tower or heat injector. Water source heat pumps enjoy a broad range of commercial

applications, particularly in medium to large sized buildings with many small, individually
controlled spaces. We believe the market for commercial water source heat pumps will continue
to grow due to the relative efficiency and long life of such systems as compared to other air
conditioning and heating systems, as well as to the emergence of the replacement market for
those systems.

Our Climate Control Business has also developed the use of geothermal water source heat pumps
in residential and commercial applications. Geothermal systems, which circulate water and
antifreeze through an underground heat exchanger, are among the most energy efficient systems
available. We believe the longer life, lower cost to operate, and relatively short payback periods
of geothermal systems, as compared with air-to-air systems, will continue to increase demand for
our geothermal products. We specifically target new residential construction of moderate and
high-end multi and single-family homes, as well as commercial applications.

Hydronic Fan Coils

We believe that our Climate Control Business is a leading provider of hydronic fan coils. Our
Climate Control Business targets the commercial and institutional markets. Hydronic fan coils
use heated or chilled water, provided by a centralized chiller or boiler through a water pipe
system, to condition the air and allow individual room control. Hydronic fan coil systems are
quieter and have longer lives and lower maintenance costs than other comparable systems used
where individual room control is required. Important components of our strategy for competing
in the commercial and institutional renovation and replacement markets include the breadth of
our product line coupled with customization capability provided by a flexible manufacturing
process. The lodging and hospitality industry is a significant user of hydronic fan coils; however,
fan coils are used in a wide variety of applications.

Geothermal and Water Source Heat Pump and Hydronic Fan Coil Market

We estimate the annual United States market for water source heat pumps and hydronic fan coils
to be approximately $589 million based on data supplied by the Air-Conditioning and
Refrigeration Institute (“ARI”). Levels of repair, replacement, and new construction activity
generally drive demand in these markets.

Production and Backlog

We manufacture our products in many sizes and configurations, as required by the purchaser, to
fit the space and capacity requirements of hotels, motels, schools, hospitals, apartment buildings,
office buildings and other commercial or residential structures. In addition, most of these
customer orders are placed well in advance of required delivery dates.

During 2006 and 2007, we invested approximately $10.6 million in production and fabrication
equipment, plant-wide process control systems and other upgrades relating to our Climate
Control Business. In addition to the spending on equipment and systems, during 2006 and 2007,
we invested a total of approximately $3.8 million in facilities.

As a result of record order intake level of our heat pump products during 2006 and 2007, our
backlog of confirmed orders for these products had increased to high levels and our lead times
had pushed out beyond levels that we consider to be optimum for good customer service. In
order to work the backlog down and to improve product lead times, we have increased unit
capacity by approximately 65% (through additional shifts, overtime, investment in equipment,
and facilities) since the end of 2005, with the potential for a further increase in capacity by
debottlenecking and the addition of certain fabrication equipment. The facility expansion
included a new 46,000 square foot building next to our existing heat pump manufacturing facility
and the renovation of 110,000 square feet of an existing facility for a distribution center.

Our fan coil business also experienced significant increases in customer orders and shipments
during 2007 and was able to increase production capacity through increased utilization of second
shifts, equipment purchases, and the extension and reconfiguration of production assembly lines.
During 2007, we also made capital investments to substantially increase our capacity of tube-in-
fin heat transfer coils used in geothermal and water source heat pumps and hydronic fan coils.

For 2008, we have committed to date to spend an additional $3.2 million for production
equipment and land for future expansion. Our investment in the Climate Control Business will
continue if order intake levels continue to warrant. These investments have and will increase our
capacity to produce and distribute our Climate Control products.

As of December 31, 2007 and 2006, the backlog of confirmed orders for our Climate Control
Business was approximately $54.5 million and $80.4 million, respectively. The decrease in our
backlog relates primarily to utilizing the increased capacity discussed above. Our experience
indicates that customers generally do not cancel orders after we receive them. We expect to ship
substantially all the orders in the backlog within the next twelve months.

Marketing and Distribution

Distribution

Our Climate Control Business sells its products to mechanical contractors, original equipment
manufacturers (“OEMs”) and distributors. Our sales to mechanical contractors primarily occur
through independent manufacturers' representatives, who also represent complementary product
lines not manufactured by us. OEMs generally consist of other air conditioning and heating
equipment manufacturers who resell under their own brand name the products purchased from
our Climate Control Business in competition with us. The following table summarizes net sales
to OEMs relating to our products of the Climate Control Business:

Net sales to OEMs as a percentage of:

Net sales of the Climate Control Business
Consolidated net sales

19 %
9 %

17 %
8 %

22 %
9 %

2007

2006

2005

Market

Our Climate Control Business depends primarily on the commercial construction industry,
including new construction and the remodeling and renovation of older buildings, and on the
residential construction industry for both new and replacement markets relating to their
geothermal products.

Raw Materials

Numerous domestic and foreign sources exist for the materials used by our Climate Control
Business, which materials include compressors, steel, electric motors, valves and copper.
Periodically, our Climate Control Business enters into fixed-price copper contracts. We do not
anticipate any difficulties in obtaining necessary materials for our Climate Control Business. In
2008, however, changes in market volatility, supply and demand could result in increased costs,
lost production and/or delayed shipments. We believe the majority of cost increases, if any, will
be passed to our customers in the form of higher prices as product price increases are
implemented and take effect and while we believe we will have sufficient materials, a shortage
of raw materials could impact production of our Climate Control products.

Competition

Our Climate Control Business competes primarily with six companies, some of whom are also
our customers. Some of our competitors serve other markets and have greater financial and other
resources than we do. Our Climate Control Business manufactures a broader line of geothermal
and water source heat pump and fan coil products than any other manufacturer in the United
States, and we believe that we are competitive as to price, service, warranty and product
performance.

Continue to Introduce New Products

Our Climate Control Business will continue to launch new products and product upgrades in an
effort to maintain and increase our current market position and to establish a presence in new
markets.

Chemical Business

General

Our Chemical Business manufactures three principal product lines that are derived from natural
gas, anhydrous ammonia, and sulfur:

•

concentrated, blended and regular nitric acid, mixed nitrating acids, metallurgical grade
anhydrous ammonia, sulfuric acid, and high purity ammonium nitrate for industrial
applications,
anhydrous ammonia, fertilizer grade ammonium nitrate, urea ammonium nitrate
(“UAN”), and ammonium nitrate ammonia solution (“ANA”) for the agricultural
applications, and
industrial grade ammonium nitrate and solutions for the mining industry.

The following table summarizes net sales information relating to our products of the Chemical
Business:

Percentage of net sales of the Chemical Business:

Agricultural products
Industrial acids and other chemical products
Mining products

Percentage of our consolidated net sales:

Agricultural products
Industrial acids and other chemical products
Mining products

Agricultural Products

2007

2006

2005

41 %
33 %
26 %
100 %

20 %
16 %
13 %
49 %

34 %
37 %
29 %
100 %

18 %
19 %
16 %
53 %

35 %
34 %
31 %
100 %

21 %
20 %
18 %
59 %

Our Chemical Business produces ammonium nitrate at the El Dorado Facility and anhydrous
ammonia, UAN, and ANA at the Cherokee Facility; all of which are nitrogen based fertilizers.
The Cherokee Facility also has the ability to produce agricultural grade ammonium nitrate.
Although, to some extent, the various forms of nitrogen-based fertilizers are interchangeable,
each has its own characteristics, which produce agronomic preferences among end users.
Farmers and ranchers decide which type of nitrogen-based fertilizer to apply based on the crop
planted, soil and weather conditions, regional farming practices and relative nitrogen fertilizer
prices. Our agricultural markets include a high concentration of pastureland and row crops,
which favor our products. We sell these agricultural products to farmers, ranchers, fertilizer
dealers and distributors located in the Central and Southeastern United States, which are in
relatively close proximity to the El Dorado and Cherokee Facilities. We develop our market
position in these areas by emphasizing high quality products, customer service and technical
advice. During the past two years, we have been successful in expanding outside our traditional
markets by barging to distributors on the Tennessee and Ohio rivers, and by railing into certain
Western States. The El Dorado Facility produces a high performance ammonium nitrate fertilizer
that, because of its uniform size, is easier to apply than many competing nitrogen-based fertilizer
products. The El Dorado Facility establishes long-term relationships with end-users through its
network of wholesale and retail distribution centers and the Cherokee Facility sells directly to
agricultural customers.

Industrial Acids and Other Chemical Products

Our Chemical Business manufactures and sells industrial acids and other chemical products
primarily to the polyurethane, paper, fibers and electronics industries. We are a major supplier of
concentrated nitric acid and mixed nitrating acids, specialty products used in the manufacture of
fibers, gaskets, fuel additives, ordnance, and other chemical products. In addition, at the El
Dorado Facility, we produce and sell blended and regular nitric acid and we are a niche market
supplier of sulfuric acid, primarily to the region’s key paper manufacturers. At the Cherokee
Facility, we are also a niche market supplier of industrial and high purity ammonia for many
specialty applications, including chemicals to treat emissions from power plants.

We compete based upon service, price, location of production and distribution sites, product
quality and performance. We also believe we are the largest domestic merchant marketer of
concentrated and blended nitric acids and provide inventory management as part of the value-
added services offered to certain customers.

The Baytown Facility is one of the two largest nitric acid manufacturing units in the United
States, with demonstrated capacity exceeding 1,350 short tons per day. Subsidiaries within our
Chemical Business entered into a series of agreements with Bayer Corporation ("Bayer")
(collectively, the "Bayer Agreement"). Under the Bayer Agreement, El Dorado Nitric Company
("EDNC"), a subsidiary within our Chemical Business, operates the Baytown Facility at Bayer's
Baytown, Texas operation. Bayer purchases from EDNC all of its requirements for nitric acid at
its Baytown operation for a term through at least May 2009. EDNC purchases from Bayer certain
of its requirements for materials, utilities and services for the manufacture of nitric acid. Upon
expiration of the initial ten-year term in 2009, the Bayer Agreement may be renewed for up to
six renewal terms of five years each; however, prior to each renewal period, either party to the
Bayer Agreement may opt against renewal. Discussions with Bayer have begun regarding a
renewal in 2009.

Mining Products

Our Chemical Business manufactures industrial grade ammonium nitrate (“AN”) and 83% AN
solution for the mining industry. The El Dorado Facility is a party to a long-term cost-plus
supply agreement. Under this supply agreement, the El Dorado Facility supplies Orica USA, Inc.
(“Orica”) with a significant volume of industrial grade ammonium nitrate per year for a term
through at least December 2010, with provisions for renewal thereafter.

Major Customer

The following summarizes net sales to our major customer relating to our products of the
Chemical Business:

Net sales to Orica as a percentage of:

Net sales of the Chemical Business
Consolidated net sales

2007

2006

2005

19%
9%

20%
10%

19 %
11 %

Raw Materials

Anhydrous ammonia and natural gas represent the primary components in the production of most
of the products of our Chemical Business. Spot natural gas and anhydrous ammonia costs have
fluctuated dramatically in recent years. The following table shows, for the period indicated, the
high and low published prices for natural gas based upon the daily spot price at the Tennessee
500 pipeline pricing point and for ammonia based upon the low Tampa metric price per ton as
published by Ferticon and FMB Ammonia reports.

Daily Spot Natural Gas Prices Per MMBtu

Ammonia Price Per Metric Ton

2005
2006
2007

High
$15.25
$ 9.90
$10.59

Low
$5.50
$3.54
$5.30

High
$399
$395
$460

Low
$235
$270
$295

As of March 7, 2008, the published price of natural gas, as described above, was approximately
$9.61 per MMBtu and ammonia was $635 per metric ton. Natural gas is an integral raw material
in the production of anhydrous ammonia. Prices of raw material feedstocks of natural gas and
anhydrous ammonia remain volatile, and we have pursued a strategy of developing customers
that purchase substantial quantities of products pursuant to sales agreements and/or pricing
formulas that provide for the pass-through of these raw material costs. These pricing
arrangements provide a hedge against the commodity risk inherent in the raw material feedstocks
of natural gas and anhydrous ammonia. In addition, we use exchange-traded futures contracts to
hedge the natural gas requirements for most sales commitments with firm sales prices.

Interruptions to the natural gas supply chain by the hurricanes of 2005 continued to exacerbate
natural gas prices into early 2006. The Cherokee Facility was forced to temporarily curtail
production in January and February of 2006 when major customers reduced purchases due to the
high natural gas raw material pass-through costs. By mid-2006, the Gulf of Mexico supply was
back to approximately 90% of pre-hurricane levels based on a report from the U.S. Department
of the Interior. During 2007, the Cherokee Facility did not curtail production due to interruptions
to their natural gas supply chain.

Under an agreement, as amended, with its principal supplier of anhydrous ammonia, the El
Dorado Facility will purchase a majority of its anhydrous ammonia requirements using a market
price-based formula plus transportation to the El Dorado Facility through at least December 31,
2008. We believe that we can obtain anhydrous ammonia from other sources in the event of an
interruption of service under the above-referenced contract. The Cherokee Facility’s natural gas
feedstock requirements are generally purchased at spot market price. Periodically, the Cherokee
Facility will hedge certain of its natural gas requirements with exchange-traded futures contracts
as discussed above.

Historically, the sulfur costs have been relatively stable; however, as of the date of this report,
the recent world sulfur shortages have led to a significant increase in the cost of this raw material
during the second half at 2007 and into 2008.

Seasonality

We believe that the only seasonal products of our Chemical Business are fertilizer and related
chemical products sold to the agricultural industry. The selling seasons for those products are
primarily during the spring and fall planting seasons, which typically extend from March through
June and from September through November in the geographical markets in which the majority
of our agricultural products are distributed. As a result, our Chemical Business increases its
inventory of ammonium nitrate and UAN prior to the beginning of each planting season. In
addition, the amount and timing of sales to the agricultural markets depend upon weather
conditions and other circumstances beyond our control.

Regulatory Matters

Our Chemical Business is subject to extensive federal, state and local environmental laws, rules
and regulations as discussed under “Environmental Matters" of this Item and "Legal
Proceedings" of Item 3.

Because of growing concerns over ammonium nitrate, other nitrogen fertilizers and other
potentially hazardous materials, there have been new and proposed federal, state and industry
requirements to place additional security controls over the distribution, transportation and
handling of these products. Based on our current requirements, we believe there are no material
capital expenditures to be expended relating to our security controls. However, this expectation
could change in the near future.

We fully support these initiatives and believe they will not materially affect the viability of
ammonium nitrate as a valued product to the agricultural industry.

Competition

Our Chemical Business competes with several chemical companies in our markets, such as CF
Industries, Dyno Nobel North America, Terra Industries and Potash Corp. of Saskatchewan,
many of whom have greater financial and other resources than us. We believe that competition
within the markets served by our Chemical Business is primarily based upon service, price,
location of production and distribution sites, and product quality and performance.

Employees

As of December 31, 2007, we employed 1,788 persons. As of that date, our Climate Control
Business employed 1,363 persons, none of whom was represented by a union, and our Chemical
Business employed 360 persons, with 138 represented by unions under currently unexecuted
negotiated agreements which the parties expect to execute in the near future. Assuming the union
agreements are executed in their current form, the agreements will expire in July through
November of 2010.

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 material costs or liabilities will not be
incurred by us 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.

The Company has certain facilities in our Chemical Business that contain asbestos insulation
around certain piping and heated surfaces. The asbestos insulation is in adequate condition to
prevent leakage and can remain in place as long as the facility is operated or remains assembled.
The Company plans to maintain the facilities in an adequate condition to prevent leakage through
its standard repair and maintenance activities.

1. Discharge Water Matters

The El Dorado Facility within our Chemical Business generates process wastewater. The process
water discharge and storm-water run off are governed by a state National Pollutant Discharge
Elimination System (“NPDES”) water discharge permit issued by the Arkansas Department of
Environmental Quality (“ADEQ”), which permit is to be renewed every five years. The ADEQ
issued to the El Dorado Facility a NPDES water discharge permit in 2004, and the El Dorado
Facility had until June 1, 2007 to meet the compliance deadline for the more restrictive limits
under the 2004 NPDES permit. In order to meet the El Dorado Facility’s June 2007 limits, the El
Dorado Facility has significantly reduced the contaminant levels of its wastewater.

The El Dorado Facility has demonstrated its ability to comply with the more restrictive permit
limits, and the rules which support the more restrictive dissolved minerals rules have been
revised to authorize a permit modification to adopt achievable dissolved minerals permit limits.
The ADEQ has agreed to issue a consent administrative order to authorize the El Dorado Facility
to continue operations without incurring permit violations pending the modification of the permit
to implement the revised rule and to dispose of the El Dorado Facility’s wastewater into the
creek adjacent to the El Dorado Facility. A draft of the proposed consent administrative order
has been prepared by the ADEQ and submitted to the El Dorado Facility for review. We are
currently reviewing the proposed consent administrative order.

To meet the June 2007 permit limits, the El Dorado Facility has conducted a study of the creek
adjacent to the El Dorado Facility to determine whether a permit modification allowing for the
discharge into the creek is appropriate. On September 22, 2006, the Arkansas Pollution Control
and Ecology Commission approved the results of the study that showed that the proposed permit
modification is appropriate and the proposal to allow the El Dorado Facility to dispose of its
wastewater into the creek. A public hearing was held on the matter on November 13, 2006 with
minimal opposition. As a result, the El Dorado Facility has been discharging its wastewater into
the creek.

new CAO and based upon the risk assessment. As an interim measure, the El Dorado Facility has
installed two recovery wells to recycle groundwater and to recover nitrates. The cost of any
additional remediation that may be required will be determined based on the results of the
investigation and risk assessment and cannot currently be reasonably estimated. Therefore, no
liability has been established at December 31, 2007.

2. Air Matters

Under the terms of a consent administrative order relating to air matters (“AirCAO”), which
became effective in February 2004, resolving certain air regulatory alleged violations associated
with the El Dorado Facility’s sulfuric acid plant and certain other alleged air emission violations,
the El Dorado Facility is required to implement additional air emission controls at the El Dorado
Facility no later than February 2010. We currently estimate the remaining environmental
compliance related expenditures to be approximately $5.6 million, which has been committed for
2008.

In December 2006, the El Dorado Facility entered into a new CAO (“2006 CAO”) with the
ADEQ to resolve a problem with ammonia emissions from certain nitric acid units. The catalyst
suppliers had represented the volume of ammonia emissions anticipated. The representation was
the basis for the permitted emission limit, but the representation of the catalyst suppliers was not
accurate. The ADEQ allowed the El Dorado Facility to re-evaluate the catalyst performance and
required the El Dorado Facility to submit a permit modification with the appropriate ammonia
limits. The permit modification was submitted to ADEQ on June 11, 2007, and is currently
under review. Until the permit is modified, the 2006 CAO authorizes the El Dorado Facility to
continue to operate certain nitric acid units (even though the El Dorado Facility is in non-
compliance with the permitted emission limit for ammonia), provided that during this period of
time, the El Dorado Facility monitors and reports the ammonia on a monthly basis.

3. Other Environmental Matters

In April 2002, Slurry Explosive Corporation (“Slurry”), later renamed Chemex I Corp., a
subsidiary within our Chemical Business, entered into a Consent Administrative Order (“Slurry
Consent Order”) with the Kansas Department of Health and Environment (“KDHE”), regarding
Slurry’s Hallowell, Kansas manufacturing facility (“Hallowell Facility”). The Slurry Consent
Order addressed the release of contaminants from the facility into the soils and groundwater and
surface water at the Hallowell Facility. There are no known users of the groundwater in the area.
The adjacent strip pit is used for fishing. Under the terms of the Slurry Consent Order, Slurry is
required to, among other things, submit an environmental assessment work plan to the KDHE for
review and approval, and agree with the KDHE as to any required corrective actions to be
performed at the Hallowell Facility.

However, Slurry retained the obligation to be responsible for, and perform the activities under,
the Slurry Consent Order. In addition, certain of our subsidiaries agreed to indemnify the buyer
of such assets for these environmental matters. The successor (“Chevron”), the prior owner of
the Hallowell Facility has agreed, within certain limitations, to pay and has been paying one-half
of the costs incurred under the Slurry Consent Order subject to reallocation.

Based on additional modeling of the site, Slurry and Chevron are pursuing a course with the
KDHE of long-term surface and ground water monitoring to track the natural decline in
contamination, instead of the soil excavation proposed previously. On September 12, 2007, the
KDHE approved our proposal to perform two years of surface and groundwater monitoring and
to implement a Mitigation Work Plan to acquire additional field data in order to more accurately
characterize the nature and extent of contaminant migration off-site. The two-year monitoring
program will terminate in February 2009. As a result of receiving approval from the KDHE for
our proposal, we recognized a reduction in our share of the estimated costs associated with this
remediation by $377,000. This reduction is included in the net income from discontinued
operations of $348,000 for 2007 (in accordance with Statement of Financial Accounting
Standards (“SFAS”) 144.

At December 31, 2007, the total estimated liability (which is included in current and noncurrent
accrued and other liabilities) in connection with this remediation matter is approximately
$378,000 and Chevron’s share for these costs (which is included in accounts receivable and other
assets) is approximately $194,000. These amounts are not discounted to their present value. It is
reasonably possible that a change in estimate of our liability and receivable will occur in the near
term.

ITEM 1A. RISK FACTORS

Risks Related to Us and Our Business

Cost and the lack of availability of raw materials could materially affect our profitability
and liquidity.

Our sales and profits are heavily affected by the costs and availability of primary raw materials.
These primary raw materials, which are purchased from unrelated third parties, are subject to
considerable price volatility. Historically, when there have been rapid increases in the cost of
these primary raw materials, we have sometimes been unable to timely increase our sales prices
to cover all of the higher costs incurred. While we periodically enter into exchange-traded
futures contracts to hedge against price increases in certain of these raw materials, there can be
no assurance that we will effectively manage against price fluctuations in those raw materials.

Anhydrous ammonia and natural gas represent the primary raw material feedstocks in the
production of most of the products of the Chemical Business. Although our Chemical Business
has a program to enter into contracts with certain customers that provide for the pass-through of
raw material costs, we have a substantial amount of sales that do not provide for the pass-through
of raw material costs. In addition, the Climate Control Business depends on raw materials such
as copper and steel, which have shown considerable price volatility. As a result, in the future, we
may not be able to pass along to all of our customers the full amount of any increases in raw

material costs. There can be no assurance that future price fluctuations in our raw materials will
not have an adverse effect on our financial condition, liquidity and results of operations.

Additionally, we depend on certain vendors to deliver the primary raw materials and other key
components that are required in the production of our products. Any disruption in the supply of
the primary raw materials and other key components could result in lost production or delayed
shipments. We have suspended in the past, and could suspend in the future, production at our
chemical facilities due to, among other things, the high cost or lack of availability of such
primary raw materials. Accordingly, our financial condition, liquidity and results of operations
could be materially affected in the future by the lack of availability of primary raw materials and
other key components.

Periodically, our Chemical Business may not generate significant positive cash flows.

Due, in part, to extensive capital expenditures, our Chemical Business may not generate
significant positive cash flows periodically. Continuing significant cash flow expenditures by
this business could have a material adverse effect on our financial condition and liquidity.

Our Climate Control and Chemical Businesses and their customers are sensitive to certain
economic cycles.

Our Climate Control Business can be affected by cyclical factors, such as interest rates, inflation
and economic downturns. Our Climate Control Business depends on sales to customers in the
commercial construction and renovation industries, which are particularly sensitive to these
factors. A decline in the economic activity in the United States has in the past, and could in the
future, have a material adverse effect on our customers in the commercial construction and
renovation industries in which our Climate Control Business sells a substantial amount of its
products. Such a decline could result in a decrease in revenues and profits, and an increase in bad
debts, in our Climate Control Business.

Our Chemical Business also can be affected by cyclical factors such as inflation, global energy
policy and costs, global market conditions and economic downturns in specific industries.
Certain sales of our Chemical Business are sensitive to the level of activity in the agricultural,
mining, automotive and housing industries. A decline in the activity in these industries in the
United States has in the past, and could in the future, have a material adverse effect on the results
of our Chemical Business.

Weather conditions adversely affect our Chemical Business.

The agricultural products produced and sold by our Chemical Business have in the past, and
could in the future, to be materially affected by adverse weather conditions (such as excessive
rains or drought) in the primary markets for our fertilizer and related agricultural products. If any
of these unusual weather events occur during the primary seasons for sales of our agricultural
products (March-June and September-November), this could have a material adverse effect on
the agricultural sales of our Chemical Business and our financial condition and results of
operation.

Environmental and regulatory matters entail significant risk for us.

As discussed under “Environmental Matters” of Item 1, our Chemical Business is subject to
numerous environmental laws and regulations. The manufacture and distribution of chemical
products are activities, which entail environmental risks and impose obligations under
environmental laws and regulations, many of which provide for substantial fines and potential
criminal sanctions for violations. Our Chemical Business has in the past, and may in the future,
be subject to fines, penalties and sanctions for violations of environmental laws and substantial
expenditures for cleanup costs and other liabilities relating to the handling, manufacture, use,
emission, discharge or disposal of effluents at or from the Chemical Business’ facilities. Further,
a number of our Chemical Business’ facilities are dependent on environmental permits to
operate, the loss or modification of which could have a material adverse effect on its operations
and our financial condition.

We may be required to expand our security procedures and install additional security
equipment for our Chemical Business in order to comply with the Homeland Security Act
of 2002 and possible future government regulation.

The chemical industry in general, and producers and distributors of ammonium nitrate
specifically, are scrutinized by the government, industry and public on security issues. Under the
Homeland Security Act of 2002, as well as current and proposed regulations, we may be required
to incur substantial additional costs relating to security at our chemical facilities, distribution
centers, and our customers, as well as in the transportation of our products. These costs could
have a material impact on our financial condition and results of operation. The cost of such
regulatory changes, if significant enough, could lead some of our customers to choose alternate
products to ammonium nitrate, which would have a significant impact on our Chemical
Business.

A substantial portion of our sales is dependent upon a limited number of customers.

During 2007, four customers of our Chemical Business accounted for 44% of its net sales and
22% of our consolidated sales, and our Climate Control Business had one customer that
accounted for 17% of its net sales and 8% of our consolidated sales. The loss of, or a material
reduction in purchase levels by, one or more of these customers could have a material adverse
effect on our business and our results of operations, financial condition and liquidity if we are
unable to replace a customer on substantially similar terms.

There is intense competition in the Climate Control and Chemical industries.

Substantially all of the markets in which we participate are highly competitive with respect to
product quality, price, design innovations, distribution, service, warranties, reliability and
efficiency. We compete with a number of established companies that have greater financial,
marketing and other resources. Competitive factors could require us to reduce prices or increase
spending on product development, marketing and sales that would have a material adverse effect
on our business, results of operation and financial condition.

We are effectively controlled by the Golsen Group.

Jack E. Golsen, our Chairman of the Board and Chief Executive Officer (“CEO”), members of
his immediate family (spouse and children), including Barry H. Golsen, our Vice Chairman and
President, entities owned by them and trusts for which they possess voting or dispositive power
as trustee (collectively, the “Golsen Group”) beneficially owned as of February 29, 2008, an
aggregate of 3,395,743 shares of our common stock and 1,020,000 shares of our voting preferred
stock (1,000,000 of which shares have .875 votes per share, or 875,000 votes), which together
votes as a class and represent approximately 19.5% of the voting power of our issued and
outstanding voting securities as of that date.
In addition, the Golsen Group also beneficially
owned options and other convertible securities that allowed its members to acquire an additional
116,500 shares of our common stock within 60 days of February 29, 2008. Thus, the Golsen
Group may be considered to effectively control us. As a result, the ability of other stockholders
to influence our management and policies could be limited.

Loss of key personnel could negatively affect our business.

We believe that our performance has been and will continue to be dependent upon the efforts of
our principal executive officers. We cannot promise you that our principal executive officers will
continue to be available. Jack E. Golsen has an employment agreement with us. No other
principal executive has an employment agreement with us. The loss of some of our principal
executive officers could have a material adverse effect on us. We believe that our future success
will depend in large part on our continued ability to attract and retain highly skilled and qualified
personnel.

We may have inadequate insurance.

liability

insurance,

While we maintain
including certain coverage for environmental
contamination, it is subject to coverage limits and policies may exclude coverage for some types
of damages (which may include warranty and product liability claims). Although there may
currently be sources from which such coverage may be obtained, it may not continue to be
available to us on commercially reasonable terms or the possible types of liabilities that may be
incurred by us may not be covered by our insurance. In addition, our insurance carriers may not
be able to meet their obligations under the policies or the dollar amount of the liabilities may
exceed our policy limits. Even a partially uninsured claim, if successful and of significant
magnitude, could have a material adverse effect on our business, results of operations, financial
condition and liquidity.

We have not paid dividends on our outstanding common stock in many years.

We have not paid cash dividends on our outstanding common stock in many years, and we do
not currently anticipate paying cash dividends on our outstanding common stock in the
foreseeable future. However, our board of directors has not made a definitive decision whether or
not to pay such dividends in 2008.

Terrorist attacks and other acts of violence or war, and natural disasters (such as
hurricanes, pandemic health crisis, etc.), have and could negatively impact the U.S. and
foreign companies, the financial markets, the industries where we operate, our operations
and profitability.

Terrorist attacks and natural disasters (such as hurricanes) have in the past, and can in the future,
negatively affect our operations. We cannot predict further terrorist attacks and natural disasters
in the United States and elsewhere. These attacks or natural disasters have contributed to
economic instability in the United States and elsewhere, and further acts of terrorism, violence,
war or natural disasters could further affect the industries where we operate, our ability to
purchase raw materials, our business, results of operations and financial condition. In addition,
terrorist attacks and natural disasters may directly impact our physical facilities, especially our
chemical facilities, or those of our suppliers or customers and could impact our sales, our
production capability and our ability to deliver products to our customers. In the past, hurricanes
affecting the Gulf Coast of the United States have resulted in damages to, or shutdown of, the
gas pipeline to the Cherokee Facility, resulting in that facility being shutdown for several weeks.
The consequences of any terrorist attacks or hostilities or natural disasters are unpredictable, and
we may not be able to foresee events that could have an adverse effect on our operations.

Restatements and amendments to our 2004 audited financial statements and certain
matters related to our disclosure controls and procedures may present a risk of future
restatements and could in turn lead to legal exposure.

In response to comments from the Securities and Exchange Commission (“SEC”) to our 2004
Form 10-K, and as a result of changes we made internally, we restated and amended our 2004
audited financial statements and on December 30, 2005, filed a Form 10-K/A (Amendment No.
1) for year ended December 31, 2004. As a result of the restatement and amendments to our
2004 audited financial statements and SEC comments, we also filed on December 30, 2005, an
amended Form 10-Q/A for each of the quarters ended March 31, 2005 and June 30, 2005.

As a result of this restatement to our 2004 financial statements, we also revised our 2004 Form
10-K and first two quarters 2005 Form 10-Qs to provide that our disclosure controls and
procedures were not effective as of December 31, 2004, March 31, 2005 and June 30, 2005, in
our Form 10-K/A and Forms 10-Q/A, as a result of assessing that the change from the LIFO
method to the FIFO method of accounting was not material resulting in the decision at the time
of the change not to disclose and not to restate the prior years financial statements. We believe
that during December 2005, we corrected the weakness to our disclosure controls and procedures
by, among other things, establishing a Disclosure Committee to maintain oversight activities and
to examine and reevaluate our policies, procedures and criteria to determine materiality of items
relative to our financial statements taken as a whole. Restatements by others have, in some cases,
resulted in the filing of class action lawsuits against such companies and their management and
further inquiries from the SEC. Any similar lawsuit against us could result in substantial defense
and/or liability costs and would likely consume a material amount of management’s attention
that might otherwise be applied to our business. Under certain circumstances, these costs might
not be covered by, or might exceed the limits of, our insurance coverage.

By letter received in August 2006 from the SEC, the SEC has made an informal inquiry of us
relating to the change in inventory accounting from LIFO to FIFO resulting in the restatement of
our financial statements, and, at this time, we do not know if the informal inquiry:

• will rise to the level of an investigation or proceeding, or
• will result in an enforcement action, if any, by the SEC.

We are a holding company and depend, in large part, on receiving funds from our
subsidiaries to fund our indebtedness.

Because we are a holding company and operations are conducted through our subsidiaries,
principally ThermaClime and its subsidiaries, our ability to make scheduled payments of
principal and interest on our indebtedness depend on operating performance and cash flows of
our subsidiaries and the ability of our subsidiaries to make distributions and pay dividends to us.
Under its loan agreements, ThermaClime and its subsidiaries may only make distributions and
pay dividends to us under limited circumstances and in limited amounts. If ThermaClime is
unable to make distributions or pay dividends to us, or the amounts of such distributions or
dividends are not sufficient for us to service our debts, we may not be able to pay the principal or
interest, or both, due on our indebtedness.

Our net operating loss carryforwards are subject to certain limitations and have not been
audited or approved by the Internal Revenue Service.

Our net operating loss (“NOL”) carryforwards have resulted from certain historical losses. At
December 31, 2006, we had regular NOL carryforwards of approximately $49.9 million, all of
which we have utilized or anticipate utilizing to reduce our federal income tax liability for 2007
and 2008. In future periods, our net income and liquidity will be negatively affected as we
recognize and pay income taxes without the benefit of these NOL carryforwards. In addition, the
amount of these NOL carryforwards utilized has not been audited or approved by the Internal
Revenue Service.

Future issuance or potential issuance of our common stock could adversely affect the price
of our common stock, our ability to raise funds in new stock offerings and dilute your
percentage interest in our common stock.

Future sales of substantial amounts of our common stock or equity-related securities in the public
market, or the perception that such sales could occur, could adversely affect prevailing trading
prices of our common stock and could impair our ability to raise capital through future offerings
of equity or equity-related securities. No prediction can be made as to the effect, if any, that
future sales of shares of common stock or the availability of shares of common stock for future
sale, will have on the trading price of our common stock. Such future sales could also
significantly reduce the percentage ownership of our existing common stockholders.

We are subject to a variety of factors that could discourage other parties from attempting
to acquire us.

Our certificate of incorporation provides for a staggered board of directors and, except in limited
circumstances, a two-thirds vote of outstanding voting shares to approve a merger, consolidation
or sale of all, or substantially all, of our assets. In addition, we have entered into severance
agreements with our executive officers and some of the executive officers of our subsidiaries that
provide, among other things, that if, within a specified period of time after the occurrence of a
change in control of our company, these officers are terminated, other than for cause, or the
officer terminates his employment for good reason, we must pay such officer an amount equal to
2.9 times the officer’s average annual gross salary for the last five years preceding the change in
control.

We have authorized and unissued (including shares held in treasury) 53,982,012 shares of
common stock and 4,229,415 shares of preferred stock as of December 31, 2007. These unissued
shares could be used by our management to make it more difficult, and thereby discourage an
attempt to acquire control of us.

We have adopted a preferred share purchase plan, which is designed to ensure that all of our
stockholders receive fair and equal treatment in the event of a proposed takeover or abusive
tender offer.

The foregoing provisions and agreements are designed to discourage a third party tender offer or
proxy contest for control of us and could have the effect of making it more difficult to remove
incumbent management.

Delaware has adopted an anti-takeover law which, among other things, will delay for three years
business combinations with acquirers of 15% or more of the outstanding voting stock of
publicly-held companies (such as us), unless (a) the acquirer owned at least 85% of the
outstanding voting stock of such company prior to commencement of the transaction, or (b) two-
thirds of the stockholders, other than the acquirer, vote to approve the business combination after
approval thereof by the board of directors, and (c) the stockholders decide to opt out of the
statute.

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

ITEM 2. PROPERTIES

Climate Control Business

Our Climate Control Business manufactures most of its heat pump products in a 270,000 square
foot facility in Oklahoma City, Oklahoma. We lease this facility, with an option to buy, through
May 2016, with options to renew for three additional five-year periods. For 2007, approximately
87% of the productive capacity of this manufacturing facility was being utilized, based primarily
on two ten-hour shifts per day and a four-day work week. In addition, we acquired a new 46,000

square foot building adjacent to our existing heat pump manufacturing facility, primarily used for
storage of raw material inventory, and we renovated 110,000 square feet of an existing facility
for a distribution center.

Our Climate Control Business conducts its fan coil manufacturing operation in a facility located
in Oklahoma City, Oklahoma, consisting of approximately 265,000 square feet. We own this
facility subject to a mortgage. For 2007, our Climate Control Business was using 87% of the
productive capacity, based on one ten-hour shift per day and a four-day work week and a limited
second shift in selected areas. The fan coil manufacturing operation increased the utilization of a
second shift in order to increase its production capacity during 2007.

Our Climate Control Business conducts its large air handler manufacturing operation in a facility
located in Oklahoma City, Oklahoma, consisting of approximately 110,000 square feet. We own
this facility subject to a mortgage. For 2007, approximately 57% of the productive capacity of
this manufacturing facility was being utilized, based on one eight-hour shift on a five-day work
week and a partial second shift in selected areas.

All of the properties utilized by our Climate Control Business are considered by our management
to be suitable to meet the current needs of that business.

Chemical Business

Our Chemical Business primarily conducts manufacturing operations (a) on 150 acres of a 1,400
acre tract of land located at the El Dorado Facility, (b) on 160 acres of a 1,300 acre tract of land
located at the Cherokee Facility and (c) on leased property within Bayer’s complex in the
Baytown, Texas. The Company and/or its subsidiaries own all of its manufacturing facilities
except the Baytown Facility. The Baytown Facility is leased pursuant to a long-term lease with
an unrelated third party. Certain real property and equipment located at the El Dorado and
Cherokee Facilities are being used to secure a $50 million term loan. For 2007, the following
facilities were utilized based on continuous operation:

Percentage of
Capacity

El Dorado Facility (1)
Cherokee Facility (2)
Baytown Facility

92 %
95 %
91 %

(1) The percentage of capacity for the El Dorado Facility relates to its nitric acid capacity. The El
Dorado Facility has capacity to produce other nitrogen products in excess of its nitric acid
capacity.

(2) The percentage of capacity for the Cherokee Facility relates to its ammonia production
capacity. The Cherokee Facility has additional capacity for nitric acid, ammonium nitrate and
urea in excess of its ammonia capacity.

In addition to the El Dorado and Cherokee Facilities, our Chemical Business distributes its
agricultural products through 15 wholesale and retail distribution centers, with 13 of the centers
located in Texas (10 of which we own and 3 of which we lease); 1 center located in Tennessee
(owned); and 1 center located in Missouri (owned).

All of the properties utilized by our Chemical Business are considered by our management to be
suitable and adequate to meet the current needs of that business.

ITEM 3. LEGAL PROCEEDINGS

1. Environmental See “Business-Environmental Matters” for a discussion as to:

•

certain environmental matters relating to air and water issues at our El Dorado Facility;
and
certain environmental remediation matters at our former Hallowell Facility.

2. Other

Zeller Pension Plan

In February 2000, the Company’s board of directors authorized management to proceed with the
sale of the automotive products business, since the automotive products business was no longer a
“core business” of the Company. In May 2000, the Company sold substantially all of its assets in
its automotive products business. After the authorization by the board, but prior to the sale, the
automotive products business purchased the assets and assumed certain liabilities of Zeller
Corporation (“Zeller”). The liabilities of Zeller assumed by the automotive products business
included Zeller’s pension plan, which is not a multi-employer pension plan. In June 2003, the
principal owner (“Owner”) of the buyer of the automotive products business was contacted by a
representative of the Pension Benefit Guaranty Corporation (“PBGC”) regarding the plan. The
Owner was informed by the PBGC of a possible under-funding of the plan and a possible
takeover of the plan by the PBGC. The PBGC previously advised the Company that the PBGC
may consider the Company potentially liable for the under-funding of the Zeller Plan in the event
that the plan is taken over by the PBGC and alleged that the under-funding is approximately
$600,000. Our ERISA counsel has advised us that, based on certain assumptions and
representations made by us to them, they believe that the possibility of an unfavorable non-
appealable verdict against us in a lawsuit if the PBGC attempts to hold us liable for under-
funding of the Zeller Plan is remote.

MEI Drafts

Masinexportimport Foreign Trade Company (“MEI”) has given notice to the Company and
Summit Machine Tool Manufacturing Corp. (“Summit”), a subsidiary of the Company, alleging
that it was owed $1,533,000 in connection with MEI’s attempted collection of ten non-negotiable
bank drafts payable to the order of MEI. The bank drafts were issued by Aerobit Ltd.
(“Aerobit”), a non-U.S. company, which at the time of issuance of the bank drafts, was a
subsidiary of the Company. Each of the bank drafts has a face value of $153,300, for an
aggregate principal face value of $1,533,000. The bank drafts were issued in September 1992,
and had a maturity date of December 31, 2001. Each bank draft was endorsed by LSB Corp.,
which at the time of endorsement, was a subsidiary of the Company.

On October 22, 1990, a settlement agreement between the Company, Summit, and MEI (the
“Settlement Agreement”), was entered into, and in connection with the Settlement Agreement,
Summit issued to MEI obligations totaling $1,533,000. On May 16, 1992, the Settlement
Agreement was rescinded by the Company, Summit, and MEI at the request of MEI, and
replaced with an agreement purportedly substantially similar to the Settlement Agreement
between MEI and Aerobit, pursuant to which MEI agreed to replace the original $1,533,000 of
Summit’s obligations with Aerobit bank drafts totaling $1,533,000, endorsed by LSB Corp.
Aerobit previously advised us that MEI has not fulfilled the requirements under the bank drafts
for payment thereof. All of the Company’s ownership interest in LSB Corp. was sold to an
unrelated third party in September 2002. Further, all of the Company’s interest in Aerobit was
sold to a separate unrelated third party, in a transaction completed on or before November 2002.
Accordingly, neither Aerobit, which was the issuer of the bank drafts, nor LSB Corp., which was
the endorser of the bank drafts, are currently subsidiaries of the Company.

During 2007, Cromus, alleged to be a Romanian company and an assignee of MEI, filed a
lawsuit against us and two of our subsidiaries, Summit Machine Tool Manufacturing Corp.
(“Summit”) and Hercules Energy Mfg. Corp., Jack Golsen, our CEO, Mike Tepper, an officer of
our company, Bank of America Corporation and others in the New York Supreme Court, in the
case styled Cromus, as the assignee of MEI vs. Summit, Index No. 114890107 (NY Sup. Ct., NY
Co. The complaint seeks $1,533,000 plus interest from 1990, $1,000,000 for failure to purchase
certain equipment and $1,000,000 in punitive damages. We intend to contest this matter
vigorously. As of December 31, 2007, no liability has been established relating to these alleged
damages.

The Jayhawk Group and the University of Kansas Endowment Fund

During July 2007, we mailed to all holders of record of our Series 2 Preferred a notice of
redemption of all of the outstanding shares of Series 2 Preferred. The redemption of our Series 2
Preferred was completed on August 27, 2007, the redemption date. The terms of the Series 2
Preferred required that for each share of Series 2 Preferred so redeemed, we would pay, in cash,
a redemption price equal to $50.00 plus $26.25 representing dividends in arrears thereon pro-rata
to the date of redemption. There were 193,295 shares of Series 2 Preferred outstanding, net of
treasury stock, as of the date the notice of redemption was mailed. Pursuant to the terms of the
Series 2 Preferred, the holders of the Series 2 Preferred could convert each share into 4.329
shares of our common stock, which right to convert terminated 10 days prior to the redemption
date. If a holder of the Series 2 Preferred elected to convert his, her or its shares into our
common stock pursuant to its terms, the Certificate of Designations for the Series 2 Preferred
provided, and it is our position, that the holder that so converts would not be entitled to receive
payment of any dividends in arrears on the shares so converted. The Jayhawk Group, a former
affiliate of ours, converted 155,012 shares of Series 2 Preferred into 671,046 shares of common
stock. The Jayhawk Group has advised us that it may bring legal action against us for all
dividends in arrears (approximately $4 million) on the shares of Series 2 Preferred that it
converted after receipt of the notice of redemption. The Company believes the likelihood that the
Jayhawk Group may recover the dividends in arrears is not probable. Therefore, no liability has
been established at December 31, 2007.

During the first quarter of 2008, the University of Kansas Endowment Charitable Gift Fund
(“KU”) filed a lawsuit against us in the U.S. District Court, for the District of Kansas at Kansas
City, styled The KU Endownment Charitable Gift Fund vs. LSB Industries, Inc., Case No.
08-CV-2066. KU alleges that we improperly refused to accept 11,200 shares of Series 2
Preferred, which KU received as a gift from the controlling party of the Jayhawk Group, in our
issuer exchange tender offer. Under the issuer exchange tender offer, we offered to exchange
each outstanding share of Series 2 Preferred for 7.4 shares of our common stock and a waiver of
all dividends in arrears, except for certain shares of Series 2 Preferred owned by the Jayhawk
Group (including its controlling party, Kent McCarthy) and the Golsen Group pursuant to an
agreement entered into between us and the Jayhawk Group. The gift to KU by the controlling
party of the Jayhawk Group was made after the announcement of the issuer exchange tender
offer, and it is our position, among other things, that the tender of the shares given as a gift was
made contrary to the agreement between us and the Jayhawk Group and contrary to the terms of
our issuer exchange tender offer. KU alleges, among other things, that it suffered losses because
it was required to convert the 11,200 shares of Series 2 Preferred pursuant to the conversion
terms of the Series 2 Preferred, which was 4.3 shares of our common stock for each share of
Series 2 Preferred, and that the conversion was less favorable than the terms of issuer exchange
tender offer. KU alleges that the refusal to accept the 11,200 shares of Series 2 Preferred was in
violation of §14(d) of the Securities Exchange Act of 1934 (“34 Act”), a violation of §10b and
Rule 10b-5 and §18 of the 34 Act, the Kansas Uniform Securities Act and common law fraud.
We intend to vigorously defend this matter. As of December 31, 2007, no liability has been
established relating to this claim. We have placed the carrier under our Executive Organizational
Liability Insurance Policy Including Securities Liability (“Policy”) on notice of this claim and
litigation. This matter is being defended by our insurance carrier under the Policy under a
reservation of rights. Our Policy is subject to a $250,000 self insured retention for securities
actions.

We received a letter dated May 23, 2007 from a law firm representing a stockholder of ours
demanding that we investigate potential short-swing profit liability under Section 16(b) of the
Exchange Act of the Jayhawk Group. The stockholder alleges that the surrender by the Jayhawk
Group of 180,450 shares of our Series 2 Preferred in our issuer exchange tender offer in March
2007 was a sale which was subject to Section 16 and matchable against prior purchases of Series
2 Preferred by the Jayhawk Group. The Jayhawk Group advised us that they do not believe that
they are liable for short-swing profits under Section 16(b). The provisions of Section 16(b)
provide that if we do not file a lawsuit against the Jayhawk Group in connection with these
Section 16(b) allegations within 60 days from the date of the stockholder’s notice to us, then the
stockholder may pursue a Section 16(b) short-swing profit claim on our behalf. We engaged our
outside corporate/securities counsel to investigate this matter. After completion of this
investigation, we attempted to settle the matter with the Jayhawk Group but were unable to reach
a resolution satisfactory to all parties. On October 9, 2007, the law firm representing the
stockholder initiated a lawsuit against the Jayhawk Group pursuing a Section 16(b) short-swing
profit claim on our behalf up to approximately $819,000. During the first quarter of 2008, the
parties have agreed to settle this claim by a payment to us by the Jayhawk Group of $180,000, of
which we will receive approximately $125,000 after attorneys’ fees. This settlement is subject to
a definitive settlement agreement.

Securities and Exchange Commission Inquiry

The SEC made an informal inquiry to the Company by letter dated August 15, 2006. The inquiry
relates to the restatement of the Company’s consolidated financial statements for the year ended
December 31, 2004 and accounting matters relating to the change in inventory accounting from
LIFO to FIFO. The Company has responded to the inquiry. At the present time, the informal
inquiry is not a pending proceeding nor does it rise to the level of a government investigation.
Until further communication and clarification with the SEC, if any, the Company is unable to
determine:

•
•

if the inquiry will ever rise to the level of an investigation or proceeding, or
the materiality to the Company’s financial position with respect to enforcement actions, if
any, the SEC may have available to it.

Other Claims and Legal Actions

Wetherell v. Climate Master, a proposed class action filed by Donna Wetherell, individually and
as a class action representative, Plaintiff, and Climate Master, Inc., Defendant, in the Circuit
Court of the First Judicial Circuit, Johnson County, Illinois on September 14, 2007 alleges that
certain evaporator coils sold by one of our subsidiaries in the Climate Control Business, Climate
Master, Inc. (“Climate Master”) in the state of Illinois from 1990 to approximately 2003 were
defective. The complaint requests certification as a class action for the State of Illinois, which
request has not yet been heard by the court. The plaintiff asserts claims based upon negligence,
strict liability, breach of implied warranties, and the Illinois Consumer Fraud and Deceptive
Business Practices Act. Climate Master has timely filed its pleadings to remove this action to
federal court. Climate Master has also filed its answer denying the plaintiff’s claims and
asserting several affirmative defenses. Climate Master’s insurers have been placed on notice of
this matter. Currently the Company is unable to determine the amount of damages or the
likelihood of any losses resulting from this claim. In addition, the Company intends to vigorously
defend Climate Master in connection with this matter. Therefore, no liability has been
established at December 31, 2007.

We are also involved in various other claims and legal actions which in the opinion of
management, after consultation with legal counsel, if determined adversely to us, would not have
a material effect on our business, financial condition or results of operations.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

No matters were submitted to a vote of our shareholders during the fourth quarter of 2007.

ITEM 4A. EXECUTIVE OFFICERS OF THE REGISTRANT

Our officers serve one-year terms, renewable on an annual basis by the board of directors.
Information regarding the Company's executive officers is as follows:

Jack E. Golsen (1)

Chairman of the Board and Chief Executive Officer. Mr. Golsen, age 79
first became a director in 1969. His term was renewed for 3 years at the
annual meeting in 2007. Mr. Golsen, founder of the Company, is our
Chairman of the Board of Directors and Chief Executive Officer and has
served in those capacities since our inception in 1969. Mr. Golsen served
as our President from 1969 until 2004. During 1996, he was inducted into
the Oklahoma Commerce and Industry Hall of Honor as one of
Oklahoma’s leading industrialists. Mr. Golsen has a Bachelor of Science
degree from the University of New Mexico. Mr. Golsen is a Trustee of
Oklahoma City University. During his career, he acquired or started the
companies which formed LSB. He has served on the boards of insurance
companies, several banks and was Board Chairman of Equity Bank for
Savings N.A. which was formerly owned by LSB.

Barry H. Golsen (1) Vice Chairman of the Board, President, and President of the Climate
Control Business. Mr. Golsen, age 57, first became a director in 1981.
His term will expire in 2009. Mr. Golsen was elected President of the
Company in 2004. Mr. Golsen has served as our Vice Chairman of the
Board of Directors since August 1994, and has been the President of our
Climate Control Business for more than five years. Mr. Golsen also
serves as a director of the Oklahoma branch of the Federal Reserve Bank.
Mr. Golsen has both his undergraduate and law degrees from the
University of Oklahoma.

David R. Goss

Tony M. Shelby

Executive Vice President of Operations and Director. Mr. Goss, age 67,
first became a director in 1971. His term will expire in 2009. Mr. Goss, a
certified public accountant, is our Executive Vice President of Operations
and has served in substantially the same capacity for more than five
years. Mr. Goss is a graduate of Rutgers University.

Executive Vice President of Finance and Director. Mr. Shelby, age 66,
first became a director in 1971. His term will expire in 2008. Mr. Shelby,
a certified public accountant, is our Executive Vice President of Finance
and Chief Financial Officer, a position he has held for more than five
years. Prior to becoming our Executive Vice President of Finance and
Chief Financial Officer, he served as Chief Financial Officer of a
subsidiary of the Company and was with the accounting firm of Arthur
Young & Co., a predecessor to Ernst & Young LLP. Mr. Shelby is a
graduate of Oklahoma City University.

Jim D. Jones

David M. Shear (1)

Senior Vice President, Corporate Controller and Treasurer. Mr. Jones,
age 65, has been Senior Vice President, Controller and Treasurer since
July 2003, and has served as an officer of the Company since April 1977.
Mr. Jones is a certified public accountant and was with the accounting
firm of Arthur Young & Co., a predecessor to Ernst & Young LLP. Mr.
Jones is a graduate of the University of Central Oklahoma.

Senior Vice President and General Counsel. Mr. Shear, age 48, has been
Senior Vice President since July 2004 and General Counsel and Secretary
since 1990. Mr. Shear attended Brandeis University, graduating cum
laude in 1981. At Brandeis University, Mr. Shear was the founding
Editor-In-Chief of Chronos, the first journal of undergraduate scholarly
articles. Mr. Shear attended the Boston University School of Law, where
he was a contributing Editor of the Annual Review of Banking Law. Mr.
Shear acted as a staff attorney at the Bureau of Competition with the
Federal Trade Commission from 1985 to 1986. From 1986 through 1989,
Mr. Shear was an associate in the Boston law firm of Weiss, Angoff,
Coltin, Koski and Wolf.

(1) Barry H. Golsen is the son of Jack E. Golsen and David M. Shear is married to the niece of

Jack E. Golsen.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

PART II

Market Information

Our common stock is listed for trading on the American Stock Exchange under the symbol
“LXU”. The following table shows, for the periods indicated, the high and low bid information
for our common stock which reflects inter-dealer prices, without retail markup, markdown or
commission, and may not represent actual transactions.

Year Ended
December 31,

2007

2006

High
$ 15.71
$ 23.70
$ 25.25
$ 28.85

Low
$ 11.41
$ 14.76
$ 17.00
$ 20.54

High
$ 7.48
$ 9.19
$ 10.25
$ 13.20

Low

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5.87
6.95
8.25
8.50

Quarter
First
Second
Third
Fourth

Stockholders

As of March 7, 2008, we had 698 record holders of our common stock. This number does not
include investors whose ownership is recorded in the name of their brokerage company.

Dividends

We are a holding company and, accordingly, our ability to pay cash dividends on our preferred
stock and our common stock depends in large part on our ability to obtain funds from our
subsidiaries. The ability of ThermaClime (which owns substantially all of the companies
comprising the Climate Control Business and Chemical Business) and its wholly-owned
subsidiaries to pay dividends and to make distributions to us is restricted by certain covenants
contained in the $50 million revolving credit facility (the “Working Capital Revolver Loan”) and
the new $50 million loan agreement due 2012 (the “Secured Term Loan”). Under the terms of
these agreements, ThermaClime cannot transfer funds to us in the form of cash dividends or
other distributions or advances, except for:

•

the amount of income taxes that ThermaClime would be required to pay if they were
not consolidated with us;
an amount not to exceed fifty percent (50%) of ThermaClime's consolidated net
income during each fiscal year determined in accordance with generally accepted
accounting principles plus amounts paid to us within the first bullet above, provided
that certain other conditions are met;

• the amount of direct and indirect costs and expenses incurred by us on behalf of

ThermaClime pursuant to a certain services agreement;

•

amounts under a certain management agreement between us and ThermaClime,
provided certain conditions are met, and
outstanding loans entered into subsequent to November 2, 2007 in excess of $2.0
million at any time.

As of December 31, 2007, we have issued and outstanding 1,000,000 shares of Series D
Preferred, 585 shares Non-Cumulative Preferred and 20,000 shares of Series B 12% Convertible,
Cumulative Preferred Stock ("Series B Preferred"). Each share of preferred stock is entitled to
receive an annual dividend, only when declared by our board of directors, payable as follows:

• Series D Preferred at the rate of $.06 a share payable on October 9, which dividend is

cumulative;

• Non-Cumulative Preferred at the rate of $10.00 a share payable April 1, which are

non-cumulative; and

• Series B Preferred at the rate of $12.00 a share payable January 1, which dividend is

cumulative.

Holders of our common stock are entitled to receive dividends only when declared by our board
of directors. We have not paid cash dividends on our outstanding common stock in many years,
and we do not currently anticipate paying cash dividends on our outstanding common stock in
the foreseeable future. However, our board of directors has not made a definitive decision
whether or not to pay such dividends in 2008.

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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS

The following Management's Discussion and Analysis of Financial Condition and Results of
Operations (“MD&A”) should be read in conjunction with a review of the other Items included
in this Form 10-K and our December 31, 2007 Consolidated Financial Statements included
elsewhere in this report. Certain statements contained in this MD&A may be deemed to be
forward-looking statements. See "Special Note Regarding Forward-Looking Statements."

Overview

General

We are a manufacturing, marketing and engineering company. Our wholly-owned subsidiary,
ThermaClime, through its subsidiaries, owns substantially all of our core businesses consisting of
the:

• Climate Control Business engaged in the manufacturing and selling of a broad range
of air conditioning and heating products in the niche markets we serve consisting of
geothermal and water source heat pumps, hydronic fan coils, large custom air handlers
and other products used in commercial and residential new building construction,
renovation of existing buildings and replacement of existing systems.

• Chemical Business engaged in the manufacturing and selling of chemical products
produced from three plants located in Arkansas, Alabama and Texas for the industrial,
mining and agricultural markets.

2007 Results

LSB's 2007 sales were $586.4 million compared to $492.0 million in 2006, operating income
was $59.0 million compared to $27.1 million in 2006 and income from continuing operations
was $46.5 million compared to $15.8 million in 2006. Net income was $46.9 million in 2007
compared to $15.5 million for 2006.

Our Climate Control Business continued to report strong sales and operating results due to
beginning backlogs and strong new order flow for the year. Our Climate Control Business net
sales were $286.4 million compared to $221.2 million in 2006, a 29.5% increase. Operating
income before allocation of corporate overhead was $34.2 million, a 34.5% increase over the
$25.4 million in 2006.

Our Chemical Business reported improved results in 2007 with net sales of $288.8 million
compared to $260.7 million in 2006, a 10.8% increase. Operating income before allocation of
corporate overhead was $35.0 million compared to $9.8 million in 2006, an increase of 257.8%.
As indicated above, the increase in 2007 operating income included certain non-recurring
income items totaling $7.1 million that are discussed below.

For 2007, net income also included a litigation settlement of $3.3 million and insurance
recoveries totaling $3.8 million, which are described more fully below under Chemical Business.

In addition, net income for 2007 was impacted by our provision for income taxes. For 2007 and
recent prior years, our provisions for income taxes have included benefits from the utilization of
NOL carryforwards. The net provisions for income taxes in 2007 and 2006 were $2,540,000 and
$901,000, respectively. The 2007 provision included a current provision for federal income taxes
of $5,260,000 for regular federal income tax and alternative minimum income tax (“AMT”).
The 2007 provision also included a current provision of state income taxes of $1,980,000 which
includes the provision for 2007 state income taxes, as well as, $1,047,000 for uncertain state
income tax positions recognized in accordance with FIN 48.

The 2007 provisions are partially offset by a benefit for deferred income taxes of $4,700,000
resulting from the reversal of valuation allowance on deferred tax assets, the benefit of AMT
credits, and other temporary differences. At December 31, 2006, we had regular NOL
carryforwards of approximately $49.9 million and other temporary differences. Prior to 2007, we
had valuation allowances in place against the net deferred tax assets arising from the NOL
carryforwards and other temporary differences. As the result of improving financial results
during 2007 and our expectation of generating taxable income in the future, we determined that
the valuation allowance was no longer required as of September 30, 2007. As a result, we
reversed the valuation allowance as a benefit for income taxes and recognized deferred tax assets
and deferred tax liabilities. At December 31, 2007, we had net current deferred tax assets of
$10.0 million and net non-current deferred tax liabilities of $5.3 million.

The existence of the valuation allowance in prior years, and the reversal of the valuation
allowance during 2007, caused our effective tax rate to be substantially lower in 2007 and prior
years than we anticipate it being in future periods. In future periods we anticipate that our
effective tax rate will more closely approximate the regular federal and state statutory tax rates,
substantially increasing the income tax expense we recognize each year.

At December 31, 2007, we have federal NOL carryforwards of only approximately $2.9 million
remaining. We anticipate fully utilizing the federal NOL carryforwards in 2008 at which time we
will begin paying federal income taxes at regular corporate tax rates.

Due to regular tax NOL carryforwards with a full valuation allowance, the only current tax
expense for 2006 was for federal AMT and state income taxes as discussed above.

Climate Control Business

Our Climate Control Business has consistently generated annual profits and positive cash flows
and continues to do so. As indicated above, Climate Control’s net sales and operating income for
2007 were higher than in 2006. The increase in sales and operating income as compared to 2006
is attributable to strong demand for the geothermal and water source heat pumps, which reported
a sales increase of $30.9 million and hydronic fan coils that reported a sales increase of $26.3
million.

Most of the products of our Climate Control Business are produced to customer orders that are
placed well in advance of required delivery dates. As a result, our Climate Control Business
maintains a significant backlog that eliminates the necessity to carry substantial inventories other
than for firm customer orders. As a result of strong order flow in the recent past, our Climate
Control backlog of confirmed orders had increased to high levels and our lead times had pushed
out beyond levels that we consider to be optimum for good customer service. In order to work
the backlog down and to improve product lead times, we increased production capacity. We
invested $7.6 million in 2006, an additional $6.8 million in 2007 and currently have committed
approximately $3.2 million for additional plant and equipment capacity and land for future
expansion. At December 31, 2007, the backlog of confirmed orders was approximately $54
million compared to $62 million at September 30, 2007 and $80 million at December 31, 2006.
We expect to ship substantially all the orders in the backlog within the next twelve months.

Our Climate Control Business will continue to launch new products and product upgrades in an
effort to maintain our current market position and to establish presence in new markets. Climate
Control Business's profitability over the last few years has been affected by operating losses of
certain new product lines being developed during that time. Our emphasis has been to increase
the sales levels of these operations above the breakeven point. During 2007, the results for these
new products reflected modest improvement. Although these new products have not yet achieved
profitability, we continue to believe that these new products have good long-term prospects.

Management continues to focus on the following objectives for Climate Control:

•
•
•

increasing the sales and operating margins of all products,
developing and introducing new and energy efficient products, and
improving production and product delivery performance.

Chemical Business

Our Chemical Business has production facilities in Baytown, Texas (the “Baytown Facility”), El
Dorado, Arkansas (the “El Dorado Facility”) and Cherokee, Alabama (the “Cherokee Facility”).
The Baytown and El Dorado Facilities produce nitrogen products from anhydrous ammonia that
is delivered by pipeline and sulfuric acid from recovered elemental sulfur delivered by truck and
rail. The Cherokee Facility produces anhydrous ammonia and nitrogen products from natural gas
that is delivered by pipeline.

As indicated above, Chemicals net sales and operating income for 2007 were higher than in
2006. The increase in sales and operating income as compared to 2006 is attributable to strong
demand for agricultural products and consistent demand for the industrial and mining products,
Also operating income for 2007 and 2006 included the following unusual income items:

2007

2006

Settlement of litigation
Insurance recoveries of business interruption claims
Total

(In Millions)
-
$
0.9
0.9

3.3
3.8
7.1

The $3.3 million reflects the net proceeds of $2.7 million received by the Cherokee Facility and
the retention by the Cherokee Facility of a disputed $0.6 million accounts payable as a result of
the settlement agreement with Dynegy, Inc. and one of its subsidiaries to settle a previously
reported lawsuit.

The $3.8 million is a result of the settlement of a business interruption claim filed by the
Cherokee Facility with their insurers. The proceeds from this settlement were used for general
working capital purposes.

The increase in operating income relative to sales (excluding the unusual income items noted
above) is primarily a result of increased gross profit margins, resulting from higher nitrogen
fertilizer demand in our agricultural markets. Low wheat and corn stocks-to-use ratios, as well as
low inventories of other crops, resulted in strong demand for nitrogen fertilizer in 2007, which
has had a positive effect on the approximate one-third of our sales which are sold in the
agricultural markets.

Our primary raw material feedstocks, anhydrous ammonia, natural gas and sulfur, are
commodities subject to significant price fluctuations, and are generally purchased at prices in
effect at the time of purchase. Due to the uncertainty of these commodity markets, we have
developed customers that purchase our products pursuant to agreements and/or pricing formulas
that provide for the pass through of raw material and other variable costs and certain fixed costs.
Approximately 60% percent of our Chemical Business’ products sold in 2007 were to those
customers.

Our Chemical Business uses precious metals as a catalyst in the manufacturing process. During
2007, we had accumulated precious metals in excess of our production requirements. Therefore
we sold a portion of the excess metals. As a result, we recognized a gain of $2.0 million which
increased gross profit and operating profit of our Chemical Business compared to 2006.
However, this increase to gross profit and operating profit of $2.0 million was partially offset by
a net decrease of $1.8 million due primarily to the increase in precious metals expense of
approximately $1.5 million compared to 2006 as the result of cost increases for these metals.

Our Chemical Business continues to focus on growing our non-seasonal industrial customer base
with an emphasis on customers accepting the risk inherent with raw material costs, while at the
same time, maintaining a strong presence in the seasonal agricultural sector, when the potential
for favorable gross profit margins is available. The operation’s strategy is to maximize
production efficiency of the facilities, thereby lowering the fixed cost of each ton produced.

Completion of Tender Offer

During November 2006, the Company entered into the Jayhawk Agreement with the Jayhawk
Group. Under the Jayhawk Agreement, the Jayhawk Group agreed to tender 180,450 shares of
the 346,662 shares of the Series 2 Preferred, if the Company made an exchange or tender offer
for the Series 2 Preferred. In addition, as a condition to the Jayhawk Group’s obligation to tender
such shares of Series 2 Preferred in an exchange/tender offer, the Jayhawk Agreement further
provided that the Golsen Group would exchange only 26,467 of the 49,550 shares of Series 2

Preferred beneficially owned by them. As a result, only 309,807 of the 499,102 shares of Series 2
Preferred outstanding would be eligible to participate in an exchange/tender offer, with the
remaining 189,295 being held by the Jayhawk Group and the Golsen Group.

On January 26, 2007, our board of directors approved and on February 9, 2007, we began a
tender offer to exchange shares of our common stock for up to 309,807 of the 499,102
outstanding shares of the Series 2 Preferred. The tender offer expired on March 12, 2007 and our
board of directors accepted the shares tendered on March 13, 2007. The terms of the tender offer
provided for the issuance by the Company of 7.4 shares of common stock in exchange for each
share of Series 2 Preferred tendered in the tender offer and the waiver of all rights to dividends in
arrears on the Series 2 Preferred tendered. As a result of this tender offer, we issued 2,262,965
shares of our common stock for 305,807 shares of Series 2 Preferred that were tendered. As a
result, we effectively settled the dividends in arrears on the Series 2 Preferred tendered totaling
approximately $7.3 million ($23.975 per share). Because the exchange was pursuant to terms
other than the original conversion terms, the transaction was considered an extinguishment of the
preferred stock. In addition, the transaction qualified as an induced conversion under SFAS 84.
Accordingly, we recorded a charge (stock dividend) to accumulated deficit of approximately
$12.3 million, which equaled the excess of the fair value of the common stock issued over the
fair value of the common stock issuable pursuant to the original conversion terms. To measure
fair value, we used the closing price of our common stock on March 13, 2007, the date the shares
so tendered were accepted by our board of directors.

Included in the amounts discussed above and pursuant to the Jayhawk Agreement and the terms
of the tender offer, the Jayhawk Group and the Golsen Group tendered 180,450 and 26,467
shares, respectively, of Series 2 Preferred for 1,335,330 and 195,855 shares, respectively, of our
common stock. As a result, we effectively settled the dividends in arrears on these shares of
Series 2 Preferred tendered totaling approximately $4.96 million with $4.33 million relating to
the Jayhawk Group and $0.63 million relating to the Golsen Group.

Stock Options Receiving Stockholders' Approval

We adopted SFAS 123 (revised 2004), Share-Based Payment (“SFAS 123(R)”) using the
modified prospective method effective January 1, 2006, which required us to measure and
recognize the cost of employee services received in exchange for an award of equity instruments
based on the grant date fair value of the award. As previously reported, on June 19, 2006, the
Compensation and Stock Option Committee of our board of directors granted 450,000 shares of
non-qualified stock options (the “Options”) to certain Climate Control Business employees,
which were subject to shareholders’ approval. The option price of the Options is $8.01 per share
which is based on the market value of our common stock at the date the board of directors
granted the shares (June 19, 2006). The Options vest over a ten-year period at a rate of 10% per
year and expire on September 16, 2016 with certain restrictions. Under SFAS 123(R), the fair
value for the Options was estimated, using an option pricing model, as of the date we received
shareholders’ approval which occurred during our 2007 annual shareholders’ meeting on June
14, 2007. Under SFAS 123(R) for accounting purposes, the grant date and service inception date
is June 14, 2007.

As previously reported, the total fair value for the Options was estimated to be approximately
$6.9 million, or $15.39 per share, using a Black-Scholes-Merton option pricing model. As of
June 14, 2007, we began amortizing the total estimated fair value of the Options to selling,
general, and administrative expense (“SG&A”) which will continue through June 18, 2016 (a
weighted-average vesting period of 8.46 years). As a result, we incurred stock-based
compensation expense of $0.4 million for 2007. At December 31, 2007, the total stock-based
compensation expense not yet recognized is approximately $6.5 million relating to the non-
vested options.

During 2005, we accounted for our stock option plans under the recognition and measurement
principles of APB Opinion No. 25 (“APB 25”) and related interpretations. Under APB 25, stock-
based compensation cost was not reflected in our results of operations, as all options granted
under those plans had an exercise price equal to the market value of the underlying common
stock on the date of grant. If we had applied the fair value recognition provisions of SFAS
123(R) to stock-based compensation during 2005, using a Black-Scholes-Merton option pricing
model, net income would have decreased by approximately $0.5 million.

Liquidity and Capital Resources

The following is our cash, total interest bearing debt and stockholders’ equity at December 31,:

Cash on hand

Long-term debt:

2007 Debentures due 2012
Secured Term Loan due 2012
Senior Secured Loan due 2009
Working Capital Revolver Loan
2006 Debentures due 2011
Other
Total long-term debt

2007

2006

(in millions)

$ 58.2

$ 2.3

$ 60.0
50.0
-
-
-
12.1
$122.1

$ -
-
50.0
26.0
4.0
17.7
$ 97.7

Total stockholder’s equity

$ 94.3

$ 43.6

As indicated above, our capital structure and liquidity at December 31, 2007, are improved from
that at December 31, 2006. Although long-term debt is $24.4 million higher, there is $58 million
cash on hand and the $50 million Working Capital Revolver Loan is undrawn and available to
fund operations, if needed. Long-term debt, before the use of cash on hand to pay down debt,
dropped from 2.2 times stockholders’ equity at December 31, 2006, to 1.3 times at December 31,
2007.

During 2007, we completed the following transactions that favorably affected our liquidity and
capital resources:

•

converted the remaining $4.0 million of the 7% Convertible Senior Subordinated
Debentures (the “2006 Debentures”) into 564,789 shares of our common stock;
exchanged, converted or redeemed the remaining 499,102 shares, net of treasury stock,
of Series 2 Preferred, along with all cumulative dividends in arrears;
prepaid the $50 million Senior Secured Loan due 2009 from proceeds of a new $50
million secured term loan due 2012, at a lower interest rate and less collateral; and
finalized a private placement of the 5.5% Convertible Senior Subordinated Notes due
2012 (the “2007 Debentures”) pursuant to which we sold $60.0 million aggregate
principal amount to twenty-two qualified institutional buyers.

The 2007 Debentures bear interest at the annual rate of 5.5% and mature on July 1, 2012. We
received net proceeds of approximately $57.0 million, after discounts and commissions.

We used the net proceeds from the 2007 Debentures for the following:

•

•
•

•

$2.0 million to redeem 25,820 outstanding shares of our Series 2 Preferred (including
dividends in arrears);
$3.9 million to repay certain outstanding mortgages and equipment loans;
$2.1 million to pay dividends in arrears on our outstanding shares of Series B Preferred
and Series D Preferred,
$25.0 million was loaned to ThermaClime to reduce the outstanding borrowing under the
Working Capital Revolver Loan; and
the remaining balance of approximately $24.0 million invested in money market
investments.

In November 2007, ThermaClime and certain of its subsidiaries entered into the $50 million
Secured Term Loan with a certain lender. Proceeds from the Secured Term Loan were used to
repay the Senior Secured Loan due 2009. The Secured Term Loan matures on November 2, 2012
and accrues interest at a defined LIBOR rate plus 3%. The interest rate at December 31, 2007
was 7.90%. The Secured Term Loan requires only quarterly interest payments with the final
payment of interest and principal at maturity.

The Secured Term Loan is secured by the real property and equipment located at the El Dorado
and Cherokee Facilities. The carrying value of the pledged assets is approximately $48 million at
December 31, 2007.

The Working Capital Revolver Loan is a $50.0 million credit facility that provides for advances
to ThermaClime and its subsidiaries based upon specified percentages of eligible accounts
receivable and inventories. At December 31, 2007, there were no borrowings outstanding under
this loan and approximately $0.8 million of the line was being used for issued and outstanding
letters of credit. Historically, ThermaClime’s primary cash needs have been for working capital

and capital expenditures. ThermaClime and its subsidiaries depend upon their Working Capital
Revolver Loan, internally generated cash flows, and secured property and equipment financing
in order to fund operations and pay obligations. In connection with the new Secured Term Loan
due 2012, the lenders of the Working Capital Revolver Loan released their second position
security liens to the assets which collateralize the Term Loan and agreed to certain other
modifications to the Working Capital Revolver Loan agreement, including, among other things,
a .25% reduction to the interest rate.

The Working Capital Revolver Loan and the Secured Term Loan have financial covenants that
are discussed below under “Loan Agreements – Terms and Conditions”.

ThermaClime’s ability to maintain borrowing availability under its Working Capital Revolver
Loan depends on its ability to comply with the terms and conditions of its loan agreements and
its ability to generate cash flow from operations. ThermaClime is restricted under its credit
agreements as to the funds it may transfer to the Company and its non-ThermaClime affiliates
and certain ThermaClime subsidiaries. This limitation does not prohibit payment to the Company
of amounts due under a Services Agreement, Management Agreement and a Tax Sharing
Agreement.

Income Taxes

In 2007 and prior years, our effective tax rate has been minimal due to the availability of NOL
carryforwards. At December 31, 2007, we have federal NOL carryforwards of only
approximately $2.9 million remaining. We anticipate fully utilizing the federal NOL
carryforwards in 2008 and we will begin paying federal income taxes at regular corporate tax
rates.

Filing Requirements Pursuant to Sarbanes Oxley

As of June 29, 2007, our public float held by non-affiliates exceeded the $75 million threshold
but was less than the $700 million threshold. As a result, we became an accelerated filer on
December 31, 2007. Therefore, we have been and will continue to incur additional costs to meet
the requirements as an accelerated filer for the year ended December 31, 2007 and future
periods.

Capital Expenditures

General

Cash used for capital expenditures in 2007 was $14.8 million, including $5.8 million primarily
for product equipment and other upgrades and for additional capacity in our Climate Control
Business and $8.6 million for our Chemical Business, primarily for process and reliability
improvements of existing facilities. As discussed below, our current commitment for 2008
includes additional spending for production equipment in our Climate Control Business and
spending for process and reliability improvement in our Chemical Business, including $5.6
million related to certain air emissions abatement.

Other capital expenditures for 2008 are believed to be discretionary and are dependent upon an
adequate amount of liquidity and/or obtaining acceptable funding. We have carefully managed
those expenditures to projects necessary to execute our business plans and those for
environmental and safety compliance.

Current Commitments

As of the date of this report, we have committed capital expenditures of approximately $14.1
million for 2008. The expenditures include $10.9 million for our Chemical Business and $3.2
million for our Climate Control Business. We plan to fund these expenditures from working
capital, which may include utilizing our Working Capital Revolver Loan.

The committed capital expenditures for our Chemical Business includes approximately $5.6
million for certain capital expenditures required to expand capacity and bring the El Dorado
Facility’s sulfuric acid plant air emissions to lower limits.

Certain events relating to our Chemical Business

Pryor Facility - We are evaluating the feasibility of activating all or a portion of our ammonia
and urea chemical plant in Pryor, Oklahoma (the “Pryor Facility”). The feasibility study is based
on producing and marketing approximately 325,000 tons of UAN fertilizer per year. A final
decision to activate the Pryor Facility has not been made. If we decide to activate the Pryor
Facility and the activation project is approved by our board of directors, this project could take
approximately twelve months to obtain the necessary permits and complete the plant
improvements. The preliminary estimated total cost to activate the Pryor Facility is
approximately $15 million to $20 million with approximately one-half of these costs to be
expensed as incurred.

El Dorado Facility - El Dorado Chemical Company (“EDC”) produces industrial grade
ammonium nitrate for Orica USA, Inc. (“Orica”) under a multi-year supply agreement which
contract includes required minimum annual and monthly volumes. Orica has notified EDC that it
will significantly reduce its expected purchases for the month of March 2008 below the required
minimum monthly volume. It is currently unknown when Orica will resume purchasing at the
contractual volumes. Under the terms of the contract, Orica must pay liquidated damages if it
fails to purchase the minimum monthly volume, which liquidated damages compensate EDC for
product not taken at the minimum monthly contractual volume. Orica has indicated that it
believes the contract may not require the payment of certain components of the normal formula
price to EDC when Orica pays liquidated damages in lieu of purchasing product at the minimum
monthly contractual level. The amount in question is approximately $230,000 for March 2008,
although Orica has agreed to pay such amount to EDC.

Baytown Facility - The Baytown Facility is operated by EDNC, a subsidiary within our
Chemical Business, under the Bayer Agreement with Bayer and a leveraged lease agreement
with a financial institution (“lessor”) all of which expire in June 2009. Under the lease
agreement, EDNC, as lessee, has the right to acquire the leased facility by exercising a fixed
price purchase option (“purchase option”). The option price is approximately $17.6 million.

Under the agreements between EDNC and Bayer, Bayer may, at its option, require EDNC to
exercise the purchase option or refuse to allow EDNC to exercise the purchase option. If Bayer
directs EDNC to exercise the purchase option, Bayer is responsible to pay the option price to the
lessor. We have had preliminary discussions with Bayer regarding a renewal of the Bayer
Agreement between EDNC and Bayer which may require EDNC to exercise the purchase option
under the lease agreement. If required by Bayer as a condition to renewing the agreements with
Bayer, we may, in our sole discretion, agree to pay the purchase option as part of the renewal
agreements, provided the economics of the transaction are acceptable to us. For 2007, the
Baytown Facility contributed approximately 19% of the net sales of our Chemical Business and
approximately 9% of our consolidated net sales.

Stock Repurchase Authorization

Our board of directors enacted a stock repurchase authorization for an unstipulated number of
shares for an indefinite period of time commencing March 12, 2008. The stock repurchase
authorization will remain in effect until such time as of our board of directors decides to end it.

Dividends

We are a holding company and, accordingly, our ability to pay cash dividends on our preferred
stock and our common stock depends in large part on our ability to obtain funds from our
subsidiaries. The ability of ThermaClime (which owns substantially all of the companies
comprising the Climate Control Business and Chemical Business) and its wholly-owned
subsidiaries to pay dividends and to make distributions to us is restricted by certain covenants
contained in the $50 million Working Capital Revolver Loan and the new $50 million Secured
Term Loan. Under the terms of these agreements, ThermaClime cannot transfer funds to us in
the form of cash dividends or other distributions or advances, except for:

•

• the amount of direct and indirect costs and expenses incurred by us on behalf of

•

ThermaClime pursuant to a certain services agreement;
amounts under a certain management agreement between us and ThermaClime,
provided certain conditions are met, and
outstanding loans entered into subsequent to November 2, 2007 in excess of $2.0
million at any time.

We have not paid cash dividends on our outstanding common stock in many years. Pursuant to
our exchange/tender offer in March 2007, we issued approximately 2.3 million shares of our
common stock in exchange for approximately 0.3 million shares of the Series 2 Preferred in
accordance with the terms of the Series 2 Preferred. As a result, we effectively settled the
dividends in arrears totaling approximately $7.3 million. Based on the terms of the tender offer,

we recorded a charge (stock dividend) to accumulated deficit of approximately $12.3 million,
which equaled the excess of the fair value of the common stock issued over the fair value of the
common stock issuable pursuant to the original conversion terms of the Series 2 Preferred.

During 2007, we paid cash dividends of approximately $678,000 on the 25,820 shares of Series 2
Preferred, which we redeemed pursuant to the notice of redemption we mailed to all holders of
record of our Series 2 Preferred on July 12, 2007. The holders of 167,475 shares of our Series 2
Preferred exercised their right to convert each share into 4.329 shares of our common stock. For
the holders that converted the shares of Series 2 Preferred into common stock, it is our position
that the holders were not entitled to any dividends in arrears on those shares so converted. See
“Related Party Transactions” of this MD&A as to certain comments made by the Jayhawk Group
relating to our redemption and amounts paid to the Golsen Group as a result of the redemption
and shares issued to the Jayhawk Group as a result of conversions of its Series 2 Preferred.

In addition, our board of directors declared and we paid dividends on the Series B Preferred,
Series D Preferred and noncumulative redeemable preferred stock totaling approximately
$1,890,000, $360,000 and $6,000, respectively. These dividends were paid with a portion of the
net proceeds of the 2007 Debentures and working capital. As a result, there were no unpaid
dividends in arrears at December 31, 2007. See “Related Party Transactions” of this MD&A for
a discussion as to the Golsen Group’s ownership of the Series B Preferred and Series D
Preferred.

We do not currently anticipate paying cash dividends on our outstanding common stock in the
foreseeable future. However, our board of directors has not made a definitive decision whether or
not to pay such dividends in 2008.

Compliance with Long-Term Debt Covenants

As discussed below under “Loan Agreements - Terms and Conditions”, the Secured Term Loan
and Working Capital Revolver Loan, as amended, of ThermaClime and its subsidiaries require,
among other things, that ThermaClime meet certain financial covenants. ThermaClime's
forecasts for 2008 indicate that ThermaClime will be able to meet all required financial covenant
tests for the year ending December 31, 2008.

Loan Agreements - Terms and Conditions

5.5% Convertible Senior Subordinated Debentures – As previously reported and as
discussed above under “Liquidity and Capital Resources,” on June 28, 2007, we completed a
private placement to twenty-two qualified institutional buyers, pursuant to which we sold $60.0
million aggregate principal amount of the 2007 Debentures. We received net proceeds of
approximately $57 million, after discounts and commissions. 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, beginning on January 1, 2008. In addition, the 2007
Debentures are unsecured obligations and are subordinated in right of payment to all of our
existing and future senior indebtedness, including indebtedness under our revolving debt
facilities. The 2007 Debentures are effectively subordinated to all present and future liabilities,
including trade payables, of our subsidiaries.

The 2007 Debentures are convertible by the holders in whole or in part into shares of our
common stock prior to their maturity. The conversion rate of the 2007 Debentures for the holders
electing to convert all or any portion of a debenture is 36.4 shares of our common stock per
$1,000 principal amount of debentures (representing a conversion price of $27.47 per share of
common stock), subject to adjustment under certain conditions as set forth in the Indenture.

Working Capital Revolver Loan – ThermaClime’s Working Capital Revolver Loan is
available to fund its working capital requirements, if necessary. Under the Working Capital
Revolver Loan, ThermaClime and its subsidiaries may borrow on a revolving basis up to $50.0
million based on specific percentages of eligible accounts receivable and inventories. In
connection with the Secured Term Loan (discussed below), the Working Capital Revolver Loan
was amended. The amendment includes the release of the lenders second position security liens
to the assets that collateralize the Secured Term Loan and certain other modifications to the
terms of the Working Capital Revolver Loan, including among other things, an interest rate
reduction of .25% and an extended maturity date of April 13, 2012. As a result of using a portion
of the proceeds from the 2007 Debentures to pay down the Working Capital Revolver Loan, at
December 31, 2007, there were no outstanding borrowings. At March 7, 2008, the net credit
available for additional borrowings under our Working Capital Revolver Loan was
approximately $49.2 million. The Working Capital Revolver Loan requires that ThermaClime
meet certain financial covenants measured quarterly. ThermaClime was in compliance with those
covenants for the twelve-month period ended December 31, 2007.

Secured Term Loan - In November 2007, ThermaClime and certain of its subsidiaries entered
into the $50 million Secured Term Loan with a certain lender. Proceeds from the Secured Term
Loan were used to repay the previous Senior Secured Loan as discussed above under “Liquidity
and Capital Resources.” The Secured Term Loan matures on November 2, 2012.

The Secured Term Loan accrues interest at a defined LIBOR rate plus 3%. The interest rate at
December 31, 2007 was 7.90%. The Secured Term Loan requires only quarterly interest
payments with the final payment of interest and principal at maturity.

The Secured Term Loan borrowers are subject to numerous covenants under the 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 us, all with certain exceptions. At December 31,
2007, the carrying value of the restricted net assets of ThermaClime and its subsidiaries was
approximately $60 million. The Secured Term Loan borrowers are also subject to a minimum
fixed charge coverage ratio and a maximum leverage ratio, both measured quarterly on a trailing
twelve-month basis. The Secured Term Loan borrowers were in compliance with these financial
covenants for the year ended December 31, 2007.

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.

A prepayment premium equal to 1% of the principal amount prepaid is due to the lender should
the borrowers elect to prepay on or prior to November 6, 2009. This premium is reduced to 0.5%
during the following twelve-month period and is eliminated thereafter.

Cross - Default Provisions - The Working Capital Revolver Loan agreement and the
Secured Term Loan contain cross-default provisions. If ThermaClime fails to meet the financial
covenants of the Secured Term Loan, the lender may declare an event of default, making the debt
due on demand. If this should occur, there are no assurances that we would have funds available
to pay such amount or that alternative borrowing arrangements would be available. Accordingly,
ThermaClime could be required to curtail operations and/or sell key assets. These actions could
result in the recognition of losses that may be material.

Seasonality

We believe that our only seasonal products are fertilizer and related chemical products sold by
our Chemical Business to the agricultural industry. The selling seasons for those products are
primarily during the spring and fall planting seasons, which typically extend from March through
June and from September through November in the geographical markets in which the majority
of our agricultural products are distributed. As a result, our Chemical Business increases its
inventory of agricultural products prior to the beginning of each planting season. In addition, the
amount and timing of sales to the agricultural markets depend upon weather conditions and other
circumstances beyond our control.

Related Party Transactions

Jayhawk

Jayhawk Capital Management, L.L.C., and certain of its affiliates (collectively, the “Jayhawk
Group”), a former significant shareholder and affiliate, were participants to various investment
transactions in certain issues of the Company’s debt and equity securities during the past several
years, which both increased and decreased their ownership interest in the Company. During
August 2007, the two directors appointed by the holders of our Series 2 Preferred were no longer
eligible to serve on our board and as of December 31, 2007, the Jayhawk Group had decreased
its ownership in our debt and equity securities to the level whereby they are no longer considered
a related party. However, the Jayhawk Group was a participant in the following transactions
related to our debt and equity securities during the period it was considered a related party:

During 2006, a member of the Jayhawk Group purchased $1,000,000 principal amount of the
2006 Debentures. In April 2007, the Jayhawk Group converted all of such 2006 Debentures into
141,040 shares of our common stock, at the conversion rate of 141.04 shares per $1,000
principal amount of 2006 Debentures (representing a conversion price of $7.09 per share
pursuant to the Indenture covering the 2006 Debentures). During 2007, we paid the Jayhawk
Group $70,000 of which $46,000 relates to interest earned on the 2006 Debentures and $24,000
relates to additional consideration paid to convert the 2006 Debentures.

On March 25, 2003, the Jayhawk Group purchased from us in a private placement pursuant to
Rule 506 of Regulation D under the Securities Act, 450,000 shares of common stock and a
warrant for the purchase of up to 112,500 shares of common stock at an exercise price of $3.49
per share. In connection with such sale, we entered into a Registration Rights Agreement with
the Jayhawk Group, dated March 23, 2003. During 2007, the Jayhawk Group exercised the
warrant and purchased 112,500 shares of our common stock at the exercise price of $3.49 per
share. The aggregate 562,500 shares of our common stock were registered for resale under the
Form S-1 Registration Statement, No. 333-145721, declared effective by the SEC on November
19, 2007.

During November 2006, we entered into an agreement (the “Jayhawk Agreement”) with the
Jayhawk Group. Under the Jayhawk Agreement, the Jayhawk Group agreed, that if we made an
exchange or tender offer for the Series 2 Preferred, to tender 180,450 shares of the 346,662
shares of Series 2 Preferred owned by the Jayhawk Group upon certain conditions being met.
The Jayhawk Agreement further provided that the Golsen Group would exchange or tender
26,467 shares of Series 2 Preferred beneficially owned by them, as a condition to the Jayhawk
Group’s tender of 180,450 of its shares of Series 2 Preferred. Pursuant to the Jayhawk
Agreement and the terms of our exchange tender offer, during March 2007, the Jayhawk Group
and members of the Golsen Group tendered 180,450 and 26,467 shares, respectively, of Series 2
Preferred for 1,335,330 and 195,855 shares, respectively, of our common stock in our tender
offer. As a result, we effectively settled the dividends in arrears totaling approximately $4.96
million, with $4.33 million relating to the Jayhawk Group and $0.63 million relating to the
Golsen Group.

We received a letter, dated May 23, 2007, from a law firm representing a stockholder of ours
demanding that we investigate potential short-swing profit liability under Section 16(b) of the
Exchange Act of the Jayhawk Group. The stockholder alleges that the surrender by the Jayhawk
Group of 180,450 shares of our Series 2 Preferred in our issuer exchange tender offer in March
2007 was a sale which was subject to Section 16 and matchable against prior purchases of Series
2 Preferred by the Jayhawk Group. The Jayhawk Group advised us that they do not believe that
they are liable for short-swing profits under Section 16(b). The provisions of Section 16(b)
provide that if we do not file a lawsuit against the Jayhawk Group in connection with these
Section 16(b) allegations within 60 days from the date of the stockholder’s notice to us, then the
stockholder may pursue a Section 16(b) short-swing profit claim on our behalf. After completion
of the investigation of this matter by our outside corporate/securities counsel, we attempted to
settle this matter with the Jayhawk Group, but were unable to reach a resolution satisfactory to
all parties. On October 9, 2007, the law firm representing the stockholder initiated a lawsuit
against the Jayhawk Group pursing a Section 16(b) short-swing profit claim on our behalf up to
$819,000. During the first quarter of 2008, the parties have agreed to settle this claim by a
payment to us by the Jayhawk Group of $180,000, of which we will receive approximately
$125,000 after attorneys’ fees. This settlement is subject to a definitive settlement agreement.

stock prior to the scheduled redemption date were not entitled to receive payment of any
dividends in arrears on the shares so converted. As a result, holders that elected to convert shares
of Series 2 Preferred were not entitled to any dividends in arrears as to the shares of Series 2
Preferred converted. On or about August 16, 2007, the Jayhawk Group elected to convert the
155,012 shares of Series 2 Preferred held by it, and we issued to the Jayhawk Group 671,046
shares of our common stock as a result of such conversion.

The Company has been advised by the Jayhawk Group, in connection with the Jayhawk Group’s
conversion of its holdings of Series 2 Preferred, the Jayhawk Group may bring legal proceedings
against us for all dividends in arrears on the Series 2 Preferred that the Jayhawk Group converted
after receiving a notice of redemption. The 155,012 shares of Series 2 Preferred converted by the
Jayhawk Group after we issued the notice of redemption for the Series 2 Preferred would have
been entitled to receive approximately $4.0 million of dividends in arrears on the August 27,
2007 redemption date, if such shares were outstanding on the redemption date and had not been
converted and into common stock.

As a holder of Series 2 Preferred, the Jayhawk Group participated in the nomination and election
of two individuals to serve on our board of directors in accordance with the terms of the Series 2
Preferred. As the result of the exchanges, conversions and redemption of the Series 2 Preferred
during 2007, resulting in less than 140,000 shares of Series 2 Preferred being outstanding, the
right of the holders of Series 2 Preferred to nominate and elect two individuals to serve on our
board of directors terminated pursuant to the terms of the Series 2 Preferred. Therefore the two
independent directors elected by the holders of our Series 2 Preferred no longer serve as directors
on our board of directors and the Jayhawk Group is no longer considered an affiliate of ours.

Golsen Group

In connection with the completion of our March 2007 tender offer for our outstanding shares of
our Series 2 Preferred, members of the Golsen Group tendered 26,467 shares of Series 2
Preferred in exchange for our issuance to them of 195,855 shares of our common stock. As a
result, we effectively settled approximately $0.63 million in dividends in arrears on the shares of
Series 2 Preferred tendered. The tender by the Golsen Group was a condition to Jayhawk’s
Agreement to tender shares of Series 2 Preferred in the tender offer. See discussion above under
“Jayhawk.”

After our exchange tender offer of our Series 2 Preferred, the Golsen Group held 23,083 shares
of Series 2 Preferred. Pursuant to our redemption of the remaining outstanding Series 2 Preferred
during August 2007, the Golsen Group redeemed 23,083 shares of Series 2 Preferred and
received the cash redemption amount of approximately $1.76 million pursuant to the terms of
our redemption of all of our outstanding Series 2 Preferred. The redemption price was $50.00 per
share of Series 2 Preferred, plus $26.25 per share in dividends in arrears pro-rata to the date of
redemption. The holders of shares of Series 2 Preferred had the right to convert each share into
4.329 shares of our common stock, which right to convert terminated 10 days prior to the
redemption date. Holders that converted shares of Series 2 Preferred were not entitled to any
dividends in arrears as to the shares of Series 2 Preferred converted.

Cash Dividends

As discussed above, during 2007, we paid cash dividends to the Golsen Group of approximately
$606,000 related to 23,083 shares of Series 2 Preferred redeemed.

In September 2007, we paid the dividends in arrears on our outstanding preferred stock utilizing
a portion of the net proceeds of the sale of the 2007 Debentures and working capital, including
approximately $2,250,000 of dividends in arrears on our Series B Preferred and our Series D
Preferred, all of the outstanding shares of which are owned by the Golsen Group.

Quail Creek Bank

Bernard Ille, a member of our board of directors, is a director of Quail Creek Bank, N.A. (the
“Bank”). The Bank was a lender to one of our subsidiaries. During 2007, the subsidiary made
interest and principal payments on outstanding debt owed to the Bank in the respective amount
of $.1 million and $3.3 million in 2007. At December 31, 2006, the subsidiary’s loan payable to
the Bank was approximately $3.3 million, (none at December 31, 2007) with an annual interest
rate of 8.25%. The loan was secured by certain of the subsidiary’s property, plant and equipment.
This loan was paid in full in June 2007 utilizing a portion of the net proceeds of our sale of the
2007 Debentures.

Critical Accounting Policies and Estimates

The preparation of financial statements requires management to make estimates and assumptions
that affect the reported amount of assets, liabilities, revenues and expenses, and disclosures of
contingencies. In addition, the more critical areas of financial reporting impacted by
management's judgment, estimates and assumptions include the following:

Changes in Accounting Estimates

During 2007, we had the following changes in accounting estimates:

• as discussed under “Overview – 2007 Results”, we reversed the valuation allowance on
our deferred tax balances which resulted in recognition of a deferred tax benefit of
$4,700,000 which is included in our provision for income taxes and

• the recognition of $1.0 million of additional state income taxes included in our provision

for income taxes as discussed above under “Overview - 2007 Results”.

The net effect of these changes in accounting estimates increased income from continuing
operations and net income by $3.7 million for 2007. In addition, these changes in accounting
estimates increased basic and diluted net income per share by $0.19 and $0.16, respectively, for
2007.

Receivables and Credit Risk - Our sales to contractors and independent sales
representatives are generally subject to a mechanics lien in the Climate Control Business. Our
other sales are generally unsecured. Credit is extended to customers based on an evaluation of
the customer's financial condition and other factors. Credit losses are provided for in the

financial statements based on historical experience and periodic assessment of outstanding
accounts receivable, particularly those accounts which are past due (determined based upon how
recently payments have been received). Our periodic assessment of accounts and credit loss
provisions are based on our best estimate of amounts that are not recoverable. Concentrations of
credit risk with respect to trade receivables are limited due to the large number of customers
comprising our customer bases and their dispersion across many different industries and
geographic areas, however, six customers account for approximately 26% of our total net
receivables at December 31, 2007. We do not believe this concentration in these six customers
represents a significant credit risk due to the financial stability of these customers. At December
31, 2007 and 2006, our allowance for doubtful accounts of $1.3 million and $2.3 million,
respectively, were netted against our accounts receivable.

Inventory Valuations - Inventories are priced at the lower of cost or market, with cost being
determined using the first-in, first-out (“FIFO”) basis. Finished goods and work-in-process
inventories include material, labor and manufacturing overhead costs. At December 31, 2007 and
2006, the carrying value of certain nitrogen-based inventories produced by our Chemical
Business was reduced to market because cost exceeded the net realizable value by $13,000 and
$426,000, respectively. In addition, the carrying value of certain slow-moving inventory items
(primarily Climate Control products) was reduced to market because cost exceeded the net
realizable value by $460,000 and $829,000 at December 31, 2007 and 2006, respectively.

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. As of December 31, 2007 and 2006, precious metals were $10.9 million and $6.4
million, respectively, and are included in supplies, prepaid items and other in the consolidated
balance sheets. 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. For 2007, 2006 and 2005, the
amounts expensed for precious metals were approximately $6.4 million, $4.8 million and $3.1
million, respectively. These precious metals expenses are included in cost of sales. Occasionally,
during major maintenance and/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. For 2007, 2006 and 2005, we recognized recoveries of precious
metals at historical FIFO costs of approximately $1.8 million, $2.1 million and $1.6 million,
respectively. When we accumulate precious metals in excess of our production requirements, we
may sell a portion of the excess metals. We recognized gains of $2.0 million for 2007 (none in
2006 and 2005) from the sale of excess precious metals. These recoveries and gains are
reductions to cost of sales.

Impairment of Long-Lived Assets and Goodwill - Long-lived assets are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying amounts may
not be recoverable and goodwill is reviewed for impairment at least annually. If assets to be held
and used are considered to be impaired, the impairment to be recognized is the amount by which
the carrying amounts of the assets exceed the fair values of the assets as measured by the present
value of future net cash flows expected to be generated by the assets or their appraised value.
Assets to be disposed of are reported at the lower of the carrying amounts of the assets or fair

values less costs to sell. At December 31, 2007, we had no long-lived assets that met the criteria
presented in SFAS 144 to be classified as assets held for sale. We have considered impairment of
our long-lived assets and goodwill. The timing of impairments cannot be predicted with
reasonable certainty and are primarily dependent on market conditions outside our control.
Should sales prices permanently decline dramatically without a similar decline in the raw
material costs or should other matters, including the environmental requirements and/or
operating requirements set by Federal and State agencies change substantially from our current
expectations, a provision for impairment may be required based upon such event or events. See
Item 1 "Business-Environmental Matters." Based on estimates obtained from external sources
and internal estimates based on inquiry and other techniques, we recognized impairments
relating to certain non-core equipment of $120,000 relating to Corporate assets during 2005
(none in 2007 and 2006) and $250,000, $286,000 and $117,000 relating to certain capital spare
parts and idle assets in our Chemical Business during 2007, 2006 and 2005, respectively. These
impairments are included in other expense in the consolidated statements of income.

Accrued Insurance Liabilities - We are self-insured up to certain limits for group health,
workers’ compensation and general liability insurance claims. Above these limits, we have
commercial insurance coverage for our contractual exposure on group health claims and
statutory limits under workers’ compensation obligations. We also carry excess umbrella
insurance of $50 million for most general liability risks excluding environmental risks. We have
a separate $30 million insurance policy covering pollution liability at our El Dorado and
Cherokee Facilities. Our accrued insurance liabilities are based on estimates of claims, which
include the incurred claims amounts plus estimates of future claims development calculated by
applying our historical claims development factors to our incurred claims amounts. We also
consider the reserves established by our insurance adjustors and/or estimates provided by
attorneys handling the claims, if any. In addition, our accrued insurance liabilities include
estimates of incurred, but not reported, claims and other insurance-related costs. At December
31, 2007 and 2006, our accrued insurance liabilities were $3.0 million and $1.6 million,
respectively, and are included in accrued and other liabilities in the consolidated balance sheets.
It is possible that the actual development of claims could exceed our estimates. Amounts
recoverable from our insurance carriers over the self-insured limits are included in accounts
receivable.

Product Warranty - Our Climate Control Business sells equipment for which we provide
warranties covering defects in materials and workmanship. Generally, the base warranty
coverage for most of the manufactured equipment is limited to 18 months from the date of
shipment or 12 months from the date of start-up, whichever is shorter, and to 90 days for spare
parts. In some cases, the customer may purchase an extended warranty. Our accounting policy
and methodology for warranty arrangements is to periodically measure and recognize the
expense and liability for such warranty obligations using a percentage of net sales, based on
historical warranty costs. It is possible that future warranty costs could exceed our estimates. At
December 31, 2007 and 2006, our accrued product warranty obligations were $1.9 million and
$1.3 million, respectively and are included in current and noncurrent accrued and other liabilities
in the consolidated balance sheets.

Plant Turnaround Costs - We expense the costs as they are incurred relating to planned
major maintenance activities (“Turnarounds”) of our Chemical Business as described as the
direct expensing method within Financial Accounting Standards Board (“FASB”) Staff Position
No. AUG AIR-1.

Executive Benefit Agreements - We have entered into benefit agreements with certain key
executives. Costs associated with these individual benefit agreements are accrued when they
become probable over the estimated remaining service period. Total costs accrued equal the
present value of specified payments to be made after benefits become payable. In 1992, we
entered into individual benefit agreements with certain key executives (“1992 Agreements”) that
provide for annual benefit payments for life (in addition to salary). The liability for these benefits
under the 1992 Agreements is $1,040,000 and $979,000 as of December 31, 2007 and 2006,
respectively, and is included in current and noncurrent accrued and other liabilities in the
consolidated balance sheets.

In 1981, we entered into individual death benefit agreements with certain key executives. In
addition, as part of the 1992 Agreements, should the executive die prior to attaining the age of
65, we will pay the beneficiary named in the agreement in 120 equal monthly installments
aggregating to an amount specified in the agreement. In 2005, we entered into a death benefit
agreement with our CEO. As of December 31, 2007, the liability for death benefits is $2.1
million ($1.4 million at December 31, 2006) which is included in current and noncurrent accrued
and noncurrent liabilities in the consolidated balance sheets.

Environmental and Regulatory Compliance - The Chemical Business is subject to specific
federal and state regulatory and environmental compliance laws and guidelines. We have
developed policies and procedures related to environmental and regulatory compliance. We must
continually monitor whether we have maintained compliance with such laws and regulations and
the operating implications, if any, and amount of penalties, fines and assessments that may result
from noncompliance. At December 31, 2007, liabilities totaling $0.4 million have been accrued
relating to a consent administrative order (“CAO”) covering the El Dorado Facility and a CAO
covering our former Hallowell facility. These 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 based on results from our surface and groundwater monitoring and mitigation work plan. In
addition, we will be required to make capital expenditures as it relates to the AirCAO.

Asset Retirement Obligations - We are obligated to monitor certain discharge water outlets
at our Chemical Business facilities should we discontinue the operations of a facility. We also
have certain facilities in our Chemical Business that contain asbestos insulation around certain
piping and heated surfaces which we plan to maintain in an adequate condition to prevent
leakage through our standard repair and maintenance activities. We do not believe the annual
costs of the required monitoring and maintenance activities would be significant and we
currently have no plans to discontinue the use of these facilities and the remaining life of the
facilities is indeterminable, an asset retirement liability has not been recognized. Currently, there
is insufficient information to estimate the fair value of the asset retirement obligations. However,
we will continue to review these obligations and record a liability when a reasonable estimate of
the fair value can be made in accordance with FIN 47.

Income Taxes - We account for income taxes in accordance with SFAS 109 and we adopted
FIN No. 48 – Accounting for Uncertainty in Income Taxes (“FIN 48”) on January 1, 2007. We
recognize deferred tax assets and liabilities for the expected future tax consequences attributable
to tax net operating loss (“NOL”) carryforwards, tax credit carryforwards, and differences
between the financial statement carrying amounts and the tax basis of our assets and liabilities.
We establish valuation allowances if we believe it is more-likely-than-not that some or all of
deferred tax assets will not be realized. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. 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 record interest related to unrecognized tax positions in interest
expense and penalties in operating other expense.

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

Contingencies - We accrue for contingent losses when such losses are probable and
reasonably estimable. In addition, we recognize contingent gains when such gains are realized.
We are a party to various litigation and other contingencies, the ultimate outcome of which is not
presently known. Should the ultimate outcome of these contingencies be adverse, such outcome
could create an event of default under ThermaClime's Working Capital Revolver Loan and the
Secured Term Loan and could adversely impact our liquidity and capital resources.

Revenue Recognition - We recognize revenue for substantially all of our operations at the
time title to the goods transfers to the buyer and there remains no significant future performance
obligations by us. Revenue relating to construction contracts is recognized using the percentage-
of-completion method based primarily on contract costs incurred to date compared with total
estimated contract costs. Changes to total estimated contract costs or losses, if any, are
recognized in the period in which they are determined. Sales of warranty contracts are
recognized as revenue ratably over the life of the contract. See discussion above under “Product
Warranty” for our accounting policy for recognizing warranty expense.

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.

Management's judgment and estimates in these areas are based on information available from
internal and external resources at that time. Actual results could differ materially from these
estimates and judgments, as additional information becomes known.

Results of Operations

The following Results of Operations should be read in conjunction with our Consolidated
Financial Statements for the years ended December 31, 2007, 2006 and 2005 and accompanying
notes and the discussions above under “Overview” And “Liquidity and Capital Resources.”

The following table contains certain information about our continuing operations in different
industry segments for each of the three years ended December 31:

Net sales:

Climate Control
Chemical
Other

Gross profit:

Climate Control
Chemical
Other

Operating income (loss):
Climate Control
Chemical
General corporate expense and other business
operations, net

2007

2006
(In Thousands)

2005

$ 286,365
288,840
11,202
$ 586,407

83,638
44,946
4,009
$ 132,593

34,194
35,011

(10,194)
59,011

$ 221,161
260,651
10,140

$ 491,952

$ 156,859
233,447
6,809
$ 397,115

65,496
22,023
3,343
90,862

25,428
9,785

(8,074)
27,139

48,122
16,314
2,330
66,766

14,097
7,591

(6,835)
14,853

Interest expense
Non-operating income, net:

Climate Control
Chemical
Corporate and other business operations

Provision for income taxes
Equity in earnings of affiliate - Climate Control
Income from continuing operations

(12,078)

(11,915)

(11,407)

2
109
1,153
(2,540)
877
46,534

1
311
312
(901)
821
15,768

-
362
1,199
(118)
745
5,634

Year Ended December 31, 2007 Compared to Year Ended December 31, 2006

Net Sales

The following table contains certain information about our net sales in different industry
segments for 2007 and 2006:

2007

2006

Change

(Dollars In Thousands)

Percentage
Change

Net sales:

Climate Control:

Geothermal and water source heat pumps
Hydronic fan coils
Other HVAC products

Total Climate Control

$ 165,115
85,815
35,435
$ 286,365

$ 134,210 $ 30,905
26,318
7,981
$ 221,161 $ 65,204

59,497
27,454

23.0 %
44.2 %
29.1 %
29.5 %

Chemical:

Agricultural products
Industrial acids and other chemical products
Mining products

Total Chemical

Other

Total net sales

Climate Control Business

$ 117,158
95,754
75,928
$ 288,840

$ 89,735 $ 27,423
546
220
$ 260,651 $ 28,189

95,208
75,708

30.6 %
0.6 %
0.3 %
10.8 %

11,202

$ 10,140 $

1,062

10.5 %

$ 586,407

$ 491,952 $ 94,455

19.2 %

• Net sales of our geothermal and water source heat pump products increased primarily as a
result of increases in original equipment manufacturer (“OEM”), export and commercial
shipments. In total, the number of geothermal and water source heat pump products
shipments increased by approximately 10% in 2007 as compared to 2006. In addition, an
increase of approximately 13% relates to the change in product mix and price increases. The
price increases were instituted in response to rising raw material and component purchase
prices. Due to the significant backlog of customer orders at the time the price increases were
put into effect, the impact of customer price increases trail cost increases in raw material and
component purchase prices. In 2007, the impact of price increases is estimated to be
approximately 4%. We continue to maintain a market share leadership position based on data
supplied by the Air-Conditioning and Refrigeration Institute;

• Net sales of our hydronic fan coils increased primarily due to a 16% increase in the number
of units sold due to an increase in large customer orders as well as a 25% increase in average
unit sales prices as the result of the change in product mix, lower discounting, and higher
selling prices driven by raw material cost increases;

• Net sales of our other HVAC products increased primarily as the result of engineering and

construction services due to work completed on construction contracts.

Chemical Business

The El Dorado and Cherokee Facilities produce all the chemical products described in the table
above and the Baytown Facility produces only nitric acid products. The volume of tons sold and
the sales prices for the Chemical Business increased 3% and 7%, respectively, compared with
2006.

• Overall, volume at the El Dorado Facility remained essentially the same while sales prices
increased 10%. However, our product mix shifted in 2007 from industrial acids products to
agricultural products driven by increased agricultural demand. The increase in sales prices
includes a 17% increase relating to our nitrogen fertilizer products.

• Overall volume at the Cherokee Facility increased 7% and sales prices increased 11%. The
Cherokee Facility also experienced the same market-driven demand for nitrogen fertilizer
products in 2007, which resulted in a 54% increase in volume and a 32% increase in sales
prices relating to these products. Additionally, there were low demand and production
curtailments experienced throughout the first quarter of 2006 as the result of reduction in
orders from several key customers due to the high cost of natural gas caused by the effects of
Hurricane Katrina.

• Volume increased 5% while sales prices remained essentially the same at the Baytown

Facility.

Other - Net sales classified as “Other” consists of sales of industrial machinery and related
components. The increase in net sales relates primarily to increased customer demand for our
machine tool products.

Gross Profit

Gross profit by industry segment represents net sales less cost of sales. The following table
contains certain information about our gross profit in different industry segments for 2007 and
2006:

2007

2006

Change

(Dollars In Thousands)

Percentage
Change

Gross profit:

Climate Control
Chemical
Other

83,638
44,946
4,009
$ 132,593

$ 65,496
22,023
3,343
$ 90,862

$ 18,142
22,923
666
$ 41,731

27.7 %
104.1 %
19.9 %
45.9%

Gross profit percentage (1):

Climate Control
Chemical
Other

Total

(1) As a percentage of net sales

29.2%
15.6%
35.8%
22.6%

29.6%
8.4%
33.0%
18.5%

(0.4)%
7.2 %
2.8 %
4.1 %

The increase in gross profit in our Climate Control Business was a direct result of the increase in
sales volume, change in product mix, and price increases as discussed above. Our gross profit
percentage as a percentage of sales decreased by 0.4% primarily due to raw material costs
increases being incurred ahead of customer price increases becoming effective as well as
changes in product mix.

The increase in gross profit of our Chemical Business relates primarily to improved margins on
agricultural products sold by the El Dorado and Cherokee Facilities. Comparing 2007 with 2006,
there was little change in the cost of the El Dorado and Cherokee Facilities’ primary feedstocks,
ammonia and natural gas. As a result, the higher selling prices and volumes as discussed above
are the primary reasons for the increase in the gross profit percentage.

During 2007 and 2006, we recorded the realization of losses on certain nitrogen-based
inventories of approximately $0.4 million and $1.0 million, respectively. In addition, during
2007, we realized insurance recoveries of approximately $3.8 million relating to a business
interruption claim associated with the Cherokee Facility. In 2006, we realized insurance
recoveries of approximately $0.9 million relating to a business interruption claim associated with
the El Dorado Facility. The above transactions contributed to an increase in gross profit for each
respective period.

As discussed above under “Overview-Chemical Business,” our Chemical Business uses precious
metals as a catalyst in the manufacturing process. During 2007, we had accumulated precious
metals in excess of our production requirements. Therefore we sold a portion of the excess
metals. As a result, we recognized a gain of $2.0 million which increased gross profit compared
to 2006. However, this increase in gross profit of $2.0 million was partially offset by a decrease
of $1.8 million due primarily to the increase in precious metals expense of approximately $1.5
million compared to 2006 as the result of cost increases for these metals.

The increase in gross profit classified as “Other” (see discussion above) is due primarily to the
increase in sales as discussed above.

Operating Income

Our chief operating decision makers use operating income by industry segment for purposes of
making decisions which include resource allocations and performance evaluations. Operating
income by industry segment represents gross profit by industry segment less SG&A incurred by
each industry segment plus other income and other expense earned/incurred by each industry
segment before general corporate expenses and other business operations, net. General corporate
expenses and other business operations, net consist of unallocated portions of gross profit,
SG&A, other income and other expense. The following table contains certain information about
our operating income for 2007 and 2006:

Operating income:
Climate Control
Chemical
General corporate expense and other

business operations, net

2007

2006
(In Thousands)

Change

$ 34,194 $ 25,428 $ 8,766
25,226

35,011

9,785

(10,194)

(8,074)
$ 59,011 $ 27,139

(2,120)
$ 31,872

Operating Income - Climate Control: The net increase in operating income of our Climate
Control Business resulted primarily from the net increase of gross profit of $18.1 million as
discussed above. This increase in operating income was partially offset primarily by increased
personnel cost of $1.8 million as the result of increased number of personnel and group
healthcare costs, increased commissions and warranty expenses of $1.6 million and $1.1 million,
respectively, due to increased sales volume and distribution/product mix increased shipping and
handling costs of $0.7 million due to increased sales volume and rising fuel costs and increased
consulting fees of $0.5 million primarily due to efforts to promote governmental support in the
geothermal market. In addition, our Climate Control Business recognized income of $1.2 million
in 2006 relating to an arbitration award received relating to an arbitration case involving a
subsidiary within the Climate Control Business.

Operating Income - Chemical: The net increase of our Chemical Business’ operating
income primarily relates to the net increase in gross profit of $22.9 million as discussed above.
Also as discussed above under “Overview - Chemical Business”, our Chemical Business
recognized income of approximately $3.3 million relating to a litigation settlement during 2007.

General Corporate Expense and Other Business Operations, Net: The net increase of
$2.1 million in our general corporate expense and other business operations, net relates primarily
to an increase of professional fees of $1.3 million primarily as the result of costs incurred
associated with the evaluation and audit of our internal controls and procedures and related
documentation for Sarbanes-Oxley requirements and an increase of $1.0 million in personnel
costs due, in part, to increased group health care costs which was partially offset by the increase
of $0.7 million in gross profit classified as “Other” as discussed above.

Interest Expense - Interest expense was $12.1 million for 2007 compared to $11.9 million for
2006, an increase of $0.2 million. This net increase includes $2.0 million relating to the 2007
Debentures, $0.6 million relating to the Secured Term Loan and the $0.6 million change in the
fair value of our interest rate caps. This increase was partially offset by a decrease of $1.3
million as the result of the conversions of the 2006 Debentures during 2006 and 2007, a decrease
of $1.1 million primarily due the pay down of the Working Capital Revolver Loan during 2007,
and a decrease of $0.6 million as the result of the acquisition of the 10.75% Senior Unsecured
Notes during 2006.

Provision For Income Taxes - The provision for income taxes for 2007 was $2.5 million
compared to $0.9 million for 2006. The increase of $1.6 million was primarily the result of an
increase in the federal and state income taxes resulting from increased taxable income and
additional prior year state income taxes recorded under FIN 48. This increase was partially offset
by the benefit of deferred taxes from the reversal of valuation allowances discussed above under
“Overview – 2007 Results”.

Net Loss (Income) From Discontinued Operations - Net income from discontinued operations
was $0.3 million for 2007 compared to a net loss from discontinued operations of $0.3 million
for 2006. The loss incurred in 2006 relates primarily to provisions for our estimated costs to
investigate and delineate a site in Hallowell, Kansas as a result of meetings with the KDHE
during 2006. However, on September 12, 2007, the KDHE approved our proposal to perform
surface and groundwater monitoring and to implement a mitigation work plan to acquire
additional field data. As a result of receiving approval from the KDHE for our proposal, net
income from discontinued operations for 2007 relates primarily to the reduction of our liability
for the estimated costs associated with this remediation.

Year Ended December 31, 2006 Compared to Year Ended December 31, 2005

Net Sales

The following table contains certain information about our net sales in different industry
segments for 2006 and 2005:

2006

2005
(Dollars In Thousands)

Change

Percentage
Change

Net sales:

Climate Control:

Geothermal and water source heat pumps
Hydronic fan coils
Other HVAC products

Total Climate Control

$ 134,210
59,497
27,454
$ 221,161

$ 85,268 $ 48,942
5,933
9,427
$ 156,859 $ 64,302

53,564
18,027

57.4 %
11.1 %
52.3 %
41.0 %

Chemical:

Industrial acids and other chemical products $
Agricultural products
Mining products

95,208
89,735
75,708
$ 260,651

$ 80,228 $ 14,980
9,097
3,127
$ 233,447 $ 27,204

80,638
72,581

18.7 %
11.3 %
4.3 %
11.7 %

Total Chemical

Other

Total net sales

10,140

6,809 $

3,331

48.9 %

$ 491,952

$ 397,115 $ 94,837

23.9 %

Climate Control Business

• Net sales of our geothermal and water source heat pump products increased primarily as a
result of a 52% increase in the number of units sold in the commercial and residential
markets due to customer demand representing an approximate 4% gain in market share based
on data supplied by the ARI;

• Net sales of our hydronic fan coils increased primarily due to a 10% increase in overall
average unit sales prices as the result of lowering discounting and higher selling prices driven
by raw material cost increases;

• Net sales of our other HVAC products increased as the result of an increase in the number of

larger custom air handlers sold primarily relating to three large projects.

Chemical Business

The El Dorado and Cherokee Facilities produce all the chemical products described in the table
above and the Baytown Facility produces only industrial acids products. Overall, volume of tons
sold for the Chemical Business increased 12% while sales prices remained consistent with 2005.

• Volume at the El Dorado Facility increased 14% primarily related to agricultural products as
the result of the loss of production during the first half of 2005 as discussed below, to
industrial acid and other chemical products due to spot sales opportunities, and to mining
products relating to the growth of coal mining in the mining industry;

• Volume at the Baytown Facility increased 24% as the result of a closing of a chemical

facility within our market and other various spot sales opportunities;

• Volume at the Cherokee Facility decreased 6% resulting from the suspension of production
during the first half of January 2006 as the result of a reduction in orders from several key
customers due to the increased natural gas costs and further production curtailments
throughout the first quarter of 2006.

Gross Profit

Gross profit by industry segment represents net sales less cost of sales. The following table
contains certain information about our gross profit in different industry segments for 2006 and
2005:

Gross profit:

Climate Control
Chemical
Other

2006

2005
(Dollars In Thousands)

Change

Percentage
Change

65,496
22,023
3,343
90,862

$ 48,122
16,314
2,330
$ 66,766

$ 17,374
5,709
1,013
$ 24,096

36.1 %
35.0%
43.5%
36.1%

Gross profit percentage (1):

Climate Control
Chemical
Other

Total

29.6%
8.4%
33.0%
18.5%

30.7%
7.0%
34.2%
16.8%

(1.1)%
1.4 %
(1.2)%
1.7 %

(1) As a percentage of net sales

The increase in gross profit in our Climate Control Business was a direct result of the increase in
sales volume as discussed above. The decline in our gross profit percentage was primarily due to
raw material costs increases being incurred ahead of customer price increases becoming
effective.

The net increase in gross profit of our Chemical Business relates primarily to:

• The Cherokee Facility as the result of not incurring the disruptions at the plant caused by
the rise in natural gas costs due to the hurricanes in the U.S. Gulf in 2005 and a decrease
in electricity costs as a result of a negotiated reduction in utility rates in 2006;

• The Baytown Facility due primarily to the increase in sales volume as discussed above;
• The El Dorado Facility as the result of the increase in sales volume as discussed above.

As previously reported, beginning in October 2004 and continuing into June 2005, the Chemical
Business’ results were adversely affected as a result of the loss of production due to a mechanical
failure of one of the four nitric acid plants at the El Dorado Facility. The plant was restored to
normal production in June 2005. We recognized insurance recoveries of $0.9 million and $1.9
million under our business interruption insurance policy relating to this claim for 2006 and 2005,
respectively, which is recorded as a reduction to cost of sales. The negative impact on gross
profit resulting from the lost production was approximately $4.1 million in 2005.

The increase in gross profit classified as “Other” (see discussion above) is due primarily to the
increase in sales as discussed above.

Operating Income

2006

2005
(In Thousands)

Change

Operating income:
Climate Control
Chemical
General corporate expense and other

business operations, net

$ 25,428 $ 14,097 $ 11,331
2,194

9,785

7,591

(8,074)

(6,835)
$ 27,139 $ 14,853

(1,239)
$ 12,286

Operating Income - Climate Control: The net increase in operating income of our Climate
Control Business resulted primarily from the net increase of gross profit of $17.4 million as
discussed above, an arbitration award of $1.2 million received in 2006 relating to the arbitration
case involving a subsidiary within the Climate Control Business, and a decrease in professional
fees of $1.0 million primarily as the result of fees incurred during 2005 relating to this arbitration
case. This increase in operating income was partially offset by increased shipping and handling
costs of $3.9 million due to increased sales volume and rising fuel costs, increased commissions
of $1.8 million due to increased sales volume and distribution mix and increased personnel cost
of $1.6 million as the result of increased number of personnel and higher incentives, and
increased warranty costs of $0.7 million due to the increased sales volume.

Operating Income - Chemical: The net increase of our Chemical Business’ operating
income primarily relates to the net increase in gross profit of $5.7 million as discussed above.
This increase in operating income was partially offset by an increase in handling costs of $0.8
million due primarily to increased sales volume and an increase in professional fees of $0.4
million relating to legal costs associated with ammonium nitrate anti-dumping tariffs. In
addition, we recognized gains of $1.6 million from certain property insurance claims in 2005.

General Corporate Expense and Other Business Operations, Net: The net increase in our
general corporate expense and other business operations, net relates primarily to an increase of
$0.6 million in personnel costs relating to increased group health care costs of $0.4 million and
commissions of $0.3 million on the increased sales classified as “Other” as discussed above, an
increase in professional fees of $0.6 million due, in part, for assistance in our evaluation of our
internal controls and procedures and related documentation for Sarbanes-Oxley requirements, a
litigation settlement of $0.3 million relating to an asserted financing fee, and a decrease in gains
of $0.7 million from the sales of corporate assets. The increase was partially offset by the
increase in gross profit classified as “Other” of $1.0 million and a refund of $0.4 million relating
to insurance brokerage fees.

Interest Expense - Interest expense was $11.9 million for 2006 compared to $11.4 million for
2005, an increase of $0.5 million. This net increase in interest expense includes $1.1 million
relating to the 2006 Debentures sold in March 2006 and $0.3 million of additional consideration
paid in conjunction with the conversion of a portion of the 2006 Debentures during 2006 which
was partially offset by a decrease of $0.8 million relating to the Notes which were purchased or
redeemed during 2006.

Non-Operating Other Income, net - Our non-operating other income, net was $0.6 million for
2006 compared to $1.6 million for 2005. In 2005, we recognized net proceeds from life
insurance policies of $1.2 million.

Provision For Income Taxes - Due to NOL carryforwards, provisions for income taxes consist
of federal alternative minimum taxes and state income taxes for 2006 and federal alternative
minimum taxes for 2005.

Net Loss From Discontinued Operations - Net loss from discontinued operations includes
provisions of $0.2 million and $0.6 million for 2006 and 2005, respectively, for our share of
estimated environmental remediation costs to investigate and delineate a site in Hallowell,
Kansas as a result of meetings with the KDHE. There are no income tax benefits related to these
expenses.

Cash Flow From Continuing Operating Activities

Historically, our primary cash needs have been for operating expenses, working capital and
capital expenditures. We have financed our cash requirements primarily through internally
generated cash flow, borrowings under our revolving credit facilities, secured asset financing and
the sale of assets. See additional discussion concerning cash flows from our Climate Control and
Chemical Businesses in "Liquidity and Capital Resources."

For 2007, net cash provided by continuing operating activities was $46.8 million, including net
income (which includes insurance recoveries of $3.8 million under our business interruption
insurance policy and a litigation settlement of $3.3 million), plus depreciation and amortization,
deferred income taxes, and other adjustments offset by cash used by the following changes in
assets and liabilities:

Accounts receivable increased a net $4.4 million including:

•

an increase of $2.4 million relating to the Chemical Business as the result of increased
sales at the Cherokee Facility as discussed above under “Results of Operations” and a
portion of the business interruption insurance claim discussed above under “Overview –
Chemical Business”,
an increase of $0.7 million relating to group health insurance claims in excess of our self-
insured limits,
a net increase of $0.5 million relating to the Climate Control Business due primarily to
increased sales of hydronic fan coils and other HVAC products relating to engineering
and construction services as discussed above under “Results of Operations” which was
partially offset by a decrease in the average number of days our receivable balances were
outstanding relating to our heat pump product customers, and

•

an increase of $0.6 million relating to the timing of payments received from our
customers of industrial machinery.

Inventories increased a net $11.0 million including:

•

a net increase of $5.3 million relating to the Climate Control Business primarily relating
to heat pump and hydronic fan coil products due primarily to increased levels of raw
materials and finished goods on hand as the result of the expansion of our facilities to
meet customer demands and the increase in number of construction contracts in progress
partially offset by a decrease in inventories held by our large custom air handler operation
as a result of an increase in sales and a decrease in production during the fourth quarter of
2007,
an increase of $3.9 million in the Chemical Business relating primarily to the Cherokee
Facility as a result of a significant amount of inventory on hand which was not delivered
to a customer until January 2008 and a reduction of inventory on hand at the end of 2006
due to a Turnaround performed in December 2006, and
an increase of $1.8 million relating to our industrial machinery to meet customer demand.

Other supplies and prepaid items increased $4.9 million primarily due to an increase in the cost
of precious metals and additional metals purchased and recovered net of the amount consumed in
the manufacturing process and sold by our Chemical Business.

Accounts payable decreased $5.1 million primarily due to:

•

a decrease of $3.9 million in our Chemical Business resulting primarily from the payment
of invoices relating to the Baytown Facility’s property taxes and scheduled lease billings
and the payment of invoices relating to a Turnaround performed in December 2006 at the
Cherokee Facility and
a decrease of $1.5 million in our Climate Control Business resulting primarily from a
decrease in the average number of days outstanding partially offset by an increase in
purchases of raw materials to manufacture primarily hydronic fan coil and air handler
products.

Customer deposits increased $6.6 million primarily due to:

•

an increase of $7.8 million in our Chemical Business due to the increase in deposits
received on sales commitments by the Cherokee and El Dorado Facilities partially offset
by
a decrease of $1.3 million in our Climate Control Business due primarily as the result of
recognizing the sales of large custom air handlers associated with those deposits.

The decrease in deferred rent expense of $0.9 million is due to the scheduled lease payments in
2007 exceeding the rent expense recognized on a straight-line basis.

The increase in other current and noncurrent liabilities of $8.7 million includes:

•

an increase of $4.0 million of accrued income and property taxes due primarily to the
increase in income taxes resulting from increased taxable income, increase in uncertain
tax positions under FIN 48, and taxes in additional state jurisdictions,

•

an increase of $1.3 million of accrued insurance due primarily to changes in our
insurance programs and as a result of an increase in group insurance claims as of
December 31, 2007.
an increase of $1.2 million of accrued payroll and related benefits primarily relating to
the Climate Control Business as the result of increases in the number of personnel and
compensation incentives,
an increase of $1.0 million of deferred revenue on extended warranty contracts as the
result of an increase in sales of our water source heat pump products, and
and a net increase of $1.2 million due to other individually immaterial items.

Cash Flow from Continuing Investing Activities

Net cash used by continuing investing activities was $11.8 million for 2007, which included
$14.8 million for capital expenditures of which $5.8 million are for the benefit of our Climate
Control Business and $8.6 million are for our Chemical Business and the purchase of interest
rate cap contracts for $0.6 million. These expenditures were partially offset by proceeds from
restricted cash of $3.5 million, which was primarily used to pay down debt.

Cash Flow from Continuing Financing Activities

Net cash provided by continuing financing activities was $21.2 million, which primarily
consisted of:

•

•
•
•

•

net proceeds of $57.0 million from the 2007 Debentures as discussed above under
“Liquidity and Capital Resources”,
proceeds of $50.0 million from the Secured Term Loan as discussed above under
“Liquidity and Capital Resources”,
net proceeds of $2.4 million from other long-term debt primarily for working capital
purposes,
proceeds of $1.9 million from the exercise of stock options and a warrant,
excess tax benefit of $1.7 million on stock options exercised, offset in part, by the
payoff of the Senior Secured Loan of $50.0 million as discussed above under
“Liquidity and Capital Resources”,
payments of $26.4 million on revolving debt facilities, net of proceeds, primarily from
the use of proceeds from the 2007 Debentures,

• payments of $9.2 million on other long-term debt and debt issuance costs,
•
•

dividend payments of $2.9 million on preferred stock,
payments of $2.1 million on short-term financing and drafts payable, net of proceeds,
and

• payments of $1.3 million to acquire non-redeemable preferred stock.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined in Item 303(a)(4)(ii) of
Regulation S-K under the Securities Exchange Act of 1934, as amended, except for the
following:

Cepolk Holding, Inc. (“CHI”), a subsidiary of the Company, 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 (“Project”). At December 31, 2007, our investment was $3.4 million. For
2007, distributions received from this Partnership were $0.8 million and our equity in earnings
was $0.9 million. As of December 31, 2007, the Partnership and general partner to the
Partnership is indebted to a term lender (“Lender”) of the Project with a term extending to
December 2010 (“Loan”). CHI has pledged its limited partnership interest in the Partnership to
the Lender as part of the Lender’s collateral securing all obligations under the Loan. This
guarantee and pledge is limited to CHI’s limited partnership interest and does not expose CHI or
the Company to liability in excess of CHI’s limited partnership interest. No liability has been
established for this pledge since it was entered into prior to adoption of FIN 45. CHI has no
recourse provisions or available collateral that would enable CHI to recover its partnership
interest should the Lender be required to perform under this pledge.

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For a discussion on our net operating loss carry-overs, see Note 12 of Notes to Consolidated
Financial Statements.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK

General

Our results of operations and operating cash flows are impacted by changes in market interest
rates and changes in market prices of copper, steel, anhydrous ammonia and natural gas.

Forward Sales Commitments Risk

Periodically our Climate Control and Chemical Businesses enter into forward sales commitments
of products for deliveries in future periods. As a result, we could be exposed to embedded losses
should our product costs exceed the firm sales prices. At December 31, 2007, we had no
embedded losses associated with sales commitments with firm sales prices.

Interest Rate Risk

Our interest rate risk exposure results from our debt portfolio which is impacted by short-term
rates, primarily variable rate-based borrowings from commercial banks, and long-term rates,
primarily fixed-rate notes, some of which prohibit prepayment or require substantial prepayment
penalties.

In 2005, we purchased two interest rate cap contracts for a cost of $590,000 to help minimize our
interest rate risk exposure relating to the Working Capital Revolver Loan. These contracts set a
maximum three-month LIBOR base rate of 4.59% on $30 million of debt and mature in March
2009. In April 2007, we purchased two interest rate cap contracts for a cost of $621,000 to help
minimize our interest rate risk exposure associated with debt. These contracts set a maximum
three-month LIBOR base rate of 5.35% on $50 million of debt and mature in April 2012. These
contracts are free-standing derivatives and are accounted for on a mark-to-market basis in
accordance with SFAS No.133. At December 31, 2007, the market value of these contracts was
$426,000.

Commodity Price Risk

Our Climate Control Business buys substantial quantities of copper and steel for use in
manufacturing processes and our Chemical Business buys substantial quantities of anhydrous
ammonia and natural gas as feedstocks generally at market prices. Periodically, our Climate
Control Business enters into exchange-traded futures for copper and our Chemical Business
enters into exchange-traded futures for natural gas, which contracts are generally accounted for
on a mark-to-market basis in accordance with SFAS 133. At December 31, 2007, our purchase
commitments under these contracts were for 3,875,000 pounds of copper through December
2008 at a weighted-average cost of $3.02 per pound ($11.7 million) and a weighted-average

market value of $3.04 per pound ($11.8 million). In addition, our Chemical Business had
purchase commitments under these contracts for 530,000 MMBtu of natural gas through April
2008 at a weighted-average cost of $7.98 per MMBtu ($4.2 million) and a weighted-average
market value of $7.51 per MMBtu ($4.0 million).

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Due to their short-term nature, the carrying values of financial instruments classified as cash,
restricted cash, accounts receivable, accounts payable, short-term financing and drafts payable,
and accrued and other liabilities approximated their estimated fair values. Carrying values for our
interest rate cap contracts and exchange-traded futures contracts approximate their fair value
since they are accounted for on a mark-to-market basis. Carrying values for variable rate
borrowings are believed to approximate their fair value. Fair values for fixed rate borrowings,
other than the 5.5% Senior Convertible Senior Subordinated Notes (“2007 Debentures”) and the
7% Senior Convertible Senior Subordinated Notes (“2006 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. The estimated fair value of the 2007 and 2006 Debentures are based on
the conversion rate and market price of our common stock at December 31, 2007 and 2006,
respectively. The following table shows the estimated fair value and carrying value of our
borrowings at:

December 31, 2007

Estimated
Fair Value

Carrying
Value

December 31, 2006
Carrying
Value

Estimated
Fair Value

(In Thousands)

Variable Rate:

Secured Term Loan
Working Capital Revolver Loan
Senior Secured Loan (1)
Other bank debt and equipment financing

50,000 $

-
-
155

50,000 $
-
-
155

- $

26,048
53,774
2,517

Fixed Rate:

5.5% Convertible Senior Subordinated Notes
Other bank debt and equipment financing
7% Convertible Senior Subordinated Notes

61,632
12,298
-

60,000
11,952
-

-
14,853
6,543

$ 124,085 $ 122,107 $ 103,735 $

-
26,048
50,000
2,517

-
15,127
4,000
97,692

(1) The Senior Secured Loan had a variable interest rate not to exceed 11% or 11.5% depending on
ThermaClime’s leverage ratio.

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

We have included the financial statements and supplementary financial information required by
this item immediately following Part IV of this report and hereby incorporate by reference the
relevant portions of those statements and information into this Item 8.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

As previously reported, we had noted various significant deficiencies in our disclosure controls
and procedures. At December 31, 2007, however, we identified one significant deficiency
relating to controls over electronic spreadsheets. To mitigate this lack of controls over
spreadsheets, we
these
spreadsheets. In evaluating the effectiveness of our disclosure controls and procedures at
December 31, 2007 as discussed below, management considered these mitigating controls and
controls involving financial review procedures.

implemented additional review and approval procedures over

As of the end of the period covered by this report, we carried out an evaluation, with the
participation of our Principal Executive Officer and Principal Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and procedures (as defined in
Rule 13a-15 under the Securities Exchange Act of 1934). Based upon that evaluation, we have
concluded, with the participation of our Principal Executive Officer and our Principal Financial
Officer, that our disclosure controls and procedures were effective. There were no changes to our
internal control over financial reporting during the quarter ended December 31, 2007 that has
materially affected, or is reasonably likely to materially affect, our internal control over financial
reporting.

Management’s Report on Internal Control over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over
financial reporting. Our internal control system was designed to provide reasonable assurance to
our management and board of directors regarding the preparation and fair presentation of
published financial statements. All internal control systems, no matter how well designed, have
inherent limitations. Therefore, even those systems determined to be effective can provide only
reasonable assurance with respect to financial statement preparation and presentation.

Our management assessed the effectiveness of our internal control over financial reporting as of
December 31, 2007. In making this assessment, it used the criteria set forth by the Committee of
Sponsoring Organizations of the Treadway Commission in Internal Control – Integrated
Framework. Based on our assessment, we believe that, as of December 31, 2007, our internal
control over financial reporting is effective based on those criteria.

Our independent registered public accounting firm has issued an attestation report on our internal
control over financial reporting. This report appears on the following page.

Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of LSB Industries, Inc.

We have audited LSB Industries, Inc.’s internal control over financial reporting as of December
31, 2007 based on criteria established in Internal Control-Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). LSB
Industries, Inc.’s management is responsible for maintaining effective internal control over
financial reporting, and for its assessment of the effectiveness of internal control over financial
reporting included in the accompanying Management’s Report on Internal Control over
Financial Reporting. Our responsibility is to express an opinion on the company’s internal
control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether effective internal control over financial reporting was
maintained in all material respects. Our audit included obtaining an understanding of internal
control over financial reporting, assessing the risk that a material weakness exists, testing and
evaluating the design and operating effectiveness of internal control based on the assessed risk,
and performing such other procedures as we considered necessary in the circumstances. We
believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable
assurance regarding the reliability of financial reporting and the preparation of financial
statements for external purposes in accordance with generally accepted accounting principles. A
company’s internal control over financial reporting includes those policies and procedures that
(1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect
the transactions and dispositions of the assets of the company; (2) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial statements in
accordance with generally accepted accounting principles, and that receipts and expenditures of
the company are being made only in accordance with authorizations of management and
directors of the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have
a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or
detect misstatements. Also, projections of any evaluation of effectiveness to future periods are
subject to the risk that controls may become inadequate because of changes in conditions, or that
the degree of compliance with the policies or procedures may deteriorate.

In our opinion, LSB Industries, Inc. maintained, in all material respects, effective internal control
over financial reporting as of December 31, 2007, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets of LSB Industries, Inc. as of
December 31, 2007 and 2006, and the related consolidated statements of income, stockholders'

equity, and cash flows for each of the three years in the period ended December 31, 2007 of LSB
Industries, Inc. and our report dated March 13, 2008 expressed an unqualified opinion thereon.

ERNST & YOUNG LLP

Oklahoma City, Oklahoma
March 13, 2008

ITEM 9B. OTHER INFORMATION

None.

SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS

Certain statements contained within this report may be deemed "Forward-Looking Statements"
within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E
of the Securities Exchange Act of 1934, as amended. All statements in this report other than
statements of historical fact are Forward-Looking Statements that are subject to known and
unknown risks, uncertainties and other factors which could cause actual results and performance
of the Company to differ materially from such statements. The words "believe", "expect",
"anticipate", "intend", "will", and similar expressions identify Forward-Looking Statements.
Forward-Looking Statements contained herein relate to, among other things,

• our Climate Control Business has developed leadership positions in niche markets by

offering extensive product lines, customized products and improved technologies,

• we have developed the most extensive line of water source heat pumps and hydronic fan

coils in the United States,

• we have used geothermal technology in the climate control industry to create the most energy

efficient climate control systems commercially available today,

• we are a leading provider of geothermal and water source heat pumps to the commercial

construction and renovation markets in the United States,

• the market for commercial water source heat pumps will continue to grow due to the relative
efficiency and long life of such systems as compared to other air conditioning and heating
systems, as well as to the emergence of the replacement market for those systems,

• the longer life, lower cost to operate, and relatively short payback periods of geothermal
systems, as compared with air-to-air systems, will continue to increase demand for our
geothermal products,

• our Climate Control Business is a leading provider of hydronic fan coils,
• the amount of capital expenditures relating to the Climate Control Business,
• obtaining raw materials for our Climate Control Business,
• the majority of raw material cost increases, if any, will be passed to our customers in the
form of higher prices as product price increases are implemented and take effect and while
we believe we will have sufficient materials, a shortage of raw materials could impact
production of our Climate Control products,

• our Climate Control Business manufactures a broader line of geothermal and water source

heat pump and fan coil products than any other manufacturer in the United States,

• we are competitive as to price, service, warranty and product performance in our Climate

Control Business,

• our Climate Control Business will continue to launch new products and product upgrades in
an effort to maintain and increase our current market position and to establish a presence in
new markets,

• shipping substantially all of our backlog at December 31, 2007 within the next twelve

months,

• increasing the sales and operating margins of all products, developing and introducing new
and energy efficient products, and increasing production to meet customer demand in the
Climate Control Business,

• our performance has been and will continue to be dependent upon the efforts of our principal
executive officers and our future success will depend in large part on our continued ability to
attract and retain highly skilled and qualified personnel,

• our NOL carryforwards and unrecognized tax benefits relating to NSOs to be utilized to

reduce federal income tax payments for 2008,

• not paying dividends on our common stock in the foreseeable future,
• the concentration relating to receivable accounts of six customers at December 31, 2007 does

not represent a significant credit risk due to the financial stability of these customers,

• important components of our strategy for competing in the commercial and institutional
renovation and replacement markets include the breadth of our product line coupled with
customization capability provided by a flexible manufacturing process,

• the annual United States market for water source heat pumps and hydronic fan coils to be

approximately $589 million based on data supplied by the ARI,

• these investments have and will increase our capacity to produce and distribute our Climate

Control products,

• the new products of our Climate Control Business have good long-term prospects,
• our Chemical Business has established leading regional market positions, which is a key

element in the success of this business,

• sales prices of our agricultural products have only a moderate correlation to the anhydrous
ammonia and natural gas feedstock costs and reflect market conditions for like and
competing nitrogen sources, which can compromise our ability to recover our full cost to
produce the product in this market,

• the lack of sufficient non-seasonal sales volume to operate our manufacturing facilities at
optimum levels can preclude the Chemical Business from reaching full performance
potential,

• our primary efforts to improve the results of our Chemical Business include maintaining the
current level of non-seasonal sales volumes with an emphasis on customers that will accept
the commodity risk inherent with natural gas and anhydrous ammonia, while maintaining a
strong presence in the agricultural sector,

• the El Dorado Facility produces a high performance ammonium nitrate fertilizer that,
because of its uniform size, is easier to apply than many competing nitrogen-based fertilizer
products,

• as of the date of this report, the recent world sulfur shortages have led to a significant

increase in the cost of this raw material during the second half at 2007 and into 2008,

• our Chemical Business’ strategy is to maximize production efficiency of the facilities,

thereby lowering the fixed cost of each ton produced,

• certain capital expenditures required to expand capacity and bring the El Dorado Facility’s

sulfuric acid plant air emissions to lower limits,

• other capital expenditures for 2008 are discretionary and dependent upon an adequate amount

of liquidity and/or obtaining acceptable funding,

• fully utilizing the regular NOL carryforwards in 2008 at which time we will begin

recognizing and paying federal income taxes at regular corporate tax rates,

• the agricultural products are the only seasonal products,
• we are the largest domestic merchant marketer of concentrated and blended nitric acids,
• competition within the Chemical Business is primarily based on service, price, location of

production and distribution sites, and product quality and performance,

• the amount of additional expenditures relating to the Air CAO,
• the annual costs of required monitoring and maintenance activities would not be significant

relating to certain facilities in our Chemical Business,

• the estimated costs to activate the Pryor Facility,
• our Chemical Business to focus on growing our non-seasonal industrial customer base with
the emphasis on customers that accept the risk inherent with raw material costs, while
maintaining a strong presence in the seasonal agricultural sector,

• obtaining our requirements for raw materials in 2008,
• the amount of committed capital expenditures for 2008,
• new and proposed requirements to place additional security controls over ammonium nitrate
and other nitrogen fertilizers will not materially affect the viability of ammonium nitrate as a
valued product,

• under the terms of an agreement with a supplier, the El Dorado Facility purchasing a majority

of its anhydrous ammonia requirements through at least December 31, 2008,

• ability to obtain anhydrous ammonia from other sources in the event of an interruption of

service under our existing purchase agreement,

• using the Working Capital Revolver Loan to fund our working capital requirements,
• outcomes of various contingencies adversely impacting our liquidity and capital resources,
• meeting all required covenant tests for all quarters and the year ending in 2008, and
• environmental and health laws and enforcement policies thereunder could result, in
compliance expenses, cleanup costs, penalties or other liabilities relating to the handling,
manufacture, use, emission, discharge or disposal of pollutants or other substances at or from
our facilities or the use or disposal of certain of its chemical products.

While we believe the expectations reflected in such Forward-Looking Statements are reasonable,
we can give no assurance such expectations will prove to have been correct. There are a variety
of factors which could cause future outcomes to differ materially from those described in this
report, including, but not limited to,

• decline in general economic conditions, both domestic and foreign,
• material reduction in revenues,
• material increase in interest rates,
• ability to collect in a timely manner a material amount of receivables,
• increased competitive pressures,
• changes in federal, state and local laws and regulations, especially environmental regulations,

or in interpretation of such, pending,

• additional releases (particularly air emissions) into the environment,
• material increases in equipment, maintenance, operating or labor costs not presently

anticipated by us,

• the requirement to use internally generated funds for purposes not presently anticipated,
• the inability to pay or secure additional financing for planned capital expenditures,

• the cost for the purchase of anhydrous ammonia and natural gas,
• changes in competition,
• the loss of any significant customer,
• changes in operating strategy or development plans,
• inability to fund the working capital and expansion of our businesses,
• adverse results in any of our pending litigation,
• inability to obtain necessary raw materials,
• other factors described in "Management's Discussion and Analysis of Financial Condition

and Results of Operation" contained in this report, and

• other factors described in “Risk Factors”.

Given these uncertainties, all parties are cautioned not to place undue reliance on such Forward-
Looking Statements. We disclaim any obligation to update any such factors or to publicly
announce the result of any revisions to any of the Forward-Looking Statements contained herein
to reflect future events or developments.

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

PART III

General

The Certificate of Incorporation and By-laws of the Company provide for the division of the
Board of Directors into three classes, each class consisting as nearly as possible of one-third of
the whole. The term of office of one class of directors expires each year; with each class of
directors elected for a term of three years and until the shareholders elect their qualified
successors.

The Company’s By-laws provide that the Board of Directors, by resolution from time to time,
may fix the number of directors that shall constitute the whole Board of Directors. The By-laws
presently provide that the number of directors may consist of not less than 3 nor more than 13.
The Board of Directors currently has set the number of directors at 13.

Directors

Raymond B. Ackerman, age 85. Mr. Ackerman first became a director in 1993. His term will
expire in 2008. From 1952 until his retirement in 1992, Mr. Ackerman served as Chairman of the
Board and President of Ackerman McQueen, Inc., the largest advertising and public relations
firm headquartered in Oklahoma. He currently serves as Chairman Emeritus of the firm. He
retired as a Rear Admiral in the United States Naval Reserve. He is a graduate of Oklahoma City
University, and in 1996, was awarded an honorary doctorate from the school. He was elected to
the Oklahoma Hall of Fame in 1993 and the Oklahoma Commerce and Industry Hall of Fame in
1998.

Robert C. Brown, M.D., age 76. Dr. Brown first became a director in 1969. His term will expire
in 2009. Dr. Brown has practiced medicine for many years and is Vice President and Treasurer
of Plaza Medical Group, P.C. and President and Chief Executive Officer of ClaimLogic L.L.C.
Dr. Brown received both his undergraduate and medical degrees from Tufts University after
which he spent two years in the United States Navy as a doctor and over three years at the Mayo
Clinic. Dr. Brown is also a Clinical Professor at University of Oklahoma Medical School.

Charles A. Burtch, age 72. Mr. Burtch first became a director in 1999. His term will expire in
2010. Mr. Burtch was formerly Executive Vice-President and West Division Manager of
BankAmerica, where he managed BankAmerica’s asset-based lending division for the western
third of the United States. He retired in 1998 and has since been engaged as a private investor.
Mr. Burtch is a graduate of Arizona State University.

Robert A. Butkin, age 55. Mr. Butkin first became a director in August 2007. His term will
expire in 2010. Mr. Butkin is currently a Professor of Law at the University of Tulsa College of
Law. He was Dean of the Tulsa College of Law from 2005 to 2007. Mr. Butkin also serves as
President of BRJN Capital Corporation a private investment company. Mr. Butkin served as
Assistant Attorney General for the State of Oklahoma from 1987 to 1993, and served from 1995

to 2005 as the State Treasurer of Oklahoma. He has served in various organizations, including
holding the presidency of the Southern State Treasurers Association. He chaired the Banking,
Collateral and Cash Management Committee for the National Association of State Treasurers. In
addition, from 1981 to 1995, he served on the Board of Citizens Bank of Velma, Oklahoma, and
he served as Chairman of the Board of that bank from 1991 to 1994. He attended and received a
Bachelor of Arts degree from Yale College. He received his Juris Doctorate from the University
of Pennsylvania Law School in Philadelphia in 1978.

Barry H. Golsen, J.D., age 57. Mr. Golsen first became a director in 1981. His term will expire
in 2009. Mr. Golsen was elected President of the Company in 2004. Mr. Golsen has served as
our Vice Chairman of the Board of Directors since August 1994, and has been the President of
our Climate Control Business for more than five years. Mr. Golsen also serves as a director of
the Oklahoma branch of the Federal Reserve Bank. Mr. Golsen has both his undergraduate and
law degrees from the University of Oklahoma.

Jack E. Golsen, age 79. Mr. Golsen first became a director in 1969. His term will expire in
2010. Mr. Golsen, founder of the Company, is our Chairman of the Board of Directors and Chief
Executive Officer and has served in that capacity since our inception in 1969. Mr. Golsen served
as our President from 1969 until 2004. During 1996, he was inducted into the Oklahoma
Commerce and Industry Hall of Honor as one of Oklahoma’s leading industrialists. Mr. Golsen
has a Bachelor of Science degree from the University of New Mexico. Mr. Golsen is a Trustee of
Oklahoma City University. During his career, he acquired or started the companies which
formed the Company. He has served on the boards of insurance companies, several banks and
was Board Chairman of Equity Bank for Savings N.A. which was formerly owned by the
Company.

David R. Goss, age 67. Mr. Goss first became a director in 1971. His term will expire in 2009.
Mr. Goss, a certified public accountant, is our Executive Vice President of Operations and has
served in substantially the same capacity for more than five years. Mr. Goss is a graduate of
Rutgers University.

Bernard G. Ille, age 81. Mr. Ille first became a director in 1971. His term will expire in 2008.
Mr. Ille served as President and Chief Executive Officer of United Founders Life from 1966 to
1988. He served as President and Chief Executive Officer of First Life Assurance Company from
1988, until it was acquired by another company in 1994. During his tenure as President of these
two companies, he served as Chairman of the Oklahoma Guaranty Association for ten years and
was President of the Oklahoma Association of Life Insurance Companies for two terms. He was
a director of Landmark Land Company, Inc., which was the parent company of First Life. He is
also a director for Quail Creek Bank, N.A. Mr. Ille is currently President of BML Consultants
and a private investor. He is a graduate of the University of Oklahoma.

Donald W. Munson, age 75. Mr. Munson first became a director in 1997. His term will expire
in 2008. From 1988, until his retirement in 1992, Mr. Munson served as President and Chief
Operating Officer of Lennox Industries. Prior to 1998, he served as Executive Vice President of
Lennox Industries’ Division Operations, President of Lennox Canada and Managing Director of
Lennox Industries’ European Operations. Prior to joining Lennox Industries, Mr. Munson served

in various capacities with the Howden Group, a company located in Scotland, and The Trane
Company, including serving as the managing director of various companies within the Howden
Group and Vice President Europe for The Trane Company. He is currently a consultant. Mr.
Munson is a resident of England. He has degrees in mechanical engineering and business
administration from the University of Minnesota.

Ronald V. Perry, age 58. Mr. Perry first became a director in August 2007. His term will expire
in 2008. Mr. Perry currently serves as President of Prime Time Travel, which he founded in
1979. Mr. Perry has served in various charitable and civic organizations. Mr. Perry is also a past
President of the Oklahoma City Food Bank and has served as President of the OKC Food Bank
Board of Directors. In 2007, the mayor of Oklahoma City appointed Mr. Perry to serve as a
commissioner on the Oklahoma City Convention and Visitors Bureau. Mr. Perry graduated from
Oklahoma State University, with a Bachelor’s degree in Business Administration.

Horace G. Rhodes, age 80. Mr. Rhodes first became a director in 1996. His term will expire in
2010. Mr. Rhodes is the Chairman of the law firm of Kerr, Irvine, Rhodes & Ables and has
served in such capacity and has practiced law for many years. From 1972 until 2001, he served
as Executive Vice President and General Counsel for the Association of Oklahoma Life
Insurance Companies and since 1982 served as Executive Vice President and General Counsel
for the Oklahoma Life and Health Insurance Guaranty Association. Mr. Rhodes received his
undergraduate and law degrees from the University of Oklahoma.

Tony M. Shelby, age 66. Mr. Shelby first became a director in 1971. His term will expire in
2008. Mr. Shelby, a certified public accountant, is our Executive Vice President of Finance and
Chief Financial Officer, a position he has held for more than five years. Prior to becoming our
Executive Vice President of Finance and Chief Financial Officer, he served as Chief Financial
Officer of a subsidiary of the Company and was with the accounting firm of Arthur Young &
Co., a predecessor to Ernst & Young LLP. Mr. Shelby is a graduate of Oklahoma City
University.

John A. Shelley, age 57. Mr. Shelley first became a director in 2005. His term will expire in
2009. Mr. Shelley is the President and Chief Executive Officer of The Bank of Union (“Bank of
Union”) located in Oklahoma. He has held this position since 1997. Prior to 1997, Mr. Shelley
held various senior level positions in financial institutions in Oklahoma including the position of
President of Equity Bank for Savings, N.A., a savings and loan that was owned by the Company
prior to 1994. Mr. Shelley is a graduate of the University of Oklahoma.

Directors Whose Term Expired in 2007

Grant J. Donovan, age 51. Mr. Donovan was a director from 2002 to August 2007. Mr.
Donovan is President and founder of Galehead, Inc., a company specializing on the collections
of accounts receivable in the international maritime trade business. Mr. Donovan received his
MBA from Stanford University and his undergraduate degree in Civil Engineering from the
University of Vermont. He currently is on the board of directors of EngenderHealth, an
international aid organization (established over 50 years ago), focused on improving women’s
healthcare.

N. Allen Ford, age 65. Mr. Ford was a director from 2002 to August 2007. Mr. Ford joined the
University of Kansas in 1976 where his teaching and research duties focus mainly on taxation.
At the University of Kansas, he has won several teaching awards and is the Larry D.
Horner/KPMG Peat Marwick Distinguished Professor of Accounting. He received his Ph.D. in
Accounting from the University of Arkansas.

The terms of the $3.25 Convertible Exchangeable Class C Preferred Stock, Series 2 (“ Series 2
Preferred”) provided that if and so long as at least 140,000 shares of Series 2 Preferred were
outstanding, whenever dividends on the Series 2 Preferred were in arrears and unpaid in an
amount equal to at least six quarterly dividends:

•

the number of members of the Board of Directors of the Company shall be increased by
two effective as of the time of election of such directors;
the Company shall, upon the written request of the record holder of 10% of the shares of
Series 2 Preferred, call a special meeting of the Series 2 Preferred holders for the purpose
of electing such two additional directors;
the Series 2 Preferred holders have the exclusive right to vote for and elect such two
additional directors; and
the term of office for such additional directors will terminate immediately upon the
termination of the right of the Series 2 Preferred holders to vote for such directors,
subject to the requirements of Delaware law.

In March 2002, the holders of the Series 2 Preferred elected Mr. Allen Ford and Mr. Grant
Donovan to serve as members of the Board of Directors pursuant to the terms of the Series 2
Preferred. On August 21, 2007, as a result of conversions of the Series 2 Preferred prior to the
August 27, 2007 redemption date for the Series 2 Preferred, less than 140,000 shares of Series 2
Preferred remained outstanding, and Messrs. Donovan and Ford’s terms as members of the
Board of Directors automatically terminated on that date.

Family Relationships

Jack E. Golsen is the father of Barry H. Golsen and Steve J. Golsen and the brother-in-law of Dr.
Robert C. Brown. Dr. Robert C. Brown is the uncle of Barry H. Golsen and Steve J. Golsen.
David M. Shear is the nephew by marriage to Jack E. Golsen and son-in-law of Dr. Robert C.
Brown. Steve J. Golsen is the Chief Operating Officer of our Climate Control Business. Heidi
Brown Shear, Senior Vice President and General Counsel of the Company, is the daughter of Dr.
Robert C. Brown and spouse of David M. Shear. As of December 31, 2007, we employed 1,788
persons, of which these 4 employees are relatives of Jack E. Golsen.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Exchange Act of 1934, as amended (the “Exchange Act”), requires the
Company’s directors, officers, and beneficial owners of more than 10% of the Company’s
common stock to file with the Securities and Exchange Commission reports of holdings and
changes in beneficial ownership of the Company’s stock. Based solely on a review of copies of
the Forms 3, 4 and 5 and amendments thereto furnished to the Company with respect to 2007, or

written representations that no Form 5 was required to be filed, the Company believes that during
2007 all directors and officers of the Company and beneficial owners of more than 10% of the
Company’s common stock filed timely their required Forms 3, 4, or 5, except (a) Kent C.
McCarthy, Jayhawk Institutional Partners, L.P., Jayhawk Capital Management LLC, Jack
Golsen, Barry Golsen, Steve Golsen, SBL LLC, Tony Shelby, Grant Donovan, and Allen Ford
each inadvertently filed one late Form 4 late to report the exchange of shares of $3.25
Convertible Exchangeable Class C Preferred, Series 2 Stock for shares of common stock
pursuant to the Company’s issuer tender offer completed on March 13, 2007, (b) David Goss
inadvertently filed one late Form 4 to report one transaction, (c) each of Bernard Ille and Charles
Burtch inadvertently filed one late Form 4 to report two transactions and (d) Raymond Ackerman
filed a late Form 5 to report three gifts.

Code of Ethics

The Chief Executive Officer, the Chief Financial Officer, the principal accounting officer, and
the controller of the Company and each of the our subsidiaries, or persons performing similar
functions, are subject to our Code of Ethics.

We and each of our subsidiary companies have adopted an amended Statement of Policy
Concerning Business Conduct applicable to our employees. Our Code of Ethics and Amended
Statement of Policy Concerning Business Conduct are available on our website at
http://www.lsb-okc.com. We will post any amendments to these documents, as well as any
waivers that are required to be disclosed pursuant to the rules of either the Securities and
Exchange Commission or the AMEX, on our website.

Audit Committee

We have has a separately-designated standing audit committee established in accordance with
Section 3(a)(58)(A) of the Exchange Act. The members of the Audit Committee are Messrs.
Bernard Ille (Chairman), Charles Burtch, Horace Rhodes, and Ray Ackerman. The Board has
determined that each member of the Audit Committee is independent, as defined in the listing
standards of the AMEX as of the Company’s fiscal year end. During 2007, the Audit Committee
had nine meetings.

Audit Committee Financial Expert

While the Board of Directors endorses the effectiveness of our Audit Committee, its membership
does not presently include a director that qualifies for designation as an “audit committee
financial expert.” However, each of the current members of the Audit Committee is able to read
and understand fundamental financial statements and at least one of its members is “financially
sophisticated” as defined by applicable AMEX rules. The Board of Directors believes that the
background and experience of each member of the Audit Committee is sufficient to fulfill the
duties of the Audit Committee. For these reasons, although members of our Audit Committee are
not professionally engaged in the practice of accounting or auditing, our Board of Directors has
concluded that the ability of our Audit Committee to perform its duties is not impaired by the
absence of an “audit committee financial expert.”

Compensation and Stock Option Committee

The Compensation and Stock Option Committee (the “Compensation Committee”) has three
members and met two times during 2007. The Committee is comprised of non-employee,
independent directors in accordance with the rules of the AMEX. The Board has adopted a
Compensation and Stock Option Committee Charter which governs the responsibilities of the
Compensation Committee. This charter is available on the Company’s website at www.lsb-
okc.com, and is also available from the Company upon request.

The Compensation Committee’s responsibilities include, among other duties, the responsibility
to:

•

establish the base salary, incentive compensation and any other compensation for the
Company’s executive officers;
administer the Company’s management incentive and stock-based compensation plans,
non-qualified death benefits, salary continuation and welfare plans, and discharge the
duties imposed on the Compensation Committee by the terms of those plans; and
perform other functions or duties deemed appropriate by the Board.

Decisions regarding non-equity compensation of non-executive officers of the Company and the
executive officers of the Company named in the Summary Compensation Table (the “named
executive officers”) other than the Chief Executive Officer and the President, are made by the
Company’s Chief Executive Officer and presented for approval or modification by the
Committee.

The agenda for meetings of the Compensation Committee is determined by its Chairman with the
assistance of the Company’s Chief Executive Officer. Committee meetings are regularly
attended by the Chief Executive Officer. At each Compensation Committee meeting, the
Compensation Committee also meets in executive session without the Chief Executive Officer.
The Committee’s Chairman
the Compensation Committee’s
recommendations on compensation for the Chief Executive Officer and the President. The Chief
Executive Officer may be delegated authority to fulfill certain administrative duties regarding the
compensation programs.

the Board

reports

The Compensation Committee has authority under its charter to retain, approve fees for, and
terminate advisors, consultants and agents as it deems necessary to assist in the fulfillment of its
responsibilities. If an outside consultant is engaged, the Compensation Committee reviews the
total fees paid to such outside consultant by the Company to ensure that the consultant maintains
its objectivity and independence when rendering advice to the Compensation Committee. For
2007, no outside consultants were engaged by the Compensation Committee.

ITEM 11. EXECUTIVE COMPENSATION

Compensation Discussion and Analysis

Overview of Compensation Program

Our long-term success depends on our ability to efficiently operate our facilities, to continue to
develop our product lines and technologies, and to focus on developing our product markets. To
achieve these goals, it is important that we be able to attract, motivate, and retain highly talented
individuals who are committed to our values and goals.

The Compensation Committee has responsibility for the establishment in consultation with
management, of our compensation philosophy for its senior executive officers and the
implementation and oversight of a compensation program consistent with the philosophy. This
group of senior executive officers includes the named executive officers, as well as our other
executives.

A primary objective of the Compensation Committee is to ensure that the compensation paid to
the senior executive officers is fair, reasonable, and competitive and provides incentives for
superior performance. The Compensation Committee is responsible for approval of all decisions
for the direct compensation, including the base salary and bonuses, stock options and other
benefit programs for the Company’s senior executive officers, including the named executive
officers.

In general, the day to day administration of savings, health and welfare plans and policies are
handled by a team of the legal and finance department employees. The Compensation Committee
(or Board) remains responsible for key policy changes outside of the day to day requirements
necessary to maintain these plans and policies.

Compensation Philosophy and Objectives

The Compensation Committee believes that the most effective executive compensation program
rewards the executive’s achievements and contribution towards the Company achieving its long-
term strategic goals. However, the Compensation Committee does not believe that executive
compensation should be tied to specific numeric or formulaic financial goals or stock price
achievement by the Company. The Compensation Committee recognizes that, given the
volatility of the market in which we do business, our economic performance in any given time
frame may not be an accurate measurement of our senior executive officer’s performance. The
Compensation Committee values both personal contribution and teamwork as factors to be
rewarded. The Compensation Committee believes that it is important to align executives’
interests with those of stockholders through the use of stock option incentive programs. The
Compensation Committee evaluates both performance and compensation to ensure that we
maintain our ability to attract and retain highly talented employees in key positions, and that
compensation provided to key employees will remain competitive relative to our other senior
executive officers. The Compensation Committee believes that executive compensation packages
should include both cash and stock-based compensation, as well as other benefit programs to
encourage senior executive officers to remain with the Company and have interests aligned with

those of the Company. Based on the foregoing, the Committee bases it executive compensation
program on the following criteria:

• Compensation should be based on the level of job responsibility, executive performance,

and Company performance.

• Compensation should enable us to attract and retain key talent.
• Compensation should be competitive with compensation offered by other companies that

compete with us for talented individuals.
• Compensation should reward performance.
• Compensation should motivate executives to achieve our strategic and operational goals.

Setting Executive Compensation

The Committee sets annual cash and non-cash executive compensation to reward the named
executive officers for achievement and to motivate the named executive officers to achieve long-
term business objectives. The Compensation Committee is unable to use peer group comparisons
in determining the compensation package because of the diverse nature of our lines of business.
Although the Compensation Committee has not engaged outside consultants to assist in
conducting its annual review of the total compensation program, it may do so in the future. The
Compensation Committee consulted some generally available compensation information for
companies of our size. The Compensation Committee did not engage consultants to prepare
specialized reports for their use. The Compensation Committee considered base salary and
current bonus awards in determining overall compensation. The Compensation Committee does
not have a policy allocating long term and currently paid compensation. The Compensation
Committee also considered the allocation between cash and non-cash compensation amounts, but
does not have a specific formula or required allocation between such compensation amounts. The
Compensation Committee compares the Chief Executive Officer’s total compensation to the total
compensation of our other named executive officers over time. However, the Compensation
Committee has not established a target ratio between total compensation of the Chief Executive
Officer and the median total compensation level for the next lower tier of management. The
Compensation Committee also considers internal pay equity among the named executive officers
and in relation to next lower tier of management in order to maintain compensation levels that
are consistent with the individual contributions and responsibilities of those executive officers.
The Compensation Committee does not consider amounts payable under severance agreements
when setting the compensation of the named executive officers.

Role of Executive Officers in Compensation Decisions

Our Chief Executive Officer annually reviews the performance of each of our named executive
officers (other than the Chief Executive Officer and the President) and presents to the
Compensation Committee recommendations with respect to salary, bonuses and other benefit
items. The Committee considers and reviews such recommendations and exercises its discretion
in accepting or modifying the recommended compensation. In determining compensation for the
Chief Executive Officer and the President, the Compensation Committee reviews the
responsibilities and performance of each of them. Such review includes interviewing both the
Chief Executive Officer and the President and consideration of the Compensation Committee’s
interaction with the Chief Executive Officer and the President during the applicable year.

2007 Executive Compensation Components

For the fiscal year ended December 31, 2007, the principal components of compensation for the
named executive officers were:

•
•
•
•

base salary;
cash bonus;
death benefit and salary continuation programs; and
perquisites and other personal benefits.

The Compensation Committee did not consider the new award of stock options as part of the
2007 compensation because there were a de minimus number of shares available for grants under
the option plans in effect.

Base Salary

We provide the named executive officers and other senior executive officers with base salary to
compensate them for services rendered during the year. We do not have a defined benefit or
retirement plan for its executives. This factor is considered when setting the base compensation
for senior executive officers.

Base salaries are determined for the named executive officers in the discretion of the
Compensation Committee based upon the recommendations of the Chief Executive Officer’s
assessment of the executive’s compensation, both individually and relative to the other senior
executive officers and based upon an assessment of the individual performance of the executive
during the proceeding year. In determining the base salary for the Chief Executive Officer and
the President, the Compensation Committee exercises its judgment based on its interactions with
such senior executive officers and the Compensation Committee’s assessment of such officers’
contribution to the Company’s performance and other leadership achievements.

Bonuses

The Compensation Committee may award cash bonuses to the named executive officers to
reward outstanding performance. No bonus is guaranteed, and there is no defined range of bonus
amounts that the Compensation Committee may award. Bonus awards are made at the
Compensation Committee’s discretion based upon an assessment of an individual’s overall
contribution to the Company.

Death Benefit and Salary Continuation Plans

The Company sponsors non-qualified arrangements to provide a death benefit to the designated
beneficiary of certain key employees (including certain of the named executive officers) in the
event of such executive’s death (the “Death Benefit Plans”). We also have a non-qualified
arrangement with certain key employees (including certain of the named executive officers) of

the Company and its subsidiaries to provide compensation to such individuals in the event that
they are employed by the Company at age 65 (the “Salary Continuation Plans”).
Attributed costs of the personal benefits described above for the named executive officers for the
fiscal year ended December 31, 2007, are discussed in footnote (1) and included in column (i) of
the “Summary Compensation Table.”

The Committee believes that the Death Benefit and Salary Continuation Plans are significant
factors in:

enabling the Company to retain its named executive officers;
encouraging our named executive officers to render outstanding service; and

•
•
• maintaining competitive levels of total compensation.

Perquisites and Other Personal Benefits

The Company and the Compensation Committee believe that perquisites are necessary and
appropriate parts of total compensation that contribute to our ability to attract and retain superior
executives. Accordingly, the Company and the Compensation Committee provided a limited
number of perquisites that are reasonable and consistent with our overall compensation program.
The Compensation Committee periodically reviews the levels of perquisites provided to the
named executive officers. We currently provide the named executive officers with the use of our
automobiles, provide cell phones that are used primarily for business purposes, and pay the
country club dues for certain of the executive officers. The executive officers are expected to
use the country club in large part for business purposes.

Severance Agreements

We have entered into Change of Control Severance Agreements with certain key employees,
including the named executive officers. The Severance Agreements are designed to promote
stability and continuity of senior management. Information regarding applicable payments under
such agreements for the named executive officers is provided under the heading “Potential
Payments Upon Termination or Change-In-Control.”

Employment Agreement

We have no employment agreements with our named executive officers, except with Jack E.
Golsen, our Chief Executive Officer. The terms of Mr. Golsen’s employment agreement are
described below under “Employment Agreement.” We believe that Mr. Golsen’s employment
agreement promotes stability in our senior management and encourages Mr. Golsen to provide
superior service to us. The current term of the Employment Agreement expires March 21, 2011.

Ownership Guidelines

At this time, we have not established any guidelines which require our executive officers to
acquire and hold our common stock. However, our named executive officers have historically
acquired and maintained a significant ownership position in our common stock.

Tax and Accounting Implications

Deductibility of Executive Compensation - As part of its role, the Committee reviews and
considers the deductibility of executive compensation under Section 162(m) of the Internal
Revenue Code, which provides that the Company may not deduct compensation of more than
$1,000,000 that is paid to certain individuals. We believe that compensation paid to the named
executive officers is fully deductible for federal income tax purposes. For 2007, there was no
payment of compensation in excess of $1,000,000 for any named executive officer.

Accounting for Stock-Based Compensation – Beginning on January 1, 2006, the Company began
accounting for stock-based payments, including its incentive and nonqualified stock options in
accordance with the requirements of SFAS 123(R).

Compensation and Stock Option Committee Report

The Compensation and Stock Option Committee of the Company has reviewed and discussed the
Compensation Discussion and Analysis with management and, based on such review and
discussions, the Compensation and Stock Option Committee recommended to the Board that the
Compensation Discussion and Analysis be included herein.

Submitted by the Compensation and Stock Option Committee of the Company’s Board of
Directors.

Charles A. Burtch
Bernard G. Ille
Horace G. Rhodes

The following table summarizes the total compensation paid or earned by each of the named
executive officers for the fiscal year ended December 31, 2007.

Summary Compensation Table

(a)

(b)

(c)

(d)

(e)

(f)

(g)

(h)

(i)

(j)

Name and Principal Position Year

Salary
($)

Bonus
($)

Stock
Awards
($)

Option
Awards
($)

Non-Equity
Incentive Plan
Compensation
($)

Jack E. Golsen,

Chairman of the Board
of Directors and
Chief Executive Officer

Tony M. Shelby,

Executive Vice President
of Finance and Chief
Financial Officer

Barry H. Golsen,

Vice Chairman of the
Board of Directors,
President, and President of
the Climate Control
Business

David R. Goss,

523,400

2007
2006 497,400

50,000
-

255,000

2007
90,000
2006 245,000 40,000

433,100

100,000
2007
2006 413,600 40,000

Executive Vice President
of Operations

240,500

2007
55,000
2006 233,000 35,000

David M. Shear,

Senior Vice President and
General Counsel

240,000

2007
75,000
2006 225,000 35,000

-
-

Change in
Pension
Value and
Nonqualified
Deferred
Compensation
Earnings
($)

All Other
Compensation
($) (1)

Total
($)

-
-

645,010
615,168

1,218,410
1,112,568

22,773
22,428

367,773
307,428

22,191
9,515

555,291
463,115

12,361
14,146

307,861
282,146

9,961
4,628

324,961
264,628

(1) As discussed below under “1981 Agreements” and “2005 Agreement,” the Company entered
into individual death benefit agreements in 1981 and a death benefit agreement in 2005. Reported
compensation for the death benefit under these agreements is the greater of:

•
•

the expense incurred associated with our accrued death benefit liability; or
the prorata portion of life insurance premium expense to fund the undiscounted death
benefit.

Amounts accrued under these agreements are not paid until the death of the named executive
officer.

As discussed below under “1992 Agreements”, the Company entered into benefit agreements in
1992 which include a death benefit until the employee reaches age 65 or benefits for life
commencing when the employee reaches age 65. Compensation for these benefits is the greater
of:

•
•

the expense incurred associated with our accrued benefit liability or
the prorata portion of life insurance premium expense to fund the undiscounted death
benefit.

The amounts set forth under “All Other Compensation” are comprised of compensation relating
to these agreements and perquisites for 2007 and 2006, as follows:

2007:

1981
Agreements

1992
Agreements

2005
Agreement

Other (1)

Total

Jack E. Golsen

Tony M. Shelby

Barry H. Golsen

David R. Goss

David M. Shear

194,982 $

- $

444,047 $ $5,981 $ $645,010

7,250 $

8,201 $

- $ $7,322 $

$22,773

4,655 $

2,745 $

- $ $4,791 $

$22,191

8,510 $

416 $

- $ $3,435 $

$12,361

6,258 $

- $ $3,703 $

$9,961

(1) Amount relates to the personal use of automobiles, cell phones and country club dues.

The Company did not grant plan-based awards to the named executive officers during 2007 or
2006.

Employment Agreement

We have an employment agreement with Jack E. Golsen, which requires the Company to employ
Mr. Golsen as an executive officer of the Company. The employment agreement may be
terminated by either party by written notice at least one year prior to the expiration of the then
current term. The current term of the employment agreement expires March 21, 2011, but will be
automatically renewed for up to three additional three-year periods. Under the terms of such
employment agreement, Mr. Golsen shall:

•

be paid an annual base salary at his 1995 base rate, as adjusted from time to time by the
Compensation and Stock Option Committee, but such shall never be adjusted to an
amount less than Mr. Golsen’s 1995 base salary,
be paid an annual bonus in an amount as determined by the Compensation and Stock
Option Committee, and
receive from the Company certain other fringe benefits (vacation; health and disability
insurance).

The employment agreement provides that Mr. Golsen’s employment may not be terminated,
except:

•

upon conviction of a felony involving moral turpitude after all appeals have been
exhausted (“Conviction”),

• Mr. Golsen’s serious, willful, gross misconduct or willful, gross negligence of duties
resulting in material damage to the Company and its subsidiaries, taken as a whole,
unless Mr. Golsen believed, in good faith, that such action or failure to act was in the
Company’s or its subsidiaries’ best interest (“Misconduct”), and

• Mr. Golsen’s death.

However, no termination for a Conviction or Misconduct may occur unless and until the
Company has delivered to Mr. Golsen a resolution duly adopted by an affirmative vote of three-
fourths of the entire membership of the Board of Directors at a meeting called for such purpose
after reasonable notice given to Mr. Golsen finding, in good faith, that Mr. Golsen violated such
item.

If Mr. Golsen’s employment is terminated for reasons other than due to a Conviction or
Misconduct, then he shall, pursuant to the employment agreement, in addition to his other rights
and remedies, receive and the Company shall pay to Mr. Golsen:

•

a cash payment, on the date of termination, a sum equal to the amount of Mr. Golsen’s
annual base salary at the time of such termination and the amount of the last bonus paid
to Mr. Golsen prior to such termination times the number of years remaining under the
then current term of the employment agreement, and
provide to Mr. Golsen all of the fringe benefits that the Company was obligated to
provide during his employment under the employment agreement for the remainder of the
term of the employment agreement.

If there is a change in control (as defined in the severance agreement between Mr. Golsen and
the Company as discussed below under “Severance Agreements”) and within 24 months after
such change in control Mr. Golsen is terminated, other than for Cause (as defined in the
severance agreement), then in such event, the severance agreement between Mr. Golsen and the
Company shall be controlling.

In the event Mr. Golsen becomes disabled and is not able to perform his duties under the
employment agreement as a result thereof for a period of 12 consecutive months within any two-
year period, the Company shall pay Mr. Golsen his full salary for the remainder of the term of
the employment agreement and thereafter 60% of such salary until Mr. Golsen’s death.

1981 Agreements

During 1981, the Company entered into individual death benefit agreements (the “1981
Agreements”) with certain key employees (including certain of the named executive officers). As
relating to the named executive officers, under the 1981 Agreements, the designated beneficiary
of the officer will receive a monthly benefit for a period of 10 years if the officer dies while in

the employment of the Company or a wholly-owned subsidiary of the Company. The 1981
Agreements provide that the Company may terminate the agreement as to any officer at anytime
prior to the officer’s death. The Company has purchased life insurance on the life of each officer
covered under the 1981 Agreements to provide a source of funds for the Company’s obligations
under the 1981 Agreements. The Company is the owner and sole beneficiary of each of the
insurance policies and the proceeds are payable to the Company upon the death of the officer.

The following table sets forth the amounts of annual benefits payable to the designated
beneficiary or beneficiaries of the named executive officer’s under the 1981 Agreements.

Name of Individual

Amount of Annual
Payment

Jack E. Golsen
Tony M. Shelby
Barry H. Golsen
David R. Goss

$ 175,000
$ 35,000
$ 30,000
$ 35,000

1992 Agreements

During 1992, the Company entered into individual benefit agreements with certain key
employees of the Company and its subsidiaries (including certain of the named executive
officers) to provide compensation to such individuals in the event that they are employed by the
Company or a subsidiary of the Company at age 65 (the “1992 Agreements”). As relating to the
named executive officers, under the 1992 Agreements, the officer is eligible to receive a
designated benefit (“Benefit”) as set forth in the 1992 Agreements. The officer will receive the
Benefit beginning at the age 65 for the remainder of the officer’s life. If prior to attaining the age
65, the officer dies while in the employment of the Company or a subsidiary of the Company, the
designated beneficiary of the officer will receive a monthly benefit (“Death Benefit”) for a
period of ten years. The 1992 Agreements provide that the Company may terminate the
agreement as to any officer at any time and for any reason prior to the death of the officer. The
Company has purchased insurance on the life of each officer covered under the 1992
Agreements. The Company is the owner and sole beneficiary of each insurance policy, and the
proceeds are payable to the Company to provide a source of funds for the Company’s obligations
under the 1992 Agreements. Under the terms of the 1992 Agreements, if the officer becomes
incapacitated prior to retirement or prior to reaching age 65, the officer may request the
Company to cash-in any life insurance on the life of such officer purchased to fund the
Company’s obligations under the 1992 Agreements. Jack E. Golsen does not participate in the
1992 Agreements. The following table sets forth the amounts of annual benefits payable to the
named executive officers under the 1992 Agreements and the net cash surrender value of the
associated life insurance policies at December 31, 2007.

Amount
of Annual
Benefit

Amount
of Annual
Death Benefit

N/A
$ 15,605
$ 17,480
$ 17,403
$ 17,822

N/A
N/A
$ 11,596
N/A
7,957
$

Amount of
Net Cash
Surrender
Value

N/A

$
-
$ 25,885
$ 44,926
-
$

Name of Individual

Jack E. Golsen
Tony M. Shelby
Barry H. Golsen
David R. Goss
David M. Shear

2005 Agreement

During 2005, the Company entered into a death benefit agreement (“2005 Agreement”) with
Jack E. Golsen. This agreement replaced existing benefits that were payable to Mr. Golsen under
a split dollar insurance policy purchased by the Company on Mr. Golsen’s life in 1996 and a
second policy purchased in 2002. The 2005 Agreement provides that, upon Mr. Golsen’s death,
the Company will pay to Mr. Golsen’s family or designated beneficiary $2.5 million to be
funded from the net proceeds received by the Company under certain life insurance policies on
Mr. Golsen’s life that were purchased and are owned by the Company. The life insurance
policies provide an aggregate stated death benefit to the Company, as beneficiary, of $7 million.
The 2005 Agreement requires that the Company is obligated to keep in existence no less than
$2.5 million of the stated death benefit.

401(k) Plan

We maintain The LSB Industries, Inc. Savings Incentive Plan (the “401(k) Plan”) for the
employees (including the named executive officers) of the Company and its subsidiaries,
excluding employees covered under union agreements and certain other employees. As relating
to the named executive officers, the 401(k) Plan is funded by the officer’s contributions. The
Company and its subsidiaries make no contributions to the 401(k) Plan for any of the named
executive officers. The amount that an officer may contribute to the 401(k) Plan equals a certain
percentage of the employee’s compensation, with the percentage based on the officer’s income
and certain other criteria as required under Section 401(k) of the Internal Revenue Code. The
Company or subsidiary deducts the amounts contributed to the 401(k) Plan from the officer’s
compensation each pay period, in accordance with the officer’s instructions, and pays the amount
into the 401(k) Plan for the officer’s benefit. The salary and bonus set forth in the Summary
Compensation Table above include any amounts contributed during the 2007 and 2006 fiscal
years pursuant to the 401(k) Plan by the named executive officers.

Outstanding Equity Awards At December 31, 2007

(a)

(b)

(c)

(d)

(e)

(f)

Options Awards (1)

Number of
Securities
Underlying
Unexercised
Options
(#) (2)
Exercisable(2)
-
100,000
15,000
55,000
11,250
100,000
15,000
50,544
15,000

Number of
Securities
Underlying
Unexercised
Options
(#)
Unexercisable
-
-
-
-
-
-
-
-
-

Equity
Incentive
Plan
Awards:
Number of
Securities
Underlying
Unexercised
Unearned
Options
(#)
-
-
-
-
-
-
-
-
-

Option
Exercise
Price
($)
-
1.25
2.73
1.25
2.73
1.25
2.73
1.25
2.73

Option
Expiration
Date(2)
-

7/8/2009
11/29/2011
7/8/2009
11/29/2011
7/8/2009
11/29/2011
7/8/2009
11/29/2011

Name

Jack E. Golsen
Tony M. Shelby

Barry H. Golsen

David R. Goss

David M. Shear

(1) There were no unvested stock awards at December 31, 2007.

(2) Options expiring on July 8, 2009 were granted on July 8, 1999, and were fully vested on July 7,
2003. Options expiring on November 29, 2011, were granted on November 29, 2001 and were fully
vested on November 28, 2005.

Options Exercised in 2007 (1)

(a)

Option Awards

(b)

(c)

Number of

Shares
Acquired on
Exercise
(#)

Value
Realized
on Exercise
($)

176,500
-
-
-
35,000

3,854,760
-
-
-
810,980

Name

Jack E. Golsen
Tony M. Shelby
Barry H. Golsen
David R. Goss
David M. Shear

(1) There were no stock awards that vested in 2007

Severance Agreements

We have entered into severance agreements with each of the named executive officers and
certain other officers. Each severance agreement provides (among other things) that if, within 24
months after the occurrence of a change in control (as defined) of the Company, the Company
terminates the officer’s employment other than for cause (as defined), or the officer terminates
his employment for good reason (as defined), the Company must pay the officer an amount equal
to 2.9 times the officer’s base amount (as defined). The phrase “base amount” means the average
annual gross compensation paid by the Company to the officer and includable in the officer’s
gross income during the most recent five year period immediately preceding the change in
control. If the officer has been employed by the Company for less than five years, the base
amount is calculated with respect to the most recent number of taxable years ending before the
change in control that the officer worked for the Company.

The severance agreements provide that a “change in control” means a change in control of the
Company of a nature that would require the filing of a Form 8-K with the SEC and, in any event,
would mean when:

•

any individual, firm, corporation, entity, or group (as defined in Section 13(d)(3) of the
Securities Exchange Act of 1934, as amended) becomes the beneficial owner, directly or
indirectly, of 30% or more of the combined voting power of the Company’s outstanding
voting securities having the right to vote for the election of directors, except acquisitions
by:
•

any person, firm, corporation, entity, or group which, as of the date of the severance
agreement, has that ownership, or
Jack E. Golsen, his wife; his children and the spouses of his children; his estate;
executor or administrator of any estate, guardian or custodian for Jack E. Golsen, his
wife, his children, or the spouses of his children, any corporation, trust, partnership,
or other entity of which Jack E. Golsen, his wife, children, or the spouses of his
children own at least 80% of the outstanding beneficial voting or equity interests,
directly or indirectly, either by any one or more of the above-described persons,
entities, or estates; and certain affiliates and associates of any of the above-described
persons, entities, or estates;

individuals who, as of the date of the severance agreement, constitute the Board of
Directors of the Company (the “Incumbent Board”) and who cease for any reason to
constitute a majority of the Board of Directors except that any person becoming a director
subsequent to the date of the severance agreement, whose election or nomination for
election is approved by a majority of the Incumbent Board (with certain limited
exceptions), will constitute a member of the Incumbent Board; or
the sale by the Company of all or substantially all of its assets.

Except for the severance agreement with Jack E. Golsen, the termination of an officer’s
employment with the Company “for cause” means termination because of:

•

the mental or physical disability from performing the officer’s duties for a period of 120
consecutive days or one hundred eighty days (even though not consecutive) within a 360
day period;
the conviction of a felony;

•

the embezzlement by the officer of Company assets resulting in substantial personal
enrichment of the officer at the expense of the Company; or
the willful failure (when not mentally or physically disabled) to follow a direct written
order from the Company’s Board of Directors within the reasonable scope of the officer’s
duties performed during the 60 day period prior to the change in control.

The definition of “Cause” contained in the severance agreement with Jack E. Golsen means
termination because of:

•

the conviction of Mr. Golsen of a felony involving moral turpitude after all appeals have
been completed; or
if due to Mr. Golsen’s serious, willful, gross misconduct or willful, gross neglect of his
duties has resulted in material damages to the Company and its subsidiaries, taken as a
whole, provided that:
•

no action or failure to act by Mr. Golsen will constitute a reason for termination if he
believed, in good faith, that such action or failure to act was in the Company’s or its
subsidiaries’ best interest, and
failure of Mr. Golsen to perform his duties hereunder due to disability shall not be
considered willful, gross misconduct or willful, gross negligence of his duties for any
purpose.

•

The termination of an officer’s employment with the Company for “good reason” means
termination because of:

•

•
•

•

the assignment to the officer of duties inconsistent with the officer’s position, authority,
duties, or responsibilities during the 60 day period immediately preceding the change in
control of the Company or any other action which results in the diminishment of those
duties, position, authority, or responsibilities;
the relocation of the officer;
any purported termination by the Company of the officer’s employment with the
Company otherwise than as permitted by the severance agreement; or
in the event of a change in control of the Company, the failure of the successor or parent
company to agree, in form and substance satisfactory to the officer, to assume (as to a
successor) or guarantee (as to a parent) the severance agreement as if no change in
control had occurred.

Except for the severance agreement with Jack E. Golsen, each severance agreement runs until the
earlier of: (a) three years after the date of the severance agreement, or (b) the officer’s normal
retirement date from the Company; however, beginning on the first anniversary of the severance
agreement and on each annual anniversary thereafter, the term of the severance agreement
automatically extends for an additional one-year period, unless the Company gives notice
otherwise at least 60 days prior to the anniversary date. The severance agreement with Jack E.
Golsen is effective for a period of three years from the date of the severance agreement; except
that, commencing on the date one year after the date of such severance agreement and on each
anniversary thereafter, the term of such severance agreement shall be automatically extended so
as to terminate three years from such renewal date, unless the Company gives notices otherwise
at least one year prior to the renewal date.

Potential Payments Upon Termination or Change-In-Control(1)

The following table reflects the amount that would have been payable to each of the named
executive officers under the applicable severance agreement if the respective trigger event had
occurred on December 31, 2007.

Severance Pay Trigger Event

Name and
Executive Benefit
and Payments
Upon Separation

Involuntary
Other Than
For Cause
Termination
($)

Involuntary
For Cause
Termination
($)

Voluntary
Termination
($)

Involuntary
Other Than
For Cause
Termination
- Change of
Control
($)

Voluntary
For Good
Reason
Termination
- Change of
Control
($)

Disability/
Incapacitation
($)

Death
($)

Jack E. Golsen:
Salary
Bonus
Death Benefits
Other

Tony M. Shelby:
Salary
Death Benefits
Other

Barry H. Golsen:

Salary
Death Benefits

David R. Goss:
Salary
Death Benefits
Other

David M. Shear:

Salary
Death Benefits

-
-
-
-

1,701,050
162,500
-
58,300

-
-
271,205

-
-

-
-
268,538

-
-

-
-
-

-
-

-
-
-

-
-

-
-
-
-

-
-
-

-
-

-
-
-

-
-

1,521,866
-
-
-

3,318,356
-
-
-

-
-
4,250,000
58,300

819,890
-
-

1,325,075
-

785,087
-
-

728,023
-

-
-
-

-
-

-
-
-

-
-

-
350,000
-

-
415,962

-
350,000
-

-
79,568

(1) This amount does not include the amount realizable under outstanding stock options granted
to the named executive officers, all of which are fully vested. See “Outstanding Equity Awards
at December 31, 2007.”

Compensation of Directors

In 2007, we compensated our non-employee directors for their services as directors on our
Board. Certain non-employee directors also served on the Board of Directors of our subsidiary,
ThermaClime, without additional compensation. Directors who are employees of the Company
receive no compensation for their services as directors.

The following table summarizes the compensation paid by us to our non-employee directors
during the year end December 31, 2007. Messrs. Perry and Butkin became directors on August
16, 2007. Messrs. Donovan and Ford’s service as directors terminated on August 21, 2007.

Director Compensation Table

(a)

(b)

(h)

Fees
Earned
or Paid
in Cash
($) (1)

Total
($)

Name

Raymond B. Ackerman

37,500

Robert C. Brown, M.D.

37,500

Charles A. Burtch

37,000

Robert A. Butkin

20,378

Grant J. Donovan

12,000

N. Allen Ford

12,000

Bernard G. Ille

37,500

Donald W. Munson

37,500

Ronald V. Perry

20,378

Horace G. Rhodes

37,500

John A. Shelley

37,500

(1) This amount includes as to each director, an annual fee of $10,000 for services as a director
($3,753 each for Mr. Butkin and Mr. Perry who began serving in August 2007) and $500 for
each Board meeting attended during 2007. This amount also includes the following fees earned
during 2007:

• Mr. Ackerman received $25,000 for his services on the Audit Committee and Public

Relations and Marketing Committee.

• Dr. Brown received $25,000 for his services on the Benefits and Programs Committee.
• Mr. Burtch received $25,000 for his services on the Audit Committee and Compensation

and Stock Option Committee.

• Mr. Butkin received $15,625 for his services on the Business Development Committee.
• Mr. Ille received $25,000 for his services on the Audit Committee, Compensation and

Stock Option Committee and Public Relations and Marketing Committee.

• Mr. Munson received $25,000 for his services on the Business Development Committee.
• Mr. Perry received $15,625 for his services on the Public Relations and Marketing

Committee.

• Mr. Rhodes received $25,000 for his services on the Audit Committee and Compensation

and Stock Option Committee.

• Mr. Shelley received $25,000 for his services on the Public Relations and Marketing

Committee.

(2) There were no other equity or non-equity compensation awarded related to directorships.

Compensation Committee Interlocks and Insider Participation

The Compensation and Stock Option Committee has the authority to set the compensation of all
of our officers. This Committee generally considers and approves the recommendations of the
Chief Executive Officer. The Chief Executive Officer does not make a recommendation
regarding his own salary, and does not make any recommendation as to the President’s salary.
The members of the Compensation and Stock Option Committee are the following non-
employee directors: Charles A. Burtch, Bernard G. Ille and Horace G. Rhodes. Neither Mr.
Burtch, Mr. Ille or Mr. Rhodes is, or ever has been, an officer or employee of the Company or
any of its subsidiaries.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND
MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The following table sets forth the information as of December 31, 2007, with respect to our
equity compensation plans.

Equity Compensation Plan Information

Number of securities
to be issued upon
exercise of outstanding
options, warrants
and rights
(a)

Weighted-average
exercise price of
outstanding options,
warrants and rights
(b)

Number of securities
remaining available
for future issuance
under equity
compensation plans
(excluding securities
reflected in column (a))
(c)

Plan Category

Equity compensation plans approved by
stockholders (1)
Equity compensation plans not approved by
stockholders (2)

Total

935,404

438,500

1,373,904

4.56

1.78

3.67

303,000

(1) Stock Options Receiving Stockholders' Approval in 2007 As previously reported, on June
19, 2006, the Compensation and Stock Option Committee granted non-qualified stock options
for the purchase of up to 450,000 shares of common stock (the “Options”) to certain Climate
Control Business employees which were subject to shareholders’ approval. These Options were
approved by our shareholders on June 14, 2007. The option exercise price of the Options is $8.01
per share, which is based on the market value of our common stock on the date the Options were
granted. The Options vest over a ten-year period at a rate of 10% per year, and expire on
September 16, 2016 with certain restrictions. Under SFAS 123(R), the fair value for the Options
was estimated, using an option pricing model, as of the date we received shareholders’ approval
which occurred during our 2007 annual shareholders’ meeting on June 14, 2007. Under SFAS
123(R) for accounting purposes, the grant date and service inception date is June 14, 2007.

100

(2) Non-Stockholder Approved Plans From time to time, the Compensation Committee and/or
the Board of Directors has approved the grants of certain nonqualified stock options as the Board
has determined to be in our best interest to compensate directors, officers, or employees for
service to the Company. Unless otherwise indicated below, the price of each such option is equal
to the market value of our common stock at the date of grant and each option expires ten years
from the grant date. All outstanding options under these plans were exercisable at December 31,
2007.

The equity compensation plans, which have not been approved by the stockholders, are the
following:

• Effective December 1, 2002, we granted nonqualified options to purchase up to an
aggregate 112,000 shares of common stock to former employees of two former
subsidiaries. These options were part of the employees’ severance compensation arising
from the sale of the former subsidiaries’ assets. Each recipient of a grant received options
for the same number of shares and having the same exercise price as under the recipient’s
vested incentive stock options which expired upon the sale. Each nonqualified option was
exercisable as of the date of grant and has a term of ten years from the original date of
grant. As of December 31, 2007, 3,000 shares are issuable at an exercise price of $4.188
per share and expire April 22, 2008.

• On November 7, 2002, we granted to an employee of the Company a nonqualified stock
option to acquire 50,000 shares of common stock in consideration of services rendered to
the Company. As of December 31, 2007, 10,000 shares are issuable at an exercise price
of $2.62 per share.

• On November 29, 2001, we granted to employees of the Company nonqualified stock
options to acquire 102,500 shares of common stock in consideration of services to the
Company. As of December 31, 2007, 22,500 shares are issuable at an exercise price of
$2.73 per share.

• On July 20, 2000, we granted nonqualified options to a former employee of the Company
to acquire 185,000 shares of common stock in consideration of services to the Company.
As of December 31, 2007, 100,000 shares are issuable under the following options:
60,000 shares at $1.375 and 40,000 shares at $1.25. These options were for the same
number of shares and the same exercise prices as under the stock options held by the
former employee prior to leaving the Company. These options were fully vested at the
date of grant and expire nine years from the date of grant.

101

• On July 8, 1999, in consideration of services to the Company, we granted nonqualified
stock options to acquire 371,500 shares of common stock at an exercise price of $1.25
per share to Jack E. Golsen (176,500 shares), Barry H. Golsen (55,000 shares) and Steven
J. Golsen (35,000 shares), David R. Goss (35,000 shares), Tony M. Shelby (35,000
shares), and David M. Shear (35,000 shares) and also granted to certain other employees
nonqualified stock options to acquire a total of 165,000 shares of common stock at an
exercise price of $1.25 per share in consideration of services to the Company. As of
December 31, 2007, 245,000 shares are issuable.

• On April 22, 1998, we granted to certain employees nonqualified stock options to acquire
shares of common stock at an exercise price of $4.188 per share in consideration of
services to the Company. As of December 31, 2007, 58,000 shares are issuable under
outstanding options under these agreements.

Security Ownership of Certain Beneficial Owners

The following table sets forth certain information as of February 29, 2008, regarding the
ownership of our voting common stock and voting preferred stock by each person (including any
“group” as used in Section 13(d)(3) of the Securities Act of 1934, as amended) that we know to
be beneficial owner of more than 5% of our voting common stock and voting preferred stock. A
person is deemed to be the beneficial owner of shares of the Company which he or she could
acquire within 60 days of February 29, 2008.

Name and Address
of
Beneficial Owner

Title
of
Class

Amounts
of Shares
Beneficially
owned (1)

Jack E. Golsen and certain

members of his family (2)

Common
Voting Preferred

4,428,909
1,020,000

(3) (4)
(5)

O’Shaughnessy Asset Management, LLC

Common

1,105,253

Winslow Management Company LLC

Common

1,085,599

Percent
of
Class+

20.0%
99.9%

5.2%

5.1%

+ Because of the requirements of the SEC as to the method of determining the amount of shares
an individual or entity may own beneficially, the amount shown for an individual may include
shares also considered beneficially owned by others. Any shares of stock which a person does
not own, but which he or she has the right to acquire within 60 days of February 29, 2008 are
deemed to be outstanding for the purpose of computing the percentage of outstanding stock of
the class owned by such person but are not deemed to be outstanding for the purpose of
computing the percentage of the class owned by any other person.

(1) We based the information with respect to beneficial ownership on information furnished by
the above-named individuals or entities or contained in filings made with the Securities and
Exchange Commission or the Company’s records.

102

(2) Includes Jack E. Golsen (“J. Golsen”) and the following members of his family: wife, Sylvia
H. Golsen; son, Barry H. Golsen (“B. Golsen”) (a director, Vice Chairman of the Board of
Directors, and President of the Company and its climate control business); son, Steven J. Golsen
(“S. Golsen”) (executive officer of several subsidiaries of the Company), Golsen Family LLC
(“LLC”) which is wholly-owned by J. Golsen (45.92% owner), Sylvia H. Golsen (45.92%
owner), B. Golsen (2.72% owner), S. Golsen (2.72% owner), and Linda F. Rappaport (2.72%
owner and daughter of J. Golsen (“L. Rappaport”)), and SBL Corporation (“SBL”) which is
wholly-owned by the LLC (49% owner), B. Golsen (17% owner), S. Golsen (17% owner), and
L. Rappaport (17% owner). J Golsen and Sylvia H. Golsen are the managers of the LLC and
share voting and dispositive power over the shares beneficially owned by the LLC. J. Golsen and
B. Golsen as the only directors and officers of SBL share the voting and dispositive power of the
shares beneficially owned by SBL and its wholly owned subsidiary, Golsen Petroleum Corp
(“GPC”). See “Description of Capital Stock.” The address of Jack E. Golsen, Sylvia H. Golsen,
and Barry H. Golsen is 16 South Pennsylvania Avenue, Oklahoma City, Oklahoma 73107; and
Steven J. Golsen’s address is 7300 SW 44th Street, Oklahoma City, Oklahoma 73179. SBL’s
address is 16 South Pennsylvania Avenue, Oklahoma City, Oklahoma 73107

(3) Includes (a) the following shares over which J. Golsen has the sole voting and dispositive
power: (i) 4,000 shares that he has the right to acquire upon conversion of a promissory note;
(ii) 263,320 shares of common stock owned of record by certain trusts for the benefit of B.
Golsen, S. Golsen and L. Rappaport over which J. Golsen is the trustee of each of these trusts;
and (iii) 198,006 shares held in certain trusts for the grandchildren and great grandchildren of J.
Golsen and Sylvia H. Golsen over which J. Golsen is the trustee; (b) 667,276 shares owned of
record by the LLC and 133,333 shares that the LLC has the right to acquire upon the conversion
of 4,000 shares of the Series B Preferred owned of record by the LLC; (c) 241,639 shares over
which B. Golsen has the sole voting and dispositive power, 533 shares owned of record by B.
Golsen’s wife, over which he shares the voting and dispositive power, and 66,250 shares that he
has the right to acquire within the next 60 days under the Company’s stock option plans;
(d) 228,915 shares over which S. Golsen has the sole voting and dispositive power and 46,250
shares that he has the right to acquire within the next 60 days under the Company’s stock option
plans; (e) 1,512,099 shares owned of record by SBL, 400,000 shares that SBL has the right to
acquire upon conversion of 12,000 shares of Series B Preferred owned of record by SBL, and
250,000 shares that SBL has to right to acquire upon conversion of 1,000,000 shares of the
Series D Preferred owned of record by SBL and (f) 283,955 shares owned of record by GPC,
which is a wholly-owned subsidiary of SBL, and 133,333 shares that GPC has the right to
acquire upon conversion of 4,000 shares of Series B Preferred owned of record by GPC. See
“Certain Relationships and Related Transactions”.

(4) J. Golsen and Sylvia H. Golsen disclaim beneficial ownership of the shares over which B.
Golsen and S. Golsen each have sole voting and investment power. Sylvia H. Golsen, B. Golsen
and S. Golsen disclaim beneficial ownership of the shares that J. Golsen has sole voting and
investment power over as noted in footnote (3)(a) above. B. Golsen and S. Golsen disclaim
beneficial ownership of the shares owned of record by the LLC, except to the extent of their
respective pecuniary interest therein. S. Golsen disclaims beneficial ownership of the shares
owned of record by SBL and GPC and all shares beneficially owned by SBL through the LLC,
except to the extent of his pecuniary interest therein.

103

(5) Includes: (a) 4,000 shares of Series B Preferred owned of record by the LLC; (b) 12,000
shares of Series B Preferred owned of record by SBL; (c) 4,000 shares Series B Preferred owned
of record by SBL’s wholly-owned subsidiary, GPC, over which SBL, J. Golsen, and B. Golsen
share the voting and dispositive power and (d) 1,000,000 shares of Series D Preferred owned of
record by SBL.

Security Ownership of Management

The following table sets forth certain information obtained from our directors and our directors
and executive officers as a group as to their beneficial ownership of our voting common stock
and voting preferred stock as of February 29, 2008.

Name of
Beneficial Owner

Title of Class

Amount of Shares
Beneficially Owned (1)

Percent of
Class+

Raymond B. Ackerman

Robert C. Brown, M.D.

Charles A. Burtch

Robert A. Butkin(5)

Barry H. Golsen

Jack E. Golsen

David R. Goss

Bernard G. Ille

Jim D. Jones

Donald W. Munson

Ronald V. Perry (12)

Horace G. Rhodes

David M. Shear

Tony M. Shelby

John A. Shelley

Common

Common
Voting Preferred

Common

16,450 (2)

130,329 (3)

9,000 (4)

400 (5)

3,688,418
1,020,000

(6)
(7)

3,845,322
1,020,000

(7)
(7)

251,594 (8)

45,000 (9)

150,252 (10)

6,740 (11)

16,000 (13)

105,581 (14)

245,810 (15)

Directors and Executive
Officers as a group number
(15 persons)

Common
Voting Preferred

5,130,900
1,020,000

(16)

104

16.7
99.9

%
%

17.5
99.9

%
%

1.2 %

22.8
99.9

%
%

* Less than 1%.
+ See footnote “+” to the table under “Security Ownership of Certain Beneficial Owners.”

(1) We based the information, with respect to beneficial ownership, on information furnished
by each director or officer, contained in filings made with the SEC, or contained in our records.

trust over which
includes 1,450 shares held by Mr. Ackerman’s
(2) This amount
Mr. Ackerman possesses sole voting and dispositive power and 15,000 shares that Mr. Ackerman
may acquire pursuant to currently exercisable non-qualified stock options.

(3) The amount includes (a) 59,516 shares are held in a joint account owned by a trust, of
which Dr. Brown’s wife is the trustee, and by a trust, of which Dr. Brown is the trustee. As
trustees, Dr. Brown and his wife share voting and dispositive power over these shares, (b) 50,727
shares owned by Robert C. Brown, M.D in a corporation wholly-owed by Dr. Brown and (c)
20,086 shares held by the Robert C. Brown, M.D Inc. Employee Profit Savings Plan, of which
Dr. Brown serves as the trustee. Dr. Brown has sole voting and dispositive power over the shares
described in (b) and (c). The amount shown does not include shares owned directly, or through
trusts, by the children of Dr. Brown and the son-in-law of Dr. Brown, David M. Shear, all of
which Dr. Brown disclaims beneficial ownership.

(4) These shares may be acquired by Mr. Burtch pursuant to currently exercisable non-
qualified stock options.

(5) These shares are held in certain trusts over which Mr. Butkin has voting and dispositive
power. Mr. Butkin was appointed to our board of directors on August 16, 2007.

(6) See footnotes (3), (4), and (5) of the table under “Security Ownership of Certain Beneficial
Owners” for a description of the amount and nature of the shares beneficially owned by B.
Golsen.

(7) See footnotes (3), (4), and (5) of the table under “Security Ownership of Certain Beneficial
Owners” for a description of the amount and nature of the shares beneficially owned by J.
Golsen.

(8) Mr. Goss has the sole voting and dispositive power over these shares, which include 600
shares held in a trust of which Mr. Goss is trustee and 115,000 shares that Mr. Goss has the right
to acquire pursuant to currently exercisable stock options granted under our stock option plans.

(9) The amount includes (a) 25,000 shares of common stock, including 15,000 shares that
Mr. Ille may purchase pursuant to currently exercisable non-qualified stock options, over which
Mr. Ille has the sole voting and dispositive power, and (b) 20,000 shares owned of record by
Mr. Ille’s wife, voting and dispositive power of which are shared by Mr. Ille and his wife.

(10) Mr. Jones and his wife share voting and dispositive power over these shares which include
115,000 shares that Mr. Jones has the right to acquire pursuant to currently exercisable stock
options granted under our stock option plans.

105

(11) Mr. Munson has the sole voting and dispositive power over these shares.

(12) Mr. Perry was appointed to our board of directors on August 16, 2007.

(13) Mr. Rhodes has sole voting and dispositive power over these shares, which include 15,000
shares that may be acquired by Mr. Rhodes pursuant to currently exercisable non-qualified stock
options.

(14) These shares are held in a joint account owned Mr. Shear’s revocable trust of which Mr.
Shear is the trustee and by Mr. Shear’s spouse’s revocable trust of which his spouse is the
trustee. As trustees, Mr. Shear and his wife share voting and dispositive power over these shares.
This amount does not include, and Mr. Shear disclaims beneficial ownership of, the shares
beneficially owned by Mr. Shear’s wife, which consist of 22,988 shares, the beneficial
ownership of which is disclaimed by her, that are held by trusts of which she is the trustee.

(15) Mr. Shelby has the sole voting and dispositive power over these shares, which include
115,000 shares that Mr. Shelby has the right to acquire pursuant to currently exercisable stock
options granted under our stock option plans.

(16) The shares of common stock include 465,250 shares of common stock that executive
officers and directors have the right to acquire within 60 days under our stock option plans and
920,666 shares of common stock that executive officers, directors, or entities controlled by our
executive officers and directors, have the right to acquire within 60 days under other convertible
securities.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND
DIRECTOR INDEPENDENCE

Policy as to Related Party Transaction

Pursuant to the Audit Committee Charter, adopted in 2003, our Audit Committee is to review
any related party transactions involving any of our directors and executive officers. The
following related party transactions were reviewed by the Audit Committee or the Board of
Directors as a whole.

Related Party Transactions

Jayhawk

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a related party. However, the Jayhawk Group was a participant in the following transactions
related to our debt and equity securities during the period it was considered a related party:

On March 25, 2003, the Jayhawk Group purchased from us in a private placement pursuant to
Rule 506 of Regulation D under the Securities Act, 450,000 shares of common stock and a
warrant for the purchase of up to 112,500 shares of common stock at an exercise price of $3.49
per share. In connection with such sale, we entered into a Registration Rights Agreement with
the Jayhawk Group, dated March 23, 2003. During 2007, the Jayhawk Group exercised the
warrant and purchased 112,500 shares of our common stock at the exercise price of $3.49 per
share. The aggregate 562,500 shares of common stock were registered for resale under the Form
S-1 Registration Statement, No. 333-145721, declared effective by the SEC on November 19,
2007.

107

settle this matter with the Jayhawk Group, but were unable to reach a resolution satisfactory to
all parties. On October 9, 2007, the law firm representing the stockholder initiated a lawsuit
against the Jayhawk Group pursing a Section 16(b) short-swing profit claim on our behalf up to
$819,000. During the first quarter of 2008, the parties have agreed to settle this claim by a
payment to us by the Jayhawk Group of $180,000, of which we will receive approximately
$125,000 after attorneys’ fees. This settlement is subject to a definitive settlement agreement.

The redemption of all of our outstanding Series 2 Preferred was completed on August 27, 2007.
The holders of shares of Series 2 Preferred had the right to convert each share into 4.329 shares
of our common stock, which right to convert terminated 10 days prior to the redemption date.
The Certificate of Designations for the Series 2 Preferred provided, and it is our position, that the
holders of Series 2 Preferred that elected to convert shares of Series 2 Preferred into our common
stock prior to the scheduled redemption date were not entitled to receive payment of any
dividends in arrears on the shares so converted. As a result, holders that elected to convert shares
of Series 2 Preferred were not entitled to any dividends in arrears as to the shares of Series 2
Preferred converted. On or about August 16, 2007, the Jayhawk Group elected to convert the
155,012 shares of Series 2 Preferred held by it, and we issued to the Jayhawk Group 671,046
shares of our common stock as a result of such conversion.

Golsen Group

108

After our exchange tender offer for our Series 2 Preferred, the Golsen Group held 23,083 shares
of Series 2 Preferred. Pursuant to our redemption of the remaining outstanding Series 2
Preferred during August 2007, the Golsen Group redeemed 23,083 shares of Series 2 Preferred
and received the cash redemption amount of approximately $1.76 million pursuant to the terms
of our redemption of all of our outstanding Series 2 Preferred. The redemption price was $50.00
per share of Series 2 Preferred, plus $26.25 per share in dividends in arrears pro-rata to the date
of redemption. The holders of shares of Series 2 Preferred had the right to convert each share
into 4.329 shares of our common stock, which right to convert terminated 10 days prior to the
redemption date. Holders that converted shares of Series 2 Preferred were not entitled to any
dividends in arrears as to the shares of Series 2 Preferred converted.

During 2007, certain subsidiaries of the Company remodeled their offices and paid $13,000 for
the replacement of carpet and flooring to a company (“Designer Rugs”) owned by Linda Golsen
Rappaport, the daughter of Jack E. Golsen, our Chairman and Chief Executive Officer, and sister
of Barry H. Golsen, our President.

The Golsen Group pays us approximately $6,000 each year for the use of approximately 600
square feet of office space in our corporate offices.

Steve Golsen, Chief Operating Officer of our Climate Control Business, 2007 compensation was
approximately $389,000, which included $150,000 bonus and $6,000 automobile allowance.
Heidi Brown Shear, Vice President and Managing Counsel to the Company, 2007 compensation
was approximately $130,000, which included $25,000 bonus and $3,900 automobile allowance.
In addition, Heidi Brown Shear realized approximately $215,000 value in 2007 from the exercise
of non-qualified stock options. Steve Golsen is the son of Jack Golsen and the brother to Barry
Golsen. Heidi Brown Shear is the daughter of Robert C. Brown, a Director, and spouse of David
Shear, Senior Vice President and General Counsel of the Company. As of December 31, 2007,
we employed 1,788 persons, of which 4 are relatives of Jack Golsen.

Cash Dividends

As discussed above, during 2007, we paid cash dividends to the Golsen Group of approximately
$606,000 related to 23,083 shares of Series 2 Preferred redeemed.

Northwest

Northwest Internal Medicine Associates (“Northwest”), a division of Plaza Medical Group, P.C.,
has an agreement with the Company to perform medical examinations of the management and
supervisory personnel of the Company and its subsidiaries. Each year, we pay Northwest $2,000
a month to perform such examinations, under the agreement. Dr. Robert C. Brown (a director of
the Company) is Vice President and Treasurer of Plaza Medical Group, P.C.

109

Quail Creek Bank

The Audit Committee of our Board of Directors or our Board of Directors reviewed each of the
above noted transactions prior to the completion of the transaction discussed, except that neither
the Audit Committee or the Board of Directors reviewed the compensation of Steve Golsen or
Heidi Brown Shear. Steve Golsen is not an officer or director of the Company and Heidi Brown
Shear’s compensation was approved by the Compensation Committee of our Board of Directors.

Board Independence

The Board of Directors has determined that each of Messrs. Ackerman, Burtch, Butkin, Ille,
Munson, Rhodes, Perry and Shelley is an “independent director” in accordance with the current
listing standards of the AMEX.

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

Audit Fees

The aggregate fees billed by Ernst & Young LLP for professional services rendered for the audit
of the Company’s annual financial statements for the fiscal years ended December 31, 2007 and
2006, for the reviews of the financial statements included in the Company’s Quarterly Reports
on Form 10-Q for those fiscal years, and for review of documents filed with the SEC for those
fiscal years were approximately $1,635,057 and $914,100, respectively.

Audit-Related Fees

Ernst & Young LLP billed the Company $95,000 and $223,540 during 2007 and 2006,
respectively, for audit-related services, which included benefit plan audit and accounting
consultations which included assistance with our internal control documentation, the issuance of
the 2006 and 2007 Debentures, and the exchange tender offer during 2007.

Tax Fees

Ernst & Young LLP billed $249,887 and $136,795 during 2007 and 2006, respectively, for tax
services to the Company, and included tax return review and preparation and tax consultations
and planning.

110

All Other Fees

The Company did not engage its accountants to provide any other services for the fiscal years
ended December 31, 2007 and 2006.

Engagement of the Independent Registered Public Accounting Firm

The Audit Committee is responsible for approving all engagements with Ernst & Young LLP to
perform audit or non-audit services for us prior to us engaging Ernst & Young LLP to provide
those services. All of the services under the headings Audit Related, Tax Services, and All Other
Fees were approved by the Audit Committee in accordance with paragraph (c)(7)(i)(C) of Rule
2-01 of Regulation S-X of the Exchange Act. The Audit Committee of the Company’s Board of
Directors has considered whether Ernst & Young LLP’s provision of the services described
above for the fiscal years ended December 31, 2007 and 2006 is compatible with maintaining its
independence.

111

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a) (1) Financial Statements

The following consolidated financial statements of the Company appear immediately following
this Part IV:

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets at December 31, 2007 and 2006

Consolidated Statements of Income for each of the three years in the period ended
December 31, 2007

Consolidated Statements of Stockholders' Equity for each of the three years in the
period ended December 31, 2007

Consolidated Statements of Cash Flows for each of the three years in the period
ended December 31, 2007

Notes to Consolidated Financial Statements

Quarterly Financial Data (Unaudited)

(a) (2) Financial Statement Schedules

The Company has included the following schedules in this report:

Page

F-2

F-3

F-5

F-6

F-8

F-10

F-73

I - Condensed Financial Information of Registrant

II - Valuation and Qualifying Accounts

F-75

F-80

We have omitted all other schedules because the conditions requiring their filing do not exist or
because the required information appears in our Consolidated Financial Statements, including the
notes to those statements.

112

(a)(3) Exhibits

3(i).1 Restated Certificate of Incorporation, as amended, which the Company hereby
incorporates by reference from Exhibit 3(i).1 to the Company’s Form S-1 Registration
Statement, file no. 333-145721, effective November 11, 2007.

3(i).2 Restated Bylaws, dated December 19, 2007, which the Company hereby incorporates by
reference from Exhibit 3.2 to the Company’s Form 8-K, filed December 20, 2007.

4.1 Specimen Certificate for the Company's Non-cumulative Preferred Stock, having a par
value of $100 per share which the Company incorporates by reference from Exhibit 4.1 to
the company’s Form 10-K for the fiscal year ended December 31, 2005.

4.2 Specimen Certificate for the Company's Series B Preferred Stock, having a par value of
$100 per share, which the Company hereby incorporates by reference from Exhibit 4.27 to
the Company's Registration Statement No. 33-9848.

4.3 Specimen of Certificate of Series D 6% Cumulative, Convertible Class C Preferred Stock
which the Company hereby incorporates by reference from Exhibit 4.1 to the Company's
Form 10-Q for the fiscal quarter ended September 30, 2001.

4.4 Specimen Certificate for the Company's Common Stock, which the Company incorporates
by reference from Exhibit 4.4 to the Company's Registration Statement No. 33-61640.

4.5 Renewed Rights Agreement, dated January 6, 1999 between the Company and Bank One,
N.A., which the Company hereby incorporates by reference from Exhibit No. 1 to the
Company's Form 8-A Registration Statement, dated January 27, 1999.

4.6 Redemption Notice, dated July 12, 2007, for the LSB Industries, Inc.’s $3.25 Convertible
Exchangeable Class C Preferred Stock, Series 2 which the Company hereby incorporates
by reference from Exhibit 99.1 to the Company’s Form 8-K, dated July 11, 2007.

4.7 Amended and Restated Loan and Security Agreement by and among LSB Industries, Inc.,
ThermaClime, Inc. and each of its subsidiaries that are Signatories, the lenders and Wells
Fargo Foothill, Inc. which the Company hereby incorporates by reference from Exhibit 4.2
to the Company’s Form 10-Q for the fiscal quarter ended September 30, 2007.

4.8 Loan Agreement, dated September 15, 2004 between ThermaClime, Inc. and certain
subsidiaries of ThermaClime, Inc., Cherokee Nitrogen Holdings, Inc., Orix Capital
Markets, L.L.C. and LSB Industries, Inc. (“Loan Agreement”) which the Company hereby
incorporates by reference from Exhibit 4.1 to the Company’s Form 8-K, dated September
16, 2004. The Loan Agreement lists numerous Exhibits and Schedules that are attached
thereto, which will be provided to the Commission upon the commission’s request.

113

4.9 First Amendment, dated February 18, 2005 to Loan Agreement, dated as of September 15,
2004, among ThermaClime, Inc., and certain subsidiaries of ThermaClime, Cherokee
Nitrogen Holdings, Inc., and Orix Capital Markets, L.L.C. which the Company hereby
incorporates by reference from Exhibit 4.21 to the Company’s Form 10-K for the year
ended December 31, 2004.

4.10 Waiver and Consent, dated as of January 1, 2006 to the Loan Agreement dated as of
September 15, 2004 among ThermaClime, Inc., and certain subsidiaries of ThermaClime,
Inc., Cherokee Nitrogen Holdings, Inc., Orix Capital Markets, L.L.C. and LSB Industries,
Inc. which the Company hereby incorporates by reference from Exhibit 4.23 to the
Company’s Form 10-K for the year ended December 31, 2005.

4.11 Consent of Orix Capital Markets, LLC and the Lenders of the Senior Credit Agreement,
dated May 12, 2006, to the interest rate of a loan between LSB and ThermaClime and the
utilization of the loan proceeds by ThermaClime and the waiver of related covenants
which the Company hereby incorporates by reference from Exhibit 4.2 to the Company’s
Form 10-Q for the fiscal quarter ended June 30, 2006.

4.12 Indenture, dated March 3, 2006, by and among the Company and UMB Bank, which the
Company hereby incorporates by reference from Exhibit 99.2 to the Company’s Form 8-
K, dated March 14, 2006.

4.13 Registration Rights Agreement, dated March 3, 2006, by and among the Company and the
Purchasers set fourth in the signature pages which the Company hereby incorporates by
reference from Exhibit 99.3 to the Company’s Form 8-K, dated March 14, 2006.

4.14 Term Loan Agreement, dated as of November 2, 2007, among LSB Industries, Inc.,
ThermaClime, Inc. and certain subsidiaries of ThermaClime, Inc., Cherokee Nitrogen
Holdings, Inc., the Lenders, the Administrative and Collateral Agent and the Payment
Agent which the Company hereby incorporates by reference from Exhibit 4.1 to the
Company’s Form 10-Q for the fiscal quarter ended September 30, 2007.

4.15 Certificate of 5.5% Senior Subordinated Convertible Debentures due 2012 which the
Company hereby incorporates by reference from Exhibit 4.1 to the Company’s Form 8-K,
dated June 28, 2007.

4.16 Indenture, dated June 28, 2007, by and among the Company and UMB Bank, n.a. which
the Company hereby incorporates by reference from Exhibit 4.2 to the Company’s Form
8-K, dated June 28, 2007

4.17 Registration Rights Agreement, dated June 28, 2007, by and among the Company and the
Purchasers set forth in the signature pages thereto which the Company hereby incorporates
by reference from Exhibit 4.3 to the Company’s Form 8-K, dated June 28, 2007.

4.18 Registration Rights Agreement, dated March 25, 2003 among LSB Industries, Inc., Kent
C. McCarthy, Jayhawk Capital management, L.L.C., Jayhawk Investments, L.P. and
Jayhawk Institutional Partners, L.P., which the Company hereby incorporates by reference
from Exhibit 10.49 to the Company's Form 10-K for the fiscal year ended December 31,
2002.

114

10.1 Limited Partnership Agreement dated as of May 4, 1995 between the general partner, and
LSB Holdings, Inc., an Oklahoma Corporation, as limited partner which the Company
hereby incorporates by reference from Exhibit 10.11 to the Company's Form 10-K for the
fiscal year ended December 31, 1995. See SEC file number 001-07677.

10.2 Form of Death Benefit Plan Agreement between the Company and the employees covered
under the plan, which the Company incorporates by reference from Exhibit 10.2 to the
company’s Form 10-K for the fiscal year ended December 31, 2005.

10.3 The Company's 1993 Stock Option and Incentive Plan, which the Company incorporates
by reference, which the Company incorporates by reference from Exhibit 10.3 to the
company’s Form 10-K for the fiscal year ended December 31, 2005.

10.4 First Amendment to Non-Qualified Stock Option Agreement, dated March 2, 1994 and
Second Amendment to Stock Option Agreement, dated April 3, 1995 each between the
Company and Jack E. Golsen, which the Company hereby incorporates by reference from
Exhibit 10.1 to the Company's Form 10-Q for the fiscal quarter ended March 31, 1995.
See SEC file number 001-07677.

10.5 Non-Qualified Stock Option Agreement, dated April 22, 1998 between the Company and
Robert C. Brown, M.D., which the Company hereby incorporates by reference from
Exhibit 10.43 to the Company’s Form 10-K for the fiscal year ended December 31, 1998.
The Company entered into substantially identical agreements with Bernard G. Ille,
Raymond B. Ackerman, Horace G. Rhodes, and Donald W. Munson. The Company will
provide copies of these agreements to the Commission upon request. See SEC file number
001-07677.

10.6 The Company's 1998 Stock Option and Incentive Plan, which the Company hereby
incorporates by reference from Exhibit 10.44 to the Company's Form 10-K for the year
ended December 31, 1998. See SEC file number 001-07677.

10.7 LSB Industries, Inc. Outside Directors Stock Option Plan, which the Company hereby
incorporates by reference from Exhibit "C" to the LSB Proxy Statement, dated May 24,
1999 for Annual Meeting of Stockholders. See SEC file number 001-07677.

10.8 Nonqualified Stock Option Agreement, dated November 7, 2002 between the Company
and John J. Bailey Jr, which the Company hereby incorporates by reference from Exhibit
55 to the Company's Form 10-K/A Amendment No.1 for the fiscal year ended December
31, 2002.

10.9 Nonqualified Stock Option Agreement, dated November 29, 2001 between the Company
and Dan Ellis, which the Company hereby incorporates by reference from Exhibit 10.56 to
the Company's Form 10-K/A Amendment No.1 for the fiscal year ended December 31,
2002.

115

10.10 Nonqualified Stock Option Agreement, dated July 20, 2000 between the Company and
Claude Rappaport for the purchase of 80,000 shares of common stock, which the
Company hereby incorporates by reference from Exhibit 10.57 to the Company's Form 10-
K/A Amendment No.1 for the fiscal year ended December 31, 2002. Substantially similar
nonqualified stock option agreements were entered into with Mr. Rappaport (40,000
shares at an exercise price of $1.25 per share, expiring on July 20, 2009), (5,000 shares at
an exercise price of $5.362 per share, expiring on July 20, 2007), and (60,000 shares at an
exercise price of $1.375 per share, expiring on July 20, 2009), copies of which will be
provided to the Commission upon request.

10.11 Nonqualified Stock Option Agreement, dated July 8, 1999 between the Company and Jack
E. Golsen, which the Company hereby incorporates by reference from Exhibit 10.58 to the
Company's Form 10-K/A Amendment No.1 for the fiscal year ended December 31, 2002.
Substantially similar nonqualified stock options were granted to Barry H. Golsen (55,000
shares), Steven J. Golsen (35,000 shares), David R. Goss (35,000 shares), Tony M. Shelby
(35,000 shares), David M. Shear (35,000 shares), Jim D. Jones (35,000 shares), and four
other employees (130,000 shares), copies of which will be provided to the Commission
upon request.

10.12 Nonqualified Stock Option Agreement, dated June 19, 2006, between LSB Industries, Inc.
and Dan Ellis which the Company hereby incorporates by reference from Exhibit 99.1 to
the Company’s Form S-8, dated September 10, 2007.

10.13 Nonqualified Stock Option Agreement, dated June 19, 2006, between LSB Industries, Inc.
and John Bailey which the Company hereby incorporates by reference from Exhibit 99.2
to the Company’s Form S-8, dated September 10, 2007.

10.14 Severance Agreement, dated January 17, 1989 between the Company and Jack E. Golsen.
which the Company hereby incorporates by reference from Exhibit 10.13 to the
Company’s Form 10-K for the year ended December 31, 2005. The Company also entered
into identical agreements with Tony M. Shelby, David R. Goss, Barry H. Golsen, David
M. Shear, and Jim D. Jones and the Company will provide copies thereof to the
Commission upon request.

10.15 Employment Agreement and Amendment to Severance Agreement dated January 12,
1989 between the Company and Jack E. Golsen, dated March 21, 1996 which the
Company hereby incorporates by reference from Exhibit 10.15 to the Company's Form 10-
K for fiscal year ended December 31, 1995. See SEC file number 001-07677.

10.16 First Amendment to Employment Agreement, dated April 29, 2003 between the Company
and Jack E. Golsen, which the Company hereby incorporates by reference from Exhibit
10.52 to the Company's Form 10-K/A Amendment No.1 for the fiscal year ended
December 31, 2002.

116

10.17 Baytown Nitric Acid Project and Supply Agreement dated June 27, 1997 by and among El
Dorado Nitrogen Company, El Dorado Chemical Company and Bayer Corporation which
the Company hereby incorporates by reference from Exhibit 10.2 to the Company's Form
10-Q for the fiscal quarter ended June 30, 1997. CERTAIN INFORMATION WITHIN
THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION
ORDER CF #5551, DATED SEPTEMBER 25, 1997 GRANTING A REQUEST FOR
CONFIDENTIAL TREATMENT UNDER THE FREEDOM OF INFORMATION ACT
AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. See SEC file
number 001-07677.

10.18 First Amendment to Baytown Nitric Acid Project and Supply Agreement, dated February
1, 1999 between El Dorado Nitrogen Company and Bayer Corporation, which the
Company hereby incorporates by reference from Exhibit 10.30 to the Company's Form 10-
K for the year ended December 31, 1998. CERTAIN INFORMATION WITHIN THIS
EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION ORDER
CF #7927, DATED JUNE 9, 1999 GRANTING A REQUEST FOR CONFIDENTIAL
TREATMENT UNDER THE FREEDOM OF INFORMATION ACT AND THE
SECURITIES EXCHANGE ACT OF 1934, AS AMENDED. See SEC file number 001-
07677.

10.19 Service Agreement, dated June 27, 1997 between Bayer Corporation and El Dorado
Nitrogen Company which the Company hereby incorporates by reference from Exhibit
10.3 to the Company's Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE
SUBJECT OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997,
GRANTING A REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED. See SEC file number 001-07677.

10.20 Ground Lease dated June 27, 1997 between Bayer Corporation and El Dorado Nitrogen
Company which the Company hereby incorporates by reference from Exhibit 10.4 to the
Company's Form 10-Q for the fiscal quarter ended June 30, 1997. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE
SUBJECT OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997
GRANTING A REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED. See SEC file number 001-07677.

10.21 Participation Agreement, dated as of June 27, 1997 among El Dorado Nitrogen Company,
Boatmen's Trust Company of Texas as Owner Trustee, Security Pacific Leasing
Corporation, as Owner Participant and a Construction Lender, Wilmington Trust
Company, Bayerische Landes Bank, New York Branch, as a Construction Lender and the
Note Purchaser, and Bank of America National Trust and Savings Association, as
Construction Loan Agent which the Company hereby incorporates by reference from
Exhibit 10.5 to the Company's Form 10-Q for the fiscal quarter ended June 30, 1997.
CERTAIN INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS
THE SUBJECT OF COMMISSION ORDER CF #5551, DATED SEPTEMBER 25, 1997
GRANTING A REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED. See SEC file number 001-07677.

117

10.22 Lease Agreement, dated as of June 27, 1997 between Boatmen's Trust Company of Texas
as Owner Trustee and El Dorado Nitrogen Company which the Company hereby
incorporates by reference from Exhibit 10.6 to the Company's Form 10-Q for the fiscal
quarter ended June 30, 1997. See SEC file number 001-07677.

10.23 Security Agreement and Collateral Assignment of Construction Documents, dated as of
June 27, 1997 made by El Dorado Nitrogen Company which the Company hereby
incorporates by reference from Exhibit 10.7 to the Company's Form 10-Q for the fiscal
quarter ended June 30, 1997. See SEC file number 001-07677.

10.24 Security Agreement and Collateral Assignment of Facility Documents, dated as of June
27, 1997 made by El Dorado Nitrogen Company and consented to by Bayer Corporation
which the Company hereby incorporates by reference from Exhibit 10.8 to the Company's
Form 10-Q for the fiscal quarter ended June 30, 1997. See SEC file number 001-07677.

10.25 Loan Agreement dated December 23, 1999 between Climate Craft, Inc. and the City of
Oklahoma City, which the Company hereby incorporates by reference from Exhibit 10.49
to the Company's Amendment No. 2 to its 1999 Form 10-K. See SEC file number 001-
07677.

10.26 Assignment, dated May 8, 2001 between Climate Master, Inc. and Prime Financial
Corporation, which the Company hereby incorporates by reference from Exhibit 10.2 to
the Company's Form 10-Q for the fiscal quarter ended March 31, 2001.

10.27 Agreement for Purchase and Sale, dated April 10, 2001 by and between Prime Financial
Corporation and Raptor Master, L.L.C. which the Company hereby incorporates by
reference from Exhibit 10.3 to the Company's Form 10-Q for the fiscal quarter ended
March 31, 2001.

10.28 Amended and Restated Lease Agreement, dated May 8, 2001 between Raptor Master,
L.L.C. and Climate Master, Inc. which the Company hereby incorporates by reference
from Exhibit 10.4 to the Company's Form 10-Q for the fiscal quarter ended March 31,
2001.

10.29 Option Agreement, dated May 8, 2001 between Raptor Master, L.L.C. and Climate
Master, Inc., which the Company hereby incorporates by reference from Exhibit 10.5 to
the Company's Form 10-Q for the fiscal quarter ended March 31, 2001.

10.30 First Amendment to Amended and Restated Lease Agreement, dated April 1, 2007,

between Raptor Master, L.L.C. and Climate Master, Inc.

10.31 Stock Purchase Agreement, dated September 30, 2001 by and between Summit Machinery
Company and SBL Corporation, which the Company hereby incorporates by reference
from Exhibit 10.1 to the Company' Form 10-Q for the fiscal quarter ended September 30,
2001.

118

10.32 Asset Purchase Agreement, dated October 22, 2001 between Orica USA, Inc. and El
Dorado Chemical Company and Northwest Financial Corporation, which the Company
hereby incorporates by reference from Exhibit 99.1 to the Company's Form 8-K dated
December 28, 2001. CERTAIN INFORMATION WITHIN THIS EXHIBIT HAS BEEN
OMITTED AS IT IS THE SUBJECT OF COMMISSION ORDER CF 12179, DATED MAY
24, 2006, GRANTING A REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED.

10.33 AN Supply Agreement, dated November 1, 2001 between Orica USA, Inc. and El Dorado
Company, which the Company hereby incorporates by reference from Exhibit 99.2 to the
Company's Form 8-K dated December 28, 2001. CERTAIN INFORMATION WITHIN
THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION
ORDER CF 12179, DATED MAY 24, 2006, AND CF 19661 DATED MARCH 23, 2007,
GRANTING A REQUEST FOR CONFIDENTIAL TREATMENT UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT OF
1934, AS AMENDED.

10.34 Second Amendment to AN Supply Agreement, executed August 24, 2006, to be effective
as of January 1, 2006, between Orica USA, Inc. and El Dorado Company which the
Company hereby incorporates by reference from Exhibit 10.1 to the Company’s Form
10-Q for the fiscal quarter ended September 30, 2006. CERTAIN INFORMATION
WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF A
COMMISSION ORDER CF 19661, DATED MARCH 23, 2007, GRANTING REQUEST
BY THE COMPANY FOR CONFIDENTIAL TREATMENT BY THE SECURITIES AND
EXCHANGE COMMISSION UNDER THE FREEDOM OF INFORMATION ACT.

10.35 Agreement, dated August 1, 2007, between El Dorado Chemical Company and United

Steelworkers of America International Union AFL-CIO and its Local 13-434.

10.36 Agreement, dated October 17, 2007, between El Dorado Chemical Company and
International Association of Machinists and Aerospace Workers, AFL-CIO Local No. 224.

10.37 Agreement, dated November 12, 2007, between United Steel, Paper and Forestry, Rubber,
Manufacturing, Energy, Allied Industrial and Service Workers International Union, AFL-
CIO, CLC, on behalf of Local No. 00417 and Cherokee Nitrogen Company.

10.38 Warrant, dated May 24, 2002 granted by the Company to a Lender for the right to
purchase up to 132,508 shares of the Company's common stock at an exercise price of
$0.10 per share, which the Company hereby incorporates by reference from Exhibit 99.1
to the Company's Form 8-K, dated May 24, 2002. Four substantially similar Warrants,
dated May 24, 2002 for the purchase of an aggregate additional 463,077 shares at an
exercise price of $0.10 were issued. Copies of these Warrants will be provided to the
Commission upon request.

119

10.39 Asset Purchase Agreement, dated as of December 6, 2002 by and among Energetic
Systems Inc. LLC, UTeC Corporation, LLC, SEC Investment Corp. LLC, DetaCorp Inc.
LLC, Energetic Properties, LLC, Slurry Explosive Corporation, Universal Tech
Corporation, El Dorado Chemical Company, LSB Chemical Corp., LSB Industries, Inc.
and Slurry Explosive Manufacturing Corporation, LLC, which the Company hereby
incorporates by reference from Exhibit 2.1 to the Company's Form 8-K, dated December
12, 2002. The asset purchase agreement contains a brief list identifying all schedules and
exhibits to the asset purchase agreement. Such schedules and exhibits are not filed, and the
Registrant agrees to furnish supplementally a copy of the omitted schedules and exhibits
to the commission upon request.

10.40 Anhydrous Ammonia Sales Agreement, dated effective January 3, 2005 between Koch
Nitrogen Company and El Dorado Chemical Company which the Company hereby
incorporates by reference from Exhibit 10.41 to the Company’s Form 10-K for the year
ended December 31, 2004. CERTAIN INFORMATION WITHIN THIS EXHIBIT HAS
BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION ORDER CF# 26082,
DATED NOVEMBER 16, 2007, GRANTING CONFIDENTIAL TREATMENT BY THE
SECURITIES AND EXCHANGE COMMISSION UNDER THE FREEDOM OF
INFORMATION ACT.

10.41 First Amendment to Anhydrous Ammonia Sales Agreement, dated effective August 29,
2005, between Koch Nitrogen Company and El Dorado Chemical Company, which the
Company hereby incorporates by reference from Exhibit 10.42 to the Company's Form
10-K for the fiscal year ended December 31, 2005, filed March 31, 2006. CERTAIN
INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE
SUBJECT OF COMMISSION ORDER CF# 18274, DATED MARCH 23, 2007, AND CF#
20082 DATED NOVEMBER 16, 2007 GRANTING A REQUEST BY THE COMPANY
FOR CONFIDENTIAL TREATMENT UNDER THE FREEDOM OF INFORMATION
ACT AND THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED.

10.42 Purchase Confirmation, dated July 1, 2006, between Koch Nitrogen Company and
Cherokee Nitrogen Company, which the Company hereby incorporates by reference from
Exhibit 10.40 to the Company’s Form 10-K for the fiscal year ended December 31, 2006.
CERTAIN INFORMATION WITHIN THIS EXHIBIT HAS BEEN OMITTED AS IT IS
THE SUBJECT OF COMMISSION ORDER CF# 20082, DATED NOVEMBER 16, 2007,
GRANTING CONFIDENTIAL TREATMENT BY THE SECURITIES AND EXCHANGE
COMMISSION UNDER THE FREEDOM OF INFORMATION ACT AND THE
SECURITIES EXCHANGE ACT, AS AMENDED.

10.43 Second Amendment to Anhydrous Ammonia Sales Agreement, dated November 3, 2006,
between Koch Nitrogen Company and El Dorado Chemical Company, which the
Company hereby incorporates by reference from Exhibit 10.41 to the Company’s Form
10-K for the fiscal year ended December 31, 2006.. CERTAIN INFORMATION WITHIN
THIS EXHIBIT HAS BEEN OMITTED AS IT IS THE SUBJECT OF COMMISSION
ORDER CF# 20082, DATED NOVEMBER 16, 2007, GRANTING CONFIDENTIAL
TREATMENT BY THE SECURITIES AND EXCHANGE COMMISSION UNDER THE
FREEDOM OF INFORMATION ACT AND THE SECURITIES EXCHANGE ACT, AS
AMENDED.

120

10.44 Warrant Agreement, dated March 25, 2003 between LSB Industries, Inc. and Jayhawk
Institutional Partners, L.P., which the Company hereby incorporates by reference from
Exhibit 10.51 to the Company's Form 10-K for the fiscal year ended December 31, 2002.

10.45 Subscription Agreement, dated March 25, 2003 by and between LSB Industries, Inc. and
Jayhawk Institutional Partners, L.P., which the Company hereby incorporates by reference
from Exhibit 10.50 to the Company's Form 10-K for the fiscal year ended December 31,
2002.

10.46 Second Amendment and Extension of Stock Purchase Option, effective July 1, 2004,
between LSB Holdings, Inc., an Oklahoma corporation and Dr. Hauri AG, a Swiss
corporation, which the Company hereby incorporates by reference from Exhibit 10.1 to
the Company’s Form 10-Q for the fiscal quarter ended September 30, 2004.

10.47 Purchase Agreement, dated March 3, 2006, by and among the Company and the investors
identified on the Schedule of Purchasers which the Company hereby incorporates by
reference from Exhibit 99.1 to the Company’s Form 8-K, dated March 14, 2006.

10.48 Exchange Agreement, dated October 6, 2006, between LSB Industries, Inc., Paul Denby,
Trustee of the Paul Denby Revocable Trust, U.A.D. 10/12/93, The Paul J. Denby IRA,
Denby Enterprises, Inc., Tracy Denby, and Paul Denby which the Company hereby
incorporates by reference from Exhibit 10.2 to the Company’s Form 10-Q for the fiscal
quarter ended September 30, 2006. Substantially similar Exchange Agreements (each
having the same exchange rate) were entered with the following individuals or entities on
the dates indicated for the exchange of the number of shares of LSB’s Series 2 Preferred
noted: October 6, 2006 - James W. Sight (35,428 shares of Series 2 Preferred), Paul
Denby, Trustee of the Paul Denby Revocable Trust, U.A.D. 10/12/93 (25,000 shares of
Series 2 Preferred), The Paul J. Denby IRA (11,000 shares of Series 2 Preferred), Denby
Enterprises, Inc. (4,000 shares of Series 2 Preferred), Tracy Denby (1,000 shares of Series
2 Preferred); October 12, 2006 - Harold Seidel (10,000 shares of Series 2 Preferred);
October 11, 2006 -Brent Cohen (4,000 shares of Series 2 Preferred), Brian J. Denby and
Mary Denby (1,200 shares of Series 2 Preferred), Brian J. Denby, Trustee, Money
Purchase Pension Plan (5,200 shares of Series 2 Preferred), Brian Denby, Inc. Profit
Sharing Plan (600 shares of Series 2 Preferred); October 25, 2006 - William M. and
Laurie Stern ( 400 shares of Series 2 Preferred), William M. Stern Revocable Living
Trust, UTD July 9, 1992 (1,570 shares of Series 2 Preferred), the William M. Stern IRA
(2,000 shares of Series 2 Preferred), and William M. Stern, Custodian for David Stern
(1,300 shares of Series 2 Preferred), John Cregan (500 shares of Series 2 Preferred), and
Frances Berger (1,350 shares of Series 2 Preferred). Copies of the foregoing Exchange
Agreements will be provided to the Commission upon request.

10.49 Purchase Agreement, dated June 28, 2007, by and among the Company and the investors
identified on the Schedule of Purchasers attached thereto which the Company hereby
incorporates by reference from Exhibit 10.1 to the Company’s Form 8-K, dated June 28,
2007.

121

10.50 Agreement, dated November 10, 2006 by and among LSB Industries, Inc., Kent C.
McCarthy, Jayhawk Capital Management, L.L.C., Jayhawk Institutional Partners, L.P. and
Jayhawk Investments, L.P., which the Company hereby incorporates by reference from
Exhibit 99d1 to the Company’s Schedule TO-I, filed February 9, 2007.

14.1 Code of Ethics for CEO and Senior Financial Officers of Subsidiaries of LSB Industries,
Inc., which the Company hereby incorporates by reference from Exhibit 14.1 to the
Company’s Form 10-K for the fiscal year ended December 31, 2003.

21.1 Subsidiaries of the Company.

23.1 Consent of Independent Registered Public Accounting Firm.

31.1 Certification of Jack E. Golsen, Chief Executive Officer, pursuant to Sarbanes-Oxley Act

of 2002, Section 302.

31.2 Certification of Tony M. Shelby, Chief Financial Officer, pursuant to Sarbanes-Oxley Act

of 2002, Section 302.

32.1 Certification of Jack E. Golsen, Chief Executive Officer, furnished pursuant to Sarbanes-

Oxley Act of 2002, Section 906.

32.2 Certification of Tony M. Shelby, Chief Financial Officer, furnished pursuant to Sarbanes-

Oxley Act of 2002, Section 906.

122

Signatures

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as
amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.

Dated:
March 13, 2008

LSB INDUSTRIES, INC.

By: /s/ Jack E. Golsen
Jack E. Golsen
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

By: /s/ Tony M. Shelby
Tony M. Shelby
Executive Vice President of Finance
and Chief Financial Officer
(Principal Financial Officer)

By: /s/ Jim D. Jones
Jim D. Jones
Senior Vice President,
Corporate Controller and Treasurer
(Principal Accounting Officer)

123

Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this report has
been signed below by the following persons on behalf of the Registrant and in the capacities and
on the dates indicated.

Dated:

March 13, 2008

Dated:
March 13, 2008

By: /s/ Jack E. Golsen

Jack E. Golsen, Director

By: /s/ Tony M. Shelby

Tony M. Shelby, Director

By: /s/ Barry H. Golsen

Barry H. Golsen, Director

By: /s/ David R. Goss

David R. Goss, Director

By: /s/ Raymond B. Ackerman

Raymond B. Ackerman, Director

By: /s/ Robert C. Brown MD

Robert C. Brown MD, Director

By: /s/ Charles A. Burtch

Charles A. Burtch, Director

By: /s/ Robert A. Butkin

Robert A. Butkin, Director

By: /s/ Bernard G. Ille

Bernard G. Ille, Director

By: /s/ Donald W. Munson

Donald W. Munson, Director

By: /s/ Ronald V. Perry

Ronald V. Perry, Director

By: /s/ Horace G. Rhodes

Horace G. Rhodes, Director

By: /s/ John A. Shelley

John A. Shelley, Director

124

LSB Industries, Inc.

Consolidated Financial Statements
And Schedules for Inclusion in Form 10-K
For the Fiscal Year ended December 31, 2007

TABLE OF CONTENTS

Financial Statements

Report of Independent Registered Public Accounting Firm

Consolidated Balance Sheets

Consolidated Statements of Income

Consolidated Statements of Stockholders’ Equity

Consolidated Statements of Cash Flows

Notes to Consolidated Financial Statements

Quarterly Financial Data (Unaudited)

Financial Statement Schedules

Schedule I – Condensed Financial Information of Registrant

Schedule II – Valuation and Qualifying Accounts

Page

F - 2

F - 3

F - 5

F - 6

F - 8

F - 10

F - 73

F - 75

F - 80

F-1

Report of Independent Registered
Public Accounting Firm

The Board of Directors and Stockholders of LSB Industries, Inc.

We have audited the accompanying consolidated balance sheets of LSB Industries, Inc. as of
December 31, 2007 and 2006, and the related consolidated statements of income, stockholders’
equity, and cash flows for each of the three years in the period ended December 31, 2007. Our
audits also included the financial statement schedules listed in the Index at Item 15(a)(2). These
financial statements and schedules are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these financial statements and schedules based on our
audits.

We conducted our audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements. An audit also includes assessing the accounting principles
used and significant estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects,
the consolidated financial position of LSB Industries, Inc. at December 31, 2007 and 2006, and
the consolidated results of its operations and its cash flows for each of the three years in the
period ended December 31, 2007, in conformity with U.S. generally accepted accounting
principles. Also, in our opinion, the related financial statement schedules, when considered in
relation to the basic financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), LSB Industries, Inc.’s internal control over financial reporting
as of December 31, 2007, based on criteria established in Internal Control-Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission and our
report dated March 13, 2008 expressed an unqualified opinion thereon.

As discussed in Notes 2, 12 and 14 to the consolidated financial statements, in 2006 the
Company adopted Statement of Financial Accounting Standards No. 123 (Revised), “Share-
Based Payment,” and in 2007, the Company adopted Financial Accounting Standards Board
Interpretation No. 48, “Accounting for Uncertainty in Income Taxes.”

ERNST & YOUNG LLP

Oklahoma City, Oklahoma
March 13, 2008

F-2

LSB Industries, Inc.

Consolidated Balance Sheets

Assets
Current assets:

Cash and cash equivalents
Restricted cash
Accounts receivable, net
Inventories
Supplies, prepaid items and other:

Prepaid insurance
Precious metals
Supplies
Other

Total supplies, prepaid items and other

Deferred income taxes

Total current assets

December 31,

2007

2006

(In Thousands)

58,224
203
70,577
56,876

3,350
10,935
3,849
1,464
19,598
10,030
215,508

2,255
2,479
67,571
45,449

3,443
6,406
3,424
1,468
14,741
-
132,495

Property, plant and equipment, net

79,692

76,404

Other assets:

Noncurrent restricted cash
Debt issuance and other debt-related costs, net
Investment in affiliate
Goodwill
Other, net

Total other assets

-
4,639
3,426
1,724
2,565
12,354
$ 307,554

1,202
2,221
3,314
1,724
2,567
11,028
$ 219,927

(Continued on following page)

F-3

LSB Industries, Inc.

Consolidated Balance Sheets (continued)

Liabilities and Stockholders’ Equity
Current liabilities:

Accounts payable
Short-term financing and drafts payable
Accrued and other liabilities
Current portion of long-term debt

Total current liabilities

Long-term debt

Noncurrent accrued and other liabilities:

Deferred income taxes
Other

Commitments and contingencies (Note 13)

Stockholders’ equity:

December 31,

2007

2006

(In Thousands)

39,060
919
38,942
1,043
79,964

$ 42,870
2,986
26,816
11,579
84,251

121,064

86,113

5,330
6,913
12,243

-
5,929
5,929

Series B 12% cumulative, convertible preferred stock, $100 par value;
20,000 shares issued and outstanding
Series 2 $3.25 convertible, exchangeable Class C preferred stock,
$50 stated value; 517,402 shares issued at December 31, 2006
Series D 6% cumulative, convertible Class C preferred stock, no par
value; 1,000,000 shares issued and outstanding
Common stock, $.10 par value; 75,000,000 shares authorized,
24,466,506 shares issued (20,215,339 at December 31, 2006)
Capital in excess of par value
Accumulated other comprehensive loss
Accumulated deficit

Less treasury stock, at cost:
Series 2 preferred, 18,300 shares at December 31, 2006
Common stock, 3,448,518 shares (3,447,754 at December 31, 2006)

Total stockholders’ equity

2,000

25,870

1,000

2,447
123,336

(411 )
(16,437 )
111,935

2,022
79,838
(701)
(47,962)
62,067

-
17,652
94,283

797
17,636
43,634
$ 219,927

See accompanying notes.

$ 307,554

F-4

LSB Industries, Inc.

Consolidated Statements of Income

Net sales
Cost of sales
Gross profit

Year ended December 31,

2007

2005
2006
(In Thousands, Except Per Share Amounts)

$ 586,407
453,814
132,593

$ 491,952
401,090
90,862

$ 397,115
330,349
66,766

Selling, general and administrative expense
Provisions for losses on accounts receivable
Other expense
Other income
Operating income

Interest expense
Non-operating other income, net
Income from continuing operations before provisions
for income taxes and equity in earnings of affiliate

Provisions for income taxes
Equity in earnings of affiliate
Income from continuing operations

Net loss (income) from discontinued operations
Net income

Dividends, dividend requirements and stock dividends

on preferred stock

Net income applicable to common stock

Income (loss) per common share:

Basic:

Income from continuing operations
Net income (loss) from discontinued operations
Net income

Diluted:

Income from continuing operations
Net income (loss) from discontinued operations
Net income

75,033
858
1,186
(3,495)
59,011

12,078
(1,264)

48,197
2,540
(877)
46,534

(348)
46,882

5,608
41,274

2.09
.02
2.11

1.82
.02
1.84

See accompanying notes.

F-5

64,134
426
722
(1,559 )
27,139

11,915

(624 )

15,848
901
(821 )

15,768

253
15,515

53,453
810
332
(2,682)
14,853

11,407
(1,561)

5,007
118
(745)
5,634

644
4,990

2,630
12,885

2,283
2,707

.92
(.02 )
.90

.77
(.01 )
.76

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(.05)
.20

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F

LSB Industries, Inc.

Consolidated Statements of Cash Flows

2007

Year ended December 31,
2006
(In Thousands)

2005

Cash flows from continuing operating activities
Net income
Adjustments to reconcile net income to net cash provided by

continuing operating activities:
Net loss (income) from discontinued operations
Deferred income taxes
Loss (gains) on sales and disposals of property and equipment
Gain on property insurance recoveries
Depreciation of property, plant and equipment
Amortization
Stock-based compensation
Provisions for losses on accounts receivable
Provisions for (realization of) losses on inventory
Provisions for impairment on long-lived assets
Provision for (realization of) losses on firm sales
commitments
Equity in earnings of affiliate
Distributions received from affiliate
Changes in fair value of interest rate caps
Other
Cash provided (used) by changes in assets and liabilities

(net of effects of discontinued operations):
Accounts receivable
Inventories
Other supplies and prepaid items
Accounts payable
Customer deposits
Deferred rent expense
Other current and noncurrent liabilities

Net cash provided by continuing operating activities

Cash flows from continuing investing activities

Capital expenditures
Proceeds from property insurance recoveries
Proceeds from sales of property and equipment
Proceeds from (deposits of) current and noncurrent restricted

cash

Purchase of interest rate cap contracts
Other assets

Net cash used by continuing investing activities

$ 46,882

$ 15,515

4,990

(348)
(4,700)
378
-

12,271
2,082
421
858
(384)
250

(328)
(877)
765
580
-

253
-
(12 )
-
11,381
1,168
-
426
(711 )
286

328
(821 )
875
44
-

(4,392)
(11,044)
(4,857)
(5,110)
6,587
(931)
8,696
46,799

(18,066 )
(7,287 )
(1,871 )
11,183
1,011
122
3,868
17,692

(14,808)

-
271

(14,701 )
-
147

3,478
(621)
(168)
(11,848)

(3,504)
-
(363 )
(18,421 )

644
-
(714)
(1,618)
10,875
1,151
-
810
239
237

-
(745)
488
162
59

(8,664)
(8,888)
798
3,990
(1,494)
6,047
2,608
10,975

(15,315)
2,888
2,355

(19)
(590)
107
(10,574)

(Continued on following page)

F-8

LSB Industries, Inc.

Consolidated Statements of Cash Flows (continued)

2007

Year ended December 31,
2006
(In Thousands)

2005

Cash flows from continuing financing activities

Proceeds from revolving debt facilities
Payments on revolving debt facilities, including fees
Proceeds from 5.5% convertible debentures, net of fees
Proceeds from Secured Term Loan
Proceeds from 7% convertible debentures, net of fees
Proceeds from other long-term debt, net of fees
Payments on Senior Secured Loan
Acquisition of 10.75% Senior Unsecured Notes
Payments on other long-term debt
Payments of debt issuance costs
Proceeds from short-term financing and drafts payable
Payments on short-term financing and drafts payable
Proceeds from exercise of stock options
Proceeds from exercise of warrant
Excess income tax benefit on stock options exercised
Dividends paid on preferred stock
Acquisition of non-redeemable preferred stock

Net cash provided (used) by continuing financing activities

Cash flows of discontinued operations:

Operating cash flows

Net increase (decrease) in cash and cash equivalents

Cash and cash equivalents at beginning of year
Cash and cash equivalents at end of year

Supplemental cash flow information:
Cash payments for:

Interest on long-term debt and other
Income taxes, net of refunds

Noncash investing and financing activities:

Receivable from sale of property and equipment
Debt issuance costs
Accounts payable and other long-term debt associated
with purchases of property, plant and equipment
Debt issuance costs associated with 7% convertible

debentures converted to common stock

7% convertible debentures converted to common stock
Series 2 preferred stock converted to common stock of
which $12,303,000 and $2,882,000 was charged to
accumulated deficit in 2007 and 2006, respectively

$ 529,766
(556,173)
56,985
50,000

-
2,424
(50,000)

(7,781)
(1,403)
1,456
(3,523)
1,522
393
1,740
(2,934)
(1,292)
21,180

(162)
55,969

2,255
58,224

$ 460,335
(466,445 )
-
-
16,876
8,218
-
(13,300 )
(6,853 )
(356 )
3,984
(3,788 )
298
-
-
(262 )
(95 )
(1,388 )

(281 )
(2,398 )

4,653
2,255

$
$

9,162
1,646

$ 11,084
445
$

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3,026

1,937

266
4,000

182
1,190

$
$

$
998
$ 14,000

$
$

149

1,036

27,593

8,109

$ 363,671
(359,226)
-
-
-
3,584
-
-
(3,267)
(225)
5,061
(5,978)
248
-
-
-
(597)
3,271

(39)
3,633

1,020
4,653

10,291
-

-
-

$
$

-
-

See accompanying notes.

F-9

LSB Industries, Inc.

Notes to Consolidated Financial Statements

1. Basis of Presentation

The accompanying consolidated financial statements include the accounts of LSB Industries, Inc.
(the “Company”, “We”, “Us”, or “Our”) and its subsidiaries. We are a manufacturing, marketing
and engineering company which is primarily engaged, through our wholly-owned subsidiary
ThermaClime, Inc. (“ThermaClime”) and its subsidiaries, 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”). The
Company and ThermaClime are holding companies with no significant assets or operations other
than cash and cash equivalents and our investments in our 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.

2. Summary of Significant Accounting Policies

Use of Estimates - The preparation of consolidated financial statements in conformity with
generally accepted accounting principles (“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.

During 2007, we had the following changes in accounting estimates:

• as discussed in Note 12, we reversed the valuation allowance on our deferred tax
balances which resulted in recognition of a deferred tax benefit of $4,700,000 which is
included in our provision for income taxes and

• the recognition of $1,005,000 of additional state income taxes included in our provision

for income taxes as discussed in Note 12 – Income Taxes.

The net effect of these changes in accounting estimates increased income from continuing
operations and net income by $3,695,000 for 2007. In addition, these changes in accounting
estimates increased basic and diluted net income per share by $0.19 and $0.16, respectively, for
2007.

Cash and Cash Equivalents - Short-term investments, which consist of highly liquid
investments with original maturities of three months or less, are considered cash equivalents. We
primarily utilize a cash management system with a series of separate accounts consisting of
several “zero-balance” disbursement accounts for funding of payroll and accounts payable. As a
result of our cash management system, checks issued, but not presented to the banks for
payment, may create negative book cash balances. At December 31, 2006, outstanding checks in
excess of related book cash balances (negative book cash balances) of $5,849,000 were included
in current portion of long-term debt because these accounts were funded primarily by our
Working Capital Revolver Loan.

Current and Noncurrent Restricted Cash - Restricted cash consists of cash balances that are
legally restricted or designated by the Company for specific purposes. At December 31, 2007,
we had restricted cash of $203,000 primarily to fund an unrealized loss on exchange-traded

F-10

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

futures contracts. At December 31, 2006, we had restricted cash totaling $3,681,000 of which
$1,202,000 is classified as noncurrent since it was used for capital expenditures in the Climate
Control Business. A portion of the current restricted cash was used for working capital while the
remaining balance was to fund an unrealized loss on exchange-traded futures contracts.

Accounts Receivable and Credit Risk - Sales to contractors and independent sales
representatives are generally subject to a mechanic’s lien in the Climate Control Business. Other
sales are generally unsecured. Credit is extended to customers based on an evaluation of the
customer’s financial condition and other factors. Credit losses are provided for in the
consolidated financial statements based on historical experience and periodic assessment of
outstanding accounts receivable, particularly those accounts which are past due (determined
based upon how recently payments have been received). Our periodic assessment of accounts
and credit loss provisions are based on our best estimate of amounts that are not recoverable.

Inventories - Inventories are priced at the lower of cost or market, with cost being determined
using the first-in, first-out (“FIFO”) basis. Finished goods and work-in-process inventories
include material, labor, and manufacturing overhead costs. At December 31, 2007 and 2006, we
had inventory reserves for certain slow-moving inventory items (primarily Climate Control
products) and inventory reserves for certain nitrogen-based inventories provided by our
Chemical Business because cost exceeded the net realizable value.

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.

Property, Plant and Equipment - Property, plant and equipment are carried at cost. For
financial reporting purposes, depreciation is primarily computed using the straight-line method
over the estimated useful lives of the assets. Leases meeting capital lease criteria have been
capitalized and included in property, plant and equipment. Amortization of assets under capital
leases is included in depreciation expense. No provision for depreciation is made on construction
in progress or capital spare parts until such time as the relevant assets are put into service.
Maintenance, repairs and minor renewals are charged to operations while major renewals and
improvements are capitalized in property, plant and equipment.

Impairment of Long-Lived Assets - Long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amounts may not be recoverable. If
assets to be held and used are considered to be impaired, the impairment to be recognized is the
amount by which the carrying amounts of the assets exceed the fair values of the assets as
measured by the present value of future net cash flows expected to be generated by the assets or
their appraised value. Assets to be disposed of are reported at the lower of the carrying amounts

F-11

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

of the assets or fair values less costs to sell. At December 31, 2007, we had no long-lived assets
that met the criteria presented in Statement of Financial Accounting Standards (“SFAS”) 144 to
be classified as assets held for sale.

We have obtained estimates from external sources and made internal estimates based on inquiry
and other techniques of the fair values of certain capital spare parts and idle assets in our
Chemical Business and certain non-core equipment included in our Corporate assets in order to
determine recoverability of the carrying amounts of such assets.

Debt Issuance and Other Debt-Related Costs - Debt issuance and other debt-related costs are
amortized over the term of the associated debt instrument except for the cost of interest rate caps.
Interest rate cap contracts that are free-standing derivatives are accounted for on a mark-to-
market basis in accordance with SFAS 133.

Goodwill - Goodwill is reviewed for impairment at least annually in accordance with SFAS 142.
As of December 31, 2007 and 2006, goodwill was $1,724,000 of which $103,000 and
$1,621,000 relates to business acquisitions in prior periods in the Climate Control and Chemical
Businesses, respectively.

Accrued Insurance Liabilities - We are self-insured up to certain limits for group health,
workers’ compensation and general liability claims. Above these limits, we have commercial
insurance coverage for our contractual exposure on group health claims and statutory limits
under workers’ compensation obligations. We also carry excess umbrella insurance of $50
million for most general liability risks excluding environmental risks. We have a separate $30
million insurance policy covering pollution liability at our El Dorado and Cherokee Facilities.
Our accrued insurance liabilities are based on estimates of claims, which include the incurred
claims amounts plus estimates of future claims development calculated by applying our historical
claims development factors to our incurred claims amounts. We also consider the reserves
established by our insurance adjustors and/or estimates provided by attorneys handling the
claims, if any. In addition, our accrued insurance liabilities include estimates of incurred, but not
reported, claims and other insurance-related costs. Accrued insurance liabilities are included in
accrued and other liabilities. It is possible that the actual development of claims could exceed our
estimates. Amounts recoverable from our insurance carriers over the self-insured limits are
included in accounts receivable.

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

Generally, 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. The warranty
provides that most equipment is required to be returned to the factory or an authorized

F-12

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

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, to certain system components, and local laws.

Our accounting policy and methodology for warranty arrangements is to periodically measure
and recognize the expense and liability for such warranty obligations using a percentage of net
sales, based upon our historical warranty costs. It is possible that future warranty costs could
exceed our estimates.

Changes in our product warranty obligation are as follows:

Balance at
Beginning
of Year

Additions-
Charged to
Costs and
Expenses

Deductions-
Costs
Incurred

Balance at
End
of Year

(In Thousands)

$ 1,251

$ 3,325

$ 2,632

$ 1,944

861

897

$ 2,199

$ 1,809

$ 1,251

$ 1,491

$ 1,527

861

2007

2006

2005

Plant Turnaround Costs - We expense the costs as they are incurred relating to planned major
maintenance activities (“Turnarounds”) of our Chemical Business as described as the direct
expensing method within Financial Accounting Standards Board (“FASB”) Staff Position No.
AUG AIR-1.

F-13

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

enacted tax rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes the
enactment date. 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 record interest related to unrecognized tax positions in interest
expense and penalties in operating other expense.

Contingencies - We accrue for contingent losses when such losses are probable and reasonably
estimable. In addition, we recognize contingent gains when such gains are realized. Our
Chemical Business is subject to specific federal and state regulatory and environmental
compliance laws and guidelines. We have developed policies and procedures related to
environmental and regulatory compliance. We must continually monitor whether we have
maintained compliance with such laws and regulations and the operating implications, if any,
and amount of penalties, fines and assessments that may result from noncompliance. 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.

Asset Retirement Obligations - We are obligated to monitor certain discharge water outlets at
our Chemical Business facilities should we discontinue the operations of a facility. We also have
certain facilities in our Chemical Business that contain asbestos insulation around certain piping
and heated surfaces which we plan to maintain in an adequate condition to prevent leakage
through our standard repair and maintenance activities. We do not believe the annual costs of the
required monitoring and maintenance activities would be significant and we currently have no
plans to discontinue the use of these facilities and the remaining life of the facilities is
indeterminable, an asset retirement liability has not been recognized. Currently, there is
insufficient information to estimate the fair value of the asset retirement obligations. However,
we will continue to review these obligations and record a liability when a reasonable estimate of
the fair value can be made in accordance of FASB Interpretation (“FIN”) 47.

Stock Options - Effective January 1, 2006, we adopted SFAS 123(R) using the modified
prospective method. Since all outstanding stock options were fully vested at December 31, 2005,
the adoption of SFAS 123(R) did not impact our consolidated financial statements. During 2005,
we accounted for those plans under the recognition and measurement principles of APB Opinion
No. 25 (“APB 25”) and related interpretations. Under APB 25, stock-based compensation cost
was not reflected in our results of operations, as all options granted under those plans had an
exercise price equal to the market value of the underlying common stock on the date of grant.

F-14

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

We issue new shares of common stock upon the exercise of stock options. See “Non-Qualified
Stock Option Plans” within Note 14 - Stockholders’ Equity for discussion of non-qualified stock
options granted in 2006 but were subject to shareholders’ approval which approval was received
in 2007.

The following table illustrates the effect on net income applicable to common stock and net
income per share if we had applied the fair value recognition provisions of SFAS 123(R) to
stock-based compensation during 2005. The fair value for these options was estimated at the date

of grant using a Black-Scholes option pricing model with the following weighted average
assumptions for 2005: risk-free interest rates of 4.64%; a dividend yield of 0; volatility factors of
the expected market price of our common stock of .75; and a weighted average expected life of
the options of 7.36 years.

For purposes of pro forma disclosures, the estimated fair value of the qualified and non-qualified
stock options was amortized to expense over the options’ vesting period. Since our board of
directors in 2005 approved the acceleration of the vesting schedule of both qualified and non-
qualified stock options that were unvested at December 31, 2005, the remaining portion
(unvested) of the pro forma stock-based compensation expense prior to the acceleration is
included in the deduction amount below.

Net income applicable to common stock, as reported
Less total stock-based compensation expense determined under fair

value based method for all awards, net of related tax effects

Pro forma net income applicable to common stock

Net income per share:
Basic-as reported
Basic-pro forma

Diluted-as reported
Diluted-pro forma

Year ended
December 31, 2005

(In Thousands, Except
Per Share Amounts)

$
$

2,707

(530)
2,177

.20
.16

.18
.15

Revenue Recognition - We recognize revenue for substantially all of our operations at the time
title to the goods transfers to the buyer and there remain no significant future performance
obligations by us. Revenue relating to construction contracts is recognized using the percentage-
of-completion method based primarily on contract costs incurred to date compared with total
estimated contract costs. Changes to total estimated contract costs or losses, if any, are
recognized in the period in which they are determined. Sales of warranty contracts are
recognized as revenue ratably over the life of the contract. See discussion above under “Product
Warranty” for our accounting policy for recognizing warranty expense.

F-15

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

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.

Cost of Sales - Cost of sales includes materials, labor and overhead costs to manufacture the
products sold plus inbound freight, purchasing and receiving costs, inspection costs, internal
transfer costs and warehousing costs (excluding certain handling costs directly related to loading
product being shipped to customers in our Chemical Business which are included in selling,
general and administrative expense). In addition, recoveries and gains from precious metals
(Chemical Business), sales of material scrap (Climate Control Business), and business
interruption insurance claims are reductions to cost of sales.

Selling, General and Administrative Expense - Selling, general and administrative expense
(“SG&A”) includes costs associated with the sales, marketing and administrative functions. Such
costs include personnel costs, including benefits, advertising costs, commission expenses,
warranty costs, office and occupancy costs associated with the sales, marketing and
administrative functions. SG&A also includes outbound freight in our Climate Control Business
and certain handling costs directly related to product being shipped to customers in our Chemical
Business. These handling costs primarily consist of personnel costs for loading product into
transportation equipment, rent and maintenance costs related to the transportation equipment,
and certain indirect costs.

Shipping and Handling Costs - For the Chemical Business in 2007, 2006 and 2005, shipping
costs of $15,209,000, $17,448,000 and $10,564,000, respectively, are included in net sales as
these costs relate to amounts billed to our customers. In addition, in 2007, 2006, and 2005,
handling costs of $5,249,000, $4,950,000 and $4,177,000, respectively, are included in SG&A as
discussed above under “Selling, General and Administrative Expense.” For the Climate Control
Business, shipping and handling costs of $11,057,000, $10,326,000 and $6,396,000 are included
in SG&A for 2007, 2006 and 2005, respectively.

Advertising Costs - Costs in connection with advertising and promotion of our products are
expensed as incurred. Such costs amounted to $1,791,000 in 2007, $1,233,000 in 2006 and
$1,402,000 in 2005.

Derivatives, Hedges and Financial Instruments - We account for derivatives in accordance
with SFAS 133, which requires the recognition of derivatives in the balance sheet and the
measurement of these instruments 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.

In 1997, we entered into an interest rate forward agreement to effectively fix the interest rate of a
long-term lease commitment (not for trading purposes). In 1999, we executed a long-term lease
agreement (initial lease term of ten years) and terminated the forward agreement at a net cost of

F-16

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

$2.8 million. We historically accounted for this cash flow hedge under the deferral method (as an
adjustment of the initial term lease rentals). Upon adoption of SFAS 133 in 2001, the remaining
deferred cost amount was reclassified from other assets to accumulated other comprehensive loss
and is being amortized to operations over the term of the lease arrangement. At December 31,
2007 and 2006, accumulated other comprehensive loss consisted of the remaining deferred cost
of $411,000 and $701,000, respectively. The amounts amortized were $290,000, $289,000 and
$290,000 for 2007, 2006 and 2005, respectively, and are included in SG&A. There were no
income tax benefits allocated to these expenses. For 2008, we currently expect approximately
$290,000 to be amortized to operations.

In March 2005, we purchased two interest rate cap contracts for a cost of $590,000. In April
2007, we purchased two interest rate cap contracts for a cost of $621,000. These contracts are
free-standing derivatives and are accounted for on a mark-to-market basis in accordance with
SFAS 133. At December 31, 2007, and 2006, the market values of these contracts were $426,000
and $385,000, respectively, and are included in other assets in the accompanying consolidated
balance sheets. The changes in the value of these contracts are included in interest expense. For
2005 and 2007, cash used to purchase these interest rate cap contracts are included in cash used
by continuing investing activities in the accompanying consolidated statements of cash flows.

Raw materials for use in our manufacturing processes include copper used by our Climate
Control Business and natural gas used by our Chemical Business. As part of our raw material
price risk management, we periodically enter into exchange-traded futures contracts for these
materials, which contracts are generally accounted for on a mark-to-market basis in accordance
with SFAS 133. At December 31, 2007 and 2006, the unrealized losses on the futures contracts
were $172,000 and $408,000, respectively, and are included in accrued and other liabilities in the
accompanying consolidated balance sheets. The unrealized losses are classified as current
liabilities as the term of these contracts are for periods of twelve months or less. For 2007 and
2006, we incurred losses of $1,317,000 and $1,516,000, respectively, on such contracts. For
2005, we recognized gains of $931,000. These losses and gains are included in cost of sales. In
addition, the cash flows relating to these contracts are included in cash flows from continuing
operating activities.

Income per Common Share - Net income applicable to common stock is computed by
adjusting net income by the amount of preferred stock dividends, dividend requirements and
stock dividends. 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.

F-17

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

The following is a summary of certain transactions which affected basic income per share or
diluted income per share, if dilutive:

During 2007,

• we sold $60 million of the 5.5% Convertible Senior Subordinated Notes due 2012 (the

•

“2007 Debentures”);
the remaining $4,000,000 of the 7% Convertible Senior Subordinated Debentures due
2011 (the “2006 Debentures”) was converted into 564,789 shares of common stock;
• we issued 2,262,965 shares of common stock for 305,807 shares of our Series 2 $3.25
convertible, exchangeable Class C preferred stock (“Series 2 Preferred”) that were
tendered pursuant to a tender offer;

• we redeemed 25,820 shares of our Series 2 Preferred and issued 724,993 shares of

common stock for 167,475 shares of our Series 2 Preferred;

• we received shareholders’ approval in granting 450,000 shares of non-qualified stock

options on June 14, 2007;

• we issued 582,000 and 112,500 shares of our common stock as the result of the exercise

of stock options and a warrant, respectively;

• we paid cash dividends of approximately $678,000 on the shares of Series 2 Preferred

which we redeemed as discussed above; and

• we paid cash dividends on the Series B 12% cumulative, convertible preferred stock
(“Series B Preferred”), Series D 6% cumulative, convertible Class C preferred stock
(“Series D Preferred”) and noncumulative redeemable preferred stock (“Noncumulative
Preferred”) totaling approximately $1,890,000, $360,000 and $6,000, respectively.

During 2006,

• we sold $18 million of the 2006 Debentures;
•

$14 million of the 2006 Debentures was converted into 1,977,499 shares our common
stock;

• we issued 374,400 shares of our common stock as the result of the exercise of stock

•

options;
104,548 shares of our Series 2 Preferred was exchanged for 773,655 shares of our
common stock; and

• we paid partial cash dividends totaling approximately $262,000 on certain preferred

stock.

During 2005,

• we issued 586,140 shares of our common stock as the result of the exercise of warrants
(under a cashless exercise provision) held by lenders of loans under a financing
agreement;

• we issued 88,900 shares of our common stock as a result of the exercise of stock options;
• we granted 61,500 shares of qualified stock options; and
• we acquired 13,300 shares of our Series 2 Preferred.

F-18

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

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

Numerator:

Net income

Dividends and dividend requirements on Series B Preferred
Dividend requirements on shares of Series 2 Preferred which
did not exchange pursuant to tender offer or redemption in
2007 or exchange agreements in 2006

Dividends and dividend requirements on shares of Series 2

Preferred which were redeemed in 2007

Dividend requirements and stock dividend on shares of
Series 2 Preferred pursuant to tender offer in 2007 (1)
Dividend requirements and stock dividend on shares of
Series 2 Preferred pursuant to exchange agreements in
2006 (2)

Dividends and dividend requirements on Series D Preferred
Dividends on Noncumulative Preferred

Total dividends, dividend requirements and stock

dividends on preferred stock

Numerator for basic net income per share - net income
applicable to common stock

Dividends and dividend requirements on preferred stock

assumed to be converted, if dilutive

Interest expense including amortization of debt issuance

costs, net of income taxes, on convertible debt assumed to
be converted, if dilutive

Numerator for diluted net income per common share

Denominator:

Denominator for basic net income per common share -
weighted-average shares

Effect of dilutive securities:

Convertible preferred stock
Convertible notes payable
Stock options
Warrants

Dilutive potential common shares

Denominator for dilutive net income per common share – adjusted

2006
2007
(Dollars In Thousands, Except Per Share Amounts)

2005

46,882
(240)

15,515
(240 )

4,990
(240)

(272)

(59)

(4,971)

-
(60)
(6)

(5,608)

41,274

(547)

(84)

(993)

(705)

(60 )
(1 )

(2,630)

12,885

(566)

(84)

(993)

(340)
(60)
-

(2,283)

2,707

637

1,925

1,276
43,187

1,083
15,893

-
2,707

19,579,664

14,331,963

13,617,418

1,478,012
1,200,044
1,160,100
77,824
3,915,980

3,112,483
2,100,325
1,261,661
65,227
6,539,696

38,390
4,000
1,195,320
51,583
1,289,293

weighted-average shares and assumed conversions

23,495,644

20,871,659

14,906,711

Basic net income per common share

Diluted net income per common share

2.11

1.84

.90

.76

.20

.18

F-19

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

(1) As discussed in Note 15 - Non-Redeemable Preferred Stock, in February 2007 we began a
tender offer to exchange shares of our common stock for up to 309,807 of the 499,102
outstanding shares of the Series 2 Preferred. The tender offer expired on March 12, 2007 and our
board of directors accepted the shares tendered on March 13, 2007. Because the exchanges under
the tender offer were pursuant to terms other than the original terms, the transactions were
considered extinguishments of the preferred stock. In addition, the transactions qualified as
induced conversions under SFAS 84. In accordance with Emerging Issues Task Force (“EITF”)
Topic No. D-42, the excess of the fair value of the common stock issued over the fair value of
the securities issuable pursuant to the original conversion terms was subtracted from net income
in computing net income per share. Because our Series 2 Preferred are cumulative and the
dividend requirements have been included in computing net income per share in previous periods
and as an element of the exchange transactions, we effectively settled the dividends in arrears,
the amount subtracted from net income in 2007 represents the excess of the fair value of the
common stock issued over the fair value of the securities issuable pursuant to the original
conversion terms less the dividends in arrears as March 13, 2007.

(2) As discussed in Note 15 - Non-Redeemable Preferred Stock, during October 2006, we
entered into several separate individually negotiated agreements (“Exchange Agreements”) with
certain holders of our Series 2 Preferred. Because the exchanges were pursuant to terms other
than the original terms, the transactions were considered extinguishments of the preferred stock.
In addition, the transactions qualified as induced conversions under SFAS 84. In accordance with
EITF Topic No. D-42, the excess of the fair value of the common stock issued over the fair value
of the securities issuable pursuant to the original conversion terms was subtracted from net
income in computing net income per share. Because our Series 2 Preferred are cumulative and
the dividend requirements have been included in computing net income per share in previous
years and as an element of the exchange transactions, we effectively settled the dividends in
arrears, the amount subtracted from net income in 2006 represents the excess of the fair value of
the common stock issued over the fair value of the securities issuable pursuant to the original
conversion terms less the dividends in arrears as of the date of the Exchange Agreements plus the
2006 dividend requirements prior to the date of the Exchange Agreements.

F-20

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

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:

Series B Preferred
Series 2 Preferred not pursuant to tender offer in

2007 or exchange agreements in 2006

Series 2 Preferred pursuant to tender offer in 2007 (1)
Series 2 Preferred pursuant to exchange agreements in

2006 (1)

Series D Preferred
Stock options

2007

2006

261,090

-
-
240,068
501,158

-
-

348,366

-
-
348,366

2005

666,666

853,309
1,323,839

452,588
250,000
-
3,546,402

(1) In accordance with EITF Topic No. D-53, the shares associated with the tender offer in 2007 and the
exchange agreements in 2006 were considered separately from other convertible shares of securities in
computing net income per common share for 2007 and 2006, respectively.

Recently Issued Accounting Pronouncements - In July 2006, the FASB issued FIN No. 48 -
Accounting for Uncertainty in Income Taxes (“FIN 48”). FIN 48 requires that realization of an
uncertain income tax position must be “more likely than not” (i.e. greater than 50% likelihood)
the position will be sustained upon examination by taxing authorities before it can be recognized
in the financial statements. Further, FIN 48 prescribes the amount to be recorded in the financial
statements as the amount most likely to be realized assuming a review by tax authorities having
all relevant information and applying current conventions. FIN 48 also clarifies the financial
statement classification of tax-related penalties and interest and sets forth new disclosures
regarding unrecognized tax benefits. On January 1, 2007, we adopted FIN 48. See Note 12 -
Income Taxes for the impact on our consolidated financial statements as the result of
implementing FIN 48.

In September 2006, the FASB issued SFAS No. 157 - Fair Value Measurements (“SFAS 157”).
SFAS 157 is definitional and disclosure oriented and addresses how companies should approach
measuring fair value when required by GAAP; it does not create or modify any current GAAP
requirements to apply fair value accounting. SFAS 157 provides a single definition for fair value
that is to be applied consistently for all accounting applications, and also generally describes and
prioritizes according to reliability the methods and input used in valuations. SFAS 157 prescribes
various disclosures about financial statement categories and amounts which are measured at fair
value, if such disclosures are not already specified elsewhere in GAAP. The new measurement
and disclosure and requirements of SFAS 157 are effective for the Company in the first quarter
of 2008 and we currently do not expect a significant impact from adopting SFAS 157.

F-21

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

2. Summary of Significant Accounting Policies (continued)

In February 2007, the FASB issued SFAS No. 159 - The Fair Value Option for Financial Assets
and Financial Liabilities (“SFAS 159”). This statement permits entities to choose to measure
many financial instruments and certain other items at fair value. SFAS 159 is effective for the
Company beginning in the first quarter of 2008 and we currently do not expect a significant
impact from adopting SFAS 159.

3. Accounts Receivable

Trade receivables
Insurance claims
Other

Allowance for doubtful accounts

December 31,

2007

2006

(In Thousands)

$ 68,234
2,469
1,182
71,885
(1,308)
$ 70,577

$ 68,165
219
1,456
69,840
(2,269 )
$ 67,571

Concentrations of credit risk with respect to trade receivables are limited due to the large number
of customers comprising our customer bases and their dispersion across many different industries
and geographic areas, however, six customers account for approximately 26% of our total net
receivables at December 31, 2007. We do not believe this concentration in these six customers
represents a significant credit risk due to the financial stability of these customers.

4. Inventories

December 31, 2007:

Climate Control products
Chemical products
Industrial machinery and components

December 31, 2006:

Climate Control products
Chemical products
Industrial machinery and components

Finished
Goods

Work-in-
Process

Raw
Materials

Total

(In Thousands)

9,025
15,409
3,743
$ 28,177

6,910
11,443
1,899
$ 20,252

3,569
-
-
3,569

3,205
-
-
3,205

$ 19,412
5,718
-
$ 25,130

$ 32,006
21,127
3,743
$ 56,876

$ 16,631
5,361
-
$ 21,992

$ 26,746
16,804
1,899
$ 45,449

F-22

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

4. Inventories (continued)

At December 31, 2007 and 2006, inventory reserves for certain slow-moving inventory items
(primarily Climate Control products) were $460,000 and $829,000, respectively. In addition,
inventory reserves for certain nitrogen-based inventories provided by our Chemical Business
were $13,000 and $426,000 at December 31, 2007 and 2006, respectively, because cost exceeded
the net realizable value.

Changes in our inventory reserves are as follows:

Balance at
Beginning
of Year

Additions-
Provision for
(realization of)
losses

Deductions-
Write-offs/
disposals

Balance at
End
of Year

(In Thousands)

2007

$ 1,255

2006

$ 2,423

2005

$ 2,185

(384)

(711)

239

398

473

457

$ 1,255

$ 2,423

The provision for losses are included in cost of sales (realization of losses are reductions to cost
of sales) in the accompanying consolidated statements of income.

5. Precious Metals

Precious metals are used as a catalyst in the Chemical Business manufacturing process. As of
December 31, 2007 and 2006, precious metals were $10,935,000 and $6,406,000, respectively,
and are included in supplies, prepaid items and other in the accompanying consolidated balance
sheets. For 2007, 2006 and 2005, the amounts expensed for precious metals were approximately
$6,352,000, $4,823,000 and $3,100,000, respectively. These precious metals expenses are
included in cost of sales in the accompanying consolidated statements of income. Occasionally,
during major maintenance and/or capital projects, we may be able to perform procedures to
recover precious metals (previously expensed) which had accumulated over time within our
manufacturing equipment. For 2007, 2006 and 2005, we recognized recoveries of precious
metals at historical FIFO costs of approximately $1,783,000, $2,082,000 and $1,615,000,
respectively. When we accumulate precious metals in excess of our production requirements, we
may sell a portion of the excess metals. We recognized gains of $2,011,000 for 2007 (none in
2006 and 2005) from the sale of excess precious metals. These recoveries and gains are
reductions to cost of sales.

F-23

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

6. Property, Plant and Equipment

Machinery, equipment and automotive
Buildings and improvements
Furniture, fixtures and store equipment
Assets under capital leases
Construction in progress
Capital spare parts
Land

Less accumulated depreciation

Useful lives
in years

3-25
3-30
3-10
3-12
N/A
N/A
N/A

December 31,

2007

2006

(In Thousands)

$ 151,633 $ 141,362
25,867
7,182
1,056
7,077
2,123
2,194
186,861
110,457
$ 79,692 $ 76,404

27,510
7,458
1,907
6,648
1,662
2,194
199,012
119,320

Machinery, equipment and automotive primarily includes the categories of property and
equipment and estimated useful lives as follows: chemical processing plants and plant
infrastructure (15-25 years); production, fabrication, and assembly equipment (7-15 years);
certain processing plant components (3-10 years); and trucks, automobiles, trailers, and other
rolling stock (3-7 years). At December 31, 2007 and 2006, assets under capital leases consist of
$1,907,000 and $961,000 of machinery, equipment and automotive, respectively, and $95,000 of
furniture, fixtures and store equipment at December 31, 2006. Accumulated depreciation for
assets under capital leases were $244,000 and $118,000 at December 31, 2007 and 2006,
respectively.

7. Debt Issuance and Other Debt-Related Costs, net

Debt issuance and other debt-related costs, which are included in other assets in the
accompanying consolidated balance sheets, include debt issuance costs of $4,213,000 and
$1,836,000, net of accumulated amortization of $2,368,000 and $3,681,000 as of December 31,
2007 and 2006, respectively.

During 2007, we incurred debt issuance costs of $4,429,000 which includes $3,224,000 relating
to the 2007 Debentures and $1,139,000 relating to the $50 million loan agreement (“Secured
Term Loan”). In addition, the remaining portion of the 2006 Debentures was converted into our
common stock. As a result of the conversions, approximately $266,000 of the remaining debt
issuance costs, net of amortization, associated with the 2006 Debentures were charged against
capital in excess of par value in 2007. Also, the Senior Secured Loan due in 2009 was repaid
with the proceeds from the Secured Term Loan. As a result, approximately $1,331,000 of the
remaining debt issuance and other debt-related costs, net of amortization, associated with the
Senior Secured Loan was charged to interest expense in 2007.

F-24

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

7. Debt Issuance and Other Debt-Related Costs, net (continued)

In 2006, we incurred debt issuance costs of $1,480,000 relating to the 2006 Debentures. During
2006, a portion of the 2006 Debentures were converted into our common stock. As a result of the
conversions, approximately $998,000 of the debt issuance costs, net of amortization, associated
with the 2006 Debentures was charged against capital in excess of par value.

Also see discussion in “Derivatives, Hedges and Financial Instruments” of Note 2 concerning
our interest rate cap contracts.

8. Investment in Affiliate

Cepolk Holding, Inc. (“CHI”), a subsidiary of the Company, 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 (“Project”). At December 31, 2007 and 2006, our investment was $3,426,000 and
$3,314,000, respectively. As of December 31, 2007, the Partnership and general partner to the
Partnership is indebted to a term lender (“Lender”) of the Project. CHI has pledged its limited
partnership interest in the Partnership to the Lender as part of the Lender’s collateral securing all
obligations under the loan. This guarantee and pledge is limited to CHI’s limited partnership
interest and does not expose CHI or the Company to liability in excess of CHI’s limited
partnership interest. No liability has been established for this pledge since it was entered into
prior to adoption of FIN 45. CHI has no recourse provisions or available collateral that would
enable CHI to recover its partnership interest should the Lender be required to perform under this
pledge.

F-25

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

9. Current and Noncurrent Accrued and Other Liabilities

Customer deposits
Accrued payroll and benefits
Deferred income taxes
Accrued income and property taxes
Deferred rent expense
Deferred revenue on extended warranty contracts
Accrued insurance
Accrued commissions
Accrued death benefits
Accrued warranty costs
Accrued contractual manufacturing obligations
Accrued precious metals costs
Accrued interest
Accrued executive benefits
Accrued environmental remediation costs
Other

Less noncurrent portion
Current portion of accrued and other liabilities

10. Redeemable Preferred Stock

December 31,

2007

2006

(In Thousands)

2,938
9,525 $
4,170
5,362
-
5,330
1,217
5,247
5,231
4,300
2,426
3,387
1,646
2,975
2,565
2,256
1,446
2,051
1,251
1,944
1,801
1,548
1,068
1,359
422
1,056
979
1,040
1,432
411
4,153
3,394
32,745
51,185
12,243
5,929
38,942 $ 26,816

At December 31, 2007 and 2006, we had 585 shares and 683 shares, respectively, outstanding of
Noncumulative Preferred. Each share of Noncumulative Preferred, $100 par value, is convertible
into 40 shares of our common stock at the option of the holder at any time and entitles the holder
to one vote. The Noncumulative Preferred is redeemable at par at the option of the holder or the
Company. The Noncumulative Preferred provides for a noncumulative annual dividend of 10%,
payable when and as declared. During 2007 and 2006, our board of directors declared and we
paid dividends totaling $6,000 ($10.00 per share) and $1,000 ($1.24 per share), respectively, on
the then outstanding Noncumulative Preferred. At December 31, 2007 and 2006, the
Noncumulative Preferred was $56,000 and $65,000, respectively, and is classified as accrued and
other liabilities in the accompanying consolidated balance sheets.

F-26

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt

Working Capital Revolver Loan due 2012 (A)
5.5% Convertible Senior Subordinated Notes due 2012 (B)
Secured Term Loan due 2012 (C)
Senior Secured Loan (D)
7% Convertible Senior Subordinated Notes (E)
Other, with current interest rates of 4.25% to 9.36%, most of

which is secured by machinery, equipment and real estate (F)

Less current portion of long-term debt
Long-term debt due after one year

December 31,

2007

2006

(In Thousands)

-
60,000
50,000
-
-

26,048
-
-
50,000
4,000

12,107
122,107
1,043

17,644
97,692
11,579
$ 121,064 $ 86,113

ThermaClime and its subsidiaries (the “Borrowers”) are parties to a $50 million revolving
(A)
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. In November 2007, in connection with the Secured Term Loan (discussed below
under (C)), the Working Capital Revolver Loan was amended. This amendment included,
among other things, the release of the lenders’ second position security liens to the assets which
collateralize the Secured Term Loan, an interest rate reduction of .25% and a revised maturity
date of April 13, 2012. The Working Capital Revolver Loan, as amended, accrues interest at a
base rate (generally equivalent to the prime rate) plus .50% or LIBOR plus 1.75%. The interest
rate at December 31, 2007 was 6.45%. Interest is paid monthly. The facility provides for up to
$8.5 million of letters of credit. All letters of credit outstanding reduce availability under the
facility. As a result of using a portion of the proceeds from the 2007 Debentures (discussed
below under (B)) to pay down the Working Capital Revolver Loan, amounts available for
additional borrowing under the Working Capital Revolver Loan at December 31, 2007 were
$49.2 million. Under the Working Capital Revolver Loan, as amended, 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 facility not drawn and various other audit, appraisal and valuation charges.

In March 2005, we purchased two interest rate cap contracts which set a maximum three-month
LIBOR base rate of 4.59% on $30 million and mature on March 29, 2009.

The lender may, upon an event of default, as defined, terminate the Working Capital Revolver
Loan and make the balance outstanding due and payable in full, if any. The Working Capital
Revolver Loan is secured by the assets of all the ThermaClime entities other than El Dorado
Nitric Company and its subsidiaries (“EDNC”) but excluding the assets securing the Secured
Term Loan discussed in (C) below and certain distribution-related assets of EDC. EDNC is
neither a borrower nor guarantor of the Working Capital Revolver Loan. The carrying value of
the pledged assets is approximately $183 million at December 31, 2007.

F-27

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

A prepayment premium of $1,000,000 is due to the lender should the Borrowers elect to prepay
the facility prior to April 13, 2008. This premium is reduced to $500,000 during the following
twelve-month period ending April 12, 2009 and is reduced to $250,000 during the following
twelve-month period ending April 12, 2010 and is eliminated thereafter.

The Working Capital Revolver Loan, as amended, requires ThermaClime to meet certain
financial covenants measured quarterly. ThermaClime was in compliance with those covenants
during 2007. The Working Capital Revolver Loan also contains covenants that, among other
things, limit the Borrowers’ (which does not include the Company) ability, without consent of
the lender, 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.

In connection with the redemption of ThermaClime’s 10.75% Senior Unsecured Notes (“the
Notes”) in July 2006 as discussed in (E) below, the lenders of the Working Capital Revolver
Loan and the Senior Secured Loan provided consents to permit ThermaClime to borrow $6.4
million from the Company for the purpose of redeeming the Notes.

(B) On June 28, 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 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 are
eligible for resale by the investors under Rule144A under the Act. We received net proceeds of
approximately $57 million, after discounts and commissions. In connection with the closing, we
entered into an indenture (the “Indenture”) with UMB Bank, as trustee (the “Trustee”),
governing the 2007 Debentures. The Trustee receives customary compensation from us for such
services.

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, beginning on January 1, 2008.

The 2007 Debentures are unsecured obligations and are subordinated in right of payment to all of
our existing and future senior indebtedness, including indebtedness under our revolving debt
facilities. The 2007 Debentures are effectively subordinated to all present and future liabilities,
including trade payables, of our subsidiaries.

F-28

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

We may redeem some or all of the 2007 Debentures at any time on or after July 2, 2010, at a
price equal to 100% of the principal amount of the 2007 Debentures, plus accrued and unpaid
interest, all as set forth in the Indenture. The redemption price will be payable at our option in
cash or, subject to certain conditions, shares of our common stock (valued at 95% of the
weighted average of the closing sale prices of the common stock for the 20 consecutive trading
days ending on the fifth trading day prior to the redemption date), subject to certain conditions
being met on the date we mail the notice of redemption.

If a designated event (as defined in the Indenture) occurs prior to maturity, holders of the 2007
Debentures may require us to repurchase all or a portion of their 2007 Debentures for cash at a
repurchase price equal to 101% of the principal amount of the 2007 Debentures plus any accrued
and unpaid interest, as set forth in the Indenture. If a fundamental change (as defined in the
Indenture) occurs on or prior to June 30, 2010, under certain circumstances, we will pay, in
addition to the repurchase price, a make-whole premium on the 2007 Debentures converted in
connection with, or tendered for repurchase upon, the fundamental change. The make-whole
premium will be payable in our common stock or the same form of consideration into which our
common stock has been exchanged or converted in the fundamental change. The amount of the
make-whole premium, if any, will be based on our stock price on the effective date of the
fundamental change. No make-whole premium will be paid if our stock price in connection with
the fundamental change is less than or equal to $23.00 per share.

At maturity, we may elect, subject to certain conditions as set forth in the Indenture, to pay up to
50% of the principal amount of the outstanding 2007 Debentures, plus all accrued and unpaid
interest thereon to, but excluding, the maturity date, in shares of our common stock (valued at
95% of the weighted average of the closing sale prices of the common stock for the 20
consecutive trading days ending on the fifth trading day prior to the maturity date), if the
common stock is then listed on an eligible market, the shares used to pay the 2007 Debentures
and any interest thereon are freely tradable, and certain required opinions of counsel are
received.

We have currently invested a portion of the net proceeds in money market investments and have
used a portion of the net proceeds to redeem our outstanding shares of Series 2 Preferred; to
repay certain outstanding mortgages and equipment loans; to pay dividends in arrears on our
outstanding shares of Series B Preferred and Series D Preferred, all of which were owned by an
affiliate; and the balance to initially reduce the outstanding borrowings under the Working
Capital Revolver Loan. See Note 21 - Related Party Transactions for a discussion of amounts
paid to affiliates and former affiliates in connection with the redemption and the dividends. In
addition, we intend to use the remaining portion of the net proceeds for certain discretionary
capital expenditures and general working capital purposes.

F-29

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

In connection with using a portion of the net proceeds of the 2007 Debentures to initially reduce
the outstanding borrowings under the Working Capital Revolver Loan, ThermaClime entered
into a $25 million demand promissory note (“Demand Note”) with the Company. In addition, the
Company, ThermaClime, and certain of its subsidiaries entered into a subordination agreement
with the lender of the Senior Secured Loan which, among other things, states that the Demand
Note is unsecured and subordinated to the Senior Secured Loan and allows for payments on the
Demand Note by ThermaClime to the Company provided there is no potential default or event of
default, as defined in the Senior Secured Loan.

In conjunction with the 2007 Debentures, we entered into a Registration Rights Agreement (the
“5.5% Registration Rights Agreement”) with the QIBs. The term of the 5.5% Registration
Rights Agreement ends on the earlier of the date that all registrable securities, as defined in the
agreement, have ceased to be registrable securities and July 1, 2010.

In connection with the 5.5% Registration Rights Agreement, we were required to file, and did
file, a registration statement (“5.5% Registration Statement”), which registration statement was
declared effective by the Securities and Exchange Commission (“SEC”) on November 19, 2007.

We are obligated to update the 5.5% Registration Statement by filing a post-effective
amendment. The filing of a post-effective amendment is required upon the filing of a Form 10-K
or upon a “fundamental change” in the information described in the 5.5% Registration
Statement. Pursuant to the terms of the 5.5% Registration Rights Agreement, the deadline for
filing a post-effective amendment is determined by the event that triggers the obligation to file
the post-effective amendment, as follows:

• within 10 business days after filing a Form 10-K with the SEC;
• within 10 business days after filing such report or reports disclosing a fundamental

change to the SEC.

We are required to use commercially reasonable efforts to cause the post-effective amendment to
be declared effective as promptly as is practicable, but in any event, no later than 60 days (90
days if the post-effective amendment is reviewed by the SEC) after such post-effective
amendment is required to be filed. If, in spite of our commercially reasonable efforts, a post-
effective amendment is not declared effective within the number of days required, the liquidated
damages will accrue under the 5.5% Rights Agreement as described below, beginning on the first
day after the post-effective amendment is required to be effective. However, we are permitted to
suspend the availability of the 5.5% Registration Statement or prospectus for purposes of
updating the information therein (a “Deferral Period”) without incurring or accruing any
liquidated damages, unless the Deferral Period exceeds (a) 30 days in any 90 day period, or (b)
90 days in any 12 month period, in which case, beginning on the first day following the last
permissible day of the Deferral Period, liquidated damages at the rates of 0.25% and 0.5% shall
apply, as described below, until the termination of the Deferral Period.

F-30

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

If the post-effective amendment to the 5.5% Registration Statement is not declared effective by
the appropriate time period described above, the following liquidated damages, shall accrue for
each day thereafter until the 5.5% Registration Statement is declared effective:

•

0.25% – Damages shall accrue at an annual percentage rate equal to 0.25% of the
aggregate principal amount of each debenture, from the first day of the accrual period up
to and including the 90th day (approximately $411 per day or a total of $36,900 at the end
of 90 days); and

0.5% – Damages shall accrue at an annual percentage rate equal to 0.5% of the aggregate
principal amount of each debenture, from and after the 91st day of the accrual period
(approximately $822 per day), until the 5.5% Registration Statement is declared effective.
The 5.5% Registration Rights Agreement provides no limitation to the maximum amount
of liquidation damages. The 5.5% Registration Rights Agreement does not require us to
issue shares of our equity securities relating to liquidated damages.

Liquidated damages are payable with respect to debentures that are outstanding as of the
beginning of a liquidated damages accrual period. If a debenture has been converted into
common stock prior to the beginning of a liquidated damages accrual period, no liquidated
damages are payable with respect to the common stock issued upon such conversion.

(C) In November 2007, ThermaClime and certain of its subsidiaries entered into a $50 million
loan agreement (the “Secured Term Loan”) with a certain lender. Proceeds from the Secured
Term Loan were used to repay the previous senior secured loan discussed in (D) below. The
Secured Term Loan matures on November 2, 2012.

The Secured Term Loan is secured by the real property and equipment located at our El Dorado
and Cherokee Facilities. The carrying value of the pledged assets is approximately $48 million at
December 31, 2007.

F-31

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

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.

(D) In September 2004, ThermaClime and certain of its subsidiaries completed a $50 million
term loan (“Senior Secured Loan”) with a certain lender. The Senior Secured Loan accrued
interest at the applicable LIBOR rate, as defined, plus an applicable LIBOR margin, as defined
or, at the election of the borrowers, the alternative base rate, as defined, plus an applicable base
rate margin, as defined, with the annual interest rate not to exceed 11% or 11.5% depending on
the leverage ratio. For 2007, the effective interest rate was 11%. In November 2007, the Senior
Secured Loan was repaid with the proceeds from the Secured Term Loan discussed above under
(C).

(E) On March 14, 2006, we completed a private placement to six QIBs pursuant to which we
sold $18 million aggregate principal amount of the 2006 Debentures. We used a placement agent
for this transaction which we paid a fee of 6% of the aggregate gross proceeds received in the
financing. Other offering expenses in connection with the transaction were $.4 million. As a
result, the total debt issuance costs related to this transaction were $1.5 million. The 2006
Debentures are no longer outstanding. As of April 30, 2007, all of the outstanding 2006
Debentures were converted into our common stock, plus, in certain cases, payment of additional
consideration relating to offers received from holders and accepted by us as discussed below.

During 2006, $14 million of the 2006 Debentures were converted into 1,977,499 shares of our
common stock at the conversion price of $7.08 per share. Several of the conversions related to
offers received from holders and accepted by us which included the stated conversion price of
$7.08 per share plus an additional consideration totaling $277,000 which was paid to these
holders. Because these offers met the criteria within SFAS 84-Induced Conversions of
Convertible Debt, the additional consideration of $277,000 was expensed and is included in
interest expense in our consolidated statement of income. During 2007, the remaining $4 million
of the 2006 Debentures (which includes $1 million that was held by Jayhawk Capital
Management and other Jayhawk entities, through their manager, Kent McCarthy (the “Jayhawk
Group”), were converted into 564,789 shares of our common stock at the average conversion
price of $7.082 per share.

Approximately $13.6 million of the net proceeds have been used to purchase or redeem all of the
outstanding Notes held by unrelated third parties and Jayhawk at ThermaClime’s carrying value
(which includes $1 million that was held by Jayhawk) including accrued interest of $.3 million.
The remaining balance was used for the purchase of other higher interest rate debt and for
general corporate purposes.

F-32

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

The 2006 Debentures were convertible by holders, in whole or in part, into shares of the
Company’s common stock prior to their maturity on March 1, 2011. Holders of 2006 Debentures
electing to convert all or any portion of a 2006 Debenture would obtain the following conversion
rate per $1,000 principal amount of 2006 Debentures during the dates indicated:

Prior to September 1, 2006
September 1, 2006 – February 28, 2007
March 1, 2007 - August 31, 2007
September 1, 2007 - February 29, 2008
March 1, 2008 - August 31, 2008
September 1, 2008 - February 28, 2009
March 1, 2009 - March 1, 2011

Shares Per $1,000
Principal Amount

Conversion
Price Per Share

125.00
141.25
141.04
137.27
133.32
129.23
125.00

$ 8.00
$ 7.08
$ 7.09
$ 7.28
$ 7.50
$ 7.74
$ 8.00

The conversion price was subject to anti-dilution provisions designed to maintain the value of
the 2006 Debentures in the event we had taken certain actions with respect to our common stock,
as described below, that effect all of the holders of our common stock equally and that could
have a dilutive effect on the value of the conversion rights of the holders of the 2006 Debentures
or that confer a benefit upon our current stockholders not otherwise available to the holders of
the 2006 Debentures. In this regard, the 2006 Debentures provided that the conversion rate of the
2006 Debentures would be adjusted upon the occurrence of any of the following events:

(a) the payment or issuance of common stock as a dividend or distribution on our common

stock;

(b) the issuance to all holders of common stock of rights, warrants or options to purchase our
common stock (other than pursuant to our preferred share rights plan) for a period
expiring within 45 days of the record date for such distribution at a price less than the
average of the closing sale price for the 10 trading days preceding the declaration date for
such distribution; provided that the conversion price will be readjusted to the extent that
such rights, warrants or options are not exercised;

(a) subdivisions, splits or combinations of our common stock;

(d) distributions to the holders of our common stock of a portion of our assets (including
shares of capital stock or assets of a subsidiary) or debt or other securities issued by us or
certain rights to purchase our securities (excluding dividends or distributions covered by
clauses (a) or (b) above or our preferred share rights plan); provided, however, that if we
distribute capital stock of, or similar equity interests in, a subsidiary or other business unit
of ours, the conversion rate will be adjusted based on the market value of the securities so
distributed relative to the market value of our common stock, in each case based on the
average closing sale prices of those securities for the 10 trading days commencing on and
including the fifth trading day after the date on which “ex-dividend trading” commences
for such distribution on the NASDAQ National Market or such other national or regional
exchange or market on which the securities are then listed or quoted;

F-33

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

(e) tender or exchange offer made by the Company or any subsidiary for all or any portion of
the common stock and such shall require the payment to stockholders of consideration
per share of common stock having a fair market value that exceeds the last reported
closing sale price;

(f) the Company, by dividend or otherwise, makes a distribution in cash to all holders of its

common stock; and

(g) the tender or exchange offer made by a person other than the Company or a subsidiary for
more than 50% of the Company’s common stock and shall involve a payment by such
person of consideration per share of common stock having a fair market value (as
determined by the Company’s board of directors, whose determination is conclusive) that
exceeds the closing price of a share of common stock and as of the offer expiration time
the Company’s board of directors is not recommending rejection of the offer.

The Indenture provides that the conversion rate of the 2006 Debentures is subject to adjustment
upon the occurrence of any of seven different events as described above. The first four of these
events [subparagraphs (a)-(d)] are standard anti-dilution events as described in paragraph 8 of
EITF 05-2. The last three events [subparagraphs (e), (f) and (g)] are not considered standard anti-
dilution provisions as discussed in paragraph 8 of EITF 05-2; however, these events triggering an
anti-dilution conversion rate adjustment were within the control of the Company. For those that
are not also an event of equity restructuring as defined in SFAS 123(R), they were evaluated as
contingent beneficial conversion features (“BCF”). We planned to recognize a BCF if and when
a triggering event occurred, until then it was accounted for as a contingent event and no
accounting was warranted. None of the conversion rate adjustments occurred during the term of
the debt (all of the debt was converted during 2006 and 2007 as discussed above), thus there is
no requirement to account for the contingent BCF.

To the extent that we had a rights plan in effect upon conversion of the 2006 Debentures into
common stock, holders of 2006 Debentures would have received, in addition to the common
stock, the rights under the rights plan unless the rights have separated from the common stock at
the time of conversion, in which case the conversion rate will be adjusted as if we distributed to
the holders of our common stock, a portion of our assets, or debt or other securities or rights as
set forth under clause (d) above, subject to readjustment in the event of the expiration,
termination or redemption of such rights.

Our board of directors had reserved the right to increase the conversion rate if our board of
directors determines (a) that an increase would be in our best interests or (b) it advisable to avoid
or diminish any income tax to holders of common stock resulting from any stock or rights
distribution.

F-34

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

11. Long-Term Debt (continued)

(F) Amounts include capital lease obligations of $1,230,000 and $767,000 at December 31,
2007 and 2006, respectively.

Maturities of long-term debt for each of the five years after December 31, 2007 are as follows (in
thousands):

2008
2009
2010
2011
2012
Thereafter

1,043
1,042
1,153
1,119
111,072
6,678
$ 122,107

12. Income Taxes
Provisions (benefits) for income taxes are as follows:

Current:

Federal
State

Total Current

Deferred:
Federal
State

Total Deferred

Provisions for income taxes

2007

2006
(In Thousands)

2005

$ 5,260
1,980
$ 7,240

$ (4,095)
(605)
$ (4,700)
$ 2,540

$
$

312
589
901

-
-
-
901

$
$

118
118

-
-
-
118

The current provision for federal income taxes of $5,260,000 for 2007 includes regular federal
income tax and alternative minimum income tax (“AMT”). The current provision of state
income taxes of $1,980,000 for 2007 includes the provision for 2007 state income taxes, as well
as $1,047,000 for uncertain state income tax positions recognized in accordance with FIN 48 as
discussed below.

F-35

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

12. Income Taxes (continued)

The 2007 benefit for deferred taxes of $4,700,000 results from the reversal of valuation
allowance on deferred tax assets, the benefit of AMT credits, and other temporary differences. At
December 31, 2006, we had regular NOL carryforwards of approximately $49.9 million. We
account for income taxes under the provisions of SFAS 109 which requires recognition of future
tax benefits (NOL carryforwards and other temporary differences) subject to a valuation
allowance if it is determined that it is more-likely-than-not that such asset will not be realized. In
determining whether it is more-likely-than-not that we will not realize such tax asset, SFAS 109
requires that all negative and positive evidence be considered (with more weight given to
evidence that is “objective and verifiable”) in making the determination. Prior to 2007, we had
valuation allowances in place against the net deferred tax assets arising from the NOL
carryforwards and other temporary differences. Prior to 2007, management considered certain
negative evidence in determining that it was “more-likely-than-not” that the net deferred tax
assets would not be utilized in the foreseeable future, thus a valuation allowance was required.
The negative evidence considered primarily included our history of losses, both as to amount and
trend and uncertainties surrounding our ability to generate sufficient taxable income to utilize
these NOL carryforwards.

As the result of improving financial results during 2007 including some unusual transactions
(settlement of pending litigation and insurance recovery of business interruption claim) and our
expectation of generating taxable income in the future, we determined in the third quarter that
there was sufficient objective and verifiable evidence to conclude that it was more-likely-than-
not that we would be able to realize the net deferred tax assets. As a result, we reversed the
valuation allowances as a benefit for income taxes and recognized deferred tax assets and
deferred tax liabilities. At December 31, 2007, we had net current deferred tax assets of $10.0
million and net non-current deferred tax liabilities of $5.3 million.

Due to regular tax NOL carryforwards, the only current tax expense for 2006 and 2005 was for
federal AMT and state income taxes as shown above.

At December 31, 2007, we have federal NOL carryforwards of approximately $2.9 million that
begin expiring in 2026 and state tax NOL carryforwards of approximately $28.9 million that
begin expiring in 2024. We anticipate fully utilizing the federal NOL carryforwards in 2008 at
which time we will begin paying federal income taxes at regular corporate tax rates.

When non-qualified stock options (“NSOs”) are exercised, the grantor of the options is permitted
to deduct the spread between the fair market value and the exercise price of the NSOs as
compensation expense in determining taxable income. Under SFAS 109, income tax benefits
related to stock-based compensation deductions in excess of the compensation expense recorded
for financial reporting purposes are not recognized in earnings as a reduction of income tax
expense for financial reporting purposes. As a result, during 2007, the stock-based compensation
deduction recognized in our income tax return will exceed the stock-based compensation
expense recognized in earnings. The excess tax benefit realized (i.e., the resulting reduction in
the current tax liability) related to the excess stock-based compensation tax deduction of

F-36

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

12. Income Taxes (continued)

$1,740,000 is accounted for as an increase in capital in excess of par value rather than a decrease
in the provision for income taxes.

SFAS 123(R) specifies that if the grantor of NSOs will not currently reduce its tax liability from
the excess tax benefit deduction taken at the time of the taxable event (option exercised) because
it has a NOL carryforward that is increased by the excess tax benefit, then the tax benefit should
not be recognized until the deduction actually reduces current taxes payable. As of December
31, 2007, we have approximately $2,325,000 in unrecognized federal and state tax benefits
resulting from the exercise of NSOs since the effective date of SFAS 123(R) on January 1, 2006.
We estimate that a significant portion of this benefit will be realized in 2008 when our current
tax liability is reduced by these items.

F-37

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

12. Income Taxes (continued)

Temporary differences and carryforwards which gave rise to deferred tax assets and liabilities at
December 31, 2007 and 2006 include:

2007

2006

(In Thousands)

906
902
204
2,700
2,439
655
512
900
779
3,911
13,908
-
13,908

$ 1,286
769
646
2,123
1,928
-
607
881
19,236
1,288
28,764
18,932
$ 9,832

7,273
541
1,394
9,208

$ 8,017
403
1,412
$ 9,832

4,700

10,030
(5,330)
4,700

3,921
779
4,700

-
-
-

Deferred tax assets
Amounts not deductible for tax purposes:

Allowance for doubtful accounts
Asset impairment
Inventory reserves
Deferred compensation
Other accrued liabilities
Uncertain income tax positions
Other

Capitalization of certain costs as inventory for tax purposes
Net operating loss carryforwards
Alternative minimum tax credit carryforwards
Total deferred tax assets

Less valuation allowance on deferred tax assets

Net deferred tax assets

Deferred tax liabilities
Accelerated depreciation used for tax purposes
Excess of book gain over tax gain resulting from sale of land
Investment in unconsolidated affiliate
Total deferred tax liabilities

Net deferred tax assets

Consolidated balance sheet classification:
Net current deferred tax assets
Net non-current deferred tax liabilities
Net deferred tax assets

Net deferred tax assets by tax jurisdiction:
Federal
State
Net deferred tax assets

F-38

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

12. Income Taxes (continued)

Detailed below are the differences between the amount of the provision for income taxes and the
amount which would result from the application of the federal statutory rate to “Income from
continuing operations before provision for income taxes” for the year ended December 31:

Provision for income taxes at federal statutory rate
Changes in the valuation allowance related to deferred

$ 17,176

2007

2006
(In Thousands)
$ 5,834

tax assets

Effect of discontinued operations and other
Federal alternative minimum tax
State current and deferred income taxes
Provision for uncertain tax positions
Permanent differences
Provision for income taxes

(18,476)
403

-
1,939
1,047

451
2,540

(5,950)
58
312
383
-
264
901

2005

$ 2,058

(1,743)
(249)
118
-
-
(66)
118

On January 1, 2007, we adopted FIN 48, which requires that realization of an uncertain income
tax position must be “more likely than not” (i.e., greater than 50% likelihood) that the position
will be sustained upon examination by taxing authorities before it can be recognized in the
financial statements. Further, FIN 48 prescribes the amount to be recorded in the financial
statements as the amount most likely to be realized assuming a review by tax authorities having
all relevant information and applying current conventions. FIN 48 also clarifies the financial
statement classification of tax-related penalties and interest and sets forth new disclosures
regarding unrecognized tax benefits.

We believe that we do not have any material uncertain tax positions that meet the FIN 48 more
likely than not recognition criteria other than the failure to file state income tax returns in some
jurisdictions where we or some of our subsidiaries may have a filing responsibility (i.e, nexus).
As of December 31, 2006 we had a $300,000 accrued for an uncertain tax position related to
state income taxes. As a result of the implementation of FIN 48, we recognized a $120,000
increase in the liability for uncertain tax positions related to state income taxes, which was
accounted for as an increase to the January 1, 2007 accumulated deficit balance. In 2007, we
commissioned a nexus study by an independent public accounting firm to determine if we and
our subsidiaries had any activities that would create nexus and to calculate the potential
additional state income tax liability in accordance with FIN 48. As a result of this nexus study,
we recognized additional current state income tax expense of $1,047,000 in 2007, partially offset
by a deferred tax benefit of $536,000 from additional state NOL carryforwards. In addition to
the FIN 48 liability recorded as a result of the nexus study, we reclassified $150,000 of state
income tax from the current payable account to the FIN 48 liability. This reclassification related
to state tax liabilities that we had accrued during 2006, but did not become uncertain until 2007.
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows
(in thousands):

F-39

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

12. Income Taxes (continued)

Balance at January 1, 2007
Additions based on tax positions related to the current year
Additions based on tax positions of prior years
Reductions for tax positions of prior years
Settlements
Balance at December 31, 2007

420
192
1,031
(26)
-
1,617

If the tax benefit of these uncertain tax positions were recognized in the financial statements it
would decrease the annual effective tax rate by reducing the total state tax provision by
approximately $700,000, net of federal expense.

We recognize interest accrued related to unrecognized tax benefits in interest expense and
penalties as other expense. During the year ended December 31, 2007, we recognized $253,000
in interest and penalties associated with unrecognized tax benefits (none in 2006 or 2005). We
had approximately $315,000 and $30,000 for the payment of interest and penalties accrued at
December 31, 2007 and 2006, respectively.

We plan to negotiate voluntary disclosure agreements and file prior year tax returns with various
taxing authorities in 2008. Therefore, we anticipate that the total amounts of unrecognized tax
benefits will decrease by approximately $1.4 million by December 31, 2008 as a result of state
tax payments made as part of the voluntary disclosure agreement process.

We and certain of our subsidiaries file income tax returns in the U.S. federal jurisdiction and
various state jurisdictions. The federal tax returns for 1994 through 2003 remain subject to
examination for the purpose of determining the amount of remaining tax NOL and other
carryforwards. With few exceptions, the 2004-2007 years remain open for all purposes of
examination by the IRS and other major tax jurisdictions.

F-40

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies

Capital and Operating Leases - We and our subsidiaries lease certain property, plant and
equipment under capital leases and non-cancelable operating leases in accordance with SFAS 13.
Leased assets meeting capital lease criteria have been capitalized and the present value of the
related lease payments is included in long-term debt. Future minimum payments on leases,
including the Baytown Facility lease (“Baytown Lease”) discussed below, with initial or
remaining terms of one year or more at December 31, 2007, are as follows (in thousands):

2008
2009
2010
2011
2012
Thereafter

Total minimum lease payments
Less amounts representing interest
Present value of minimum lease

Operating Leases

Baytown
Lease
$ 11,173
4,881
-
-
-
-

$ 16,054

Others
3,351
2,859
1,962
1,310
1,004
1,641
12,127

Total
15,123
8,025
2,244
1,486
1,068
1,641
29,587

Capital
Leases
599
285
282
176
64
-
1,406
176

payments included in long-term debt $

1,230

Rent expense under all operating lease agreements, including month-to-month leases, was
$13,793,000 in 2007, $12,587,000 in 2006 and $12,205,000 in 2005. Renewal options are
available under certain of the lease agreements for various periods at approximately the existing
annual rental amounts.

Baytown Facility - Our wholly owned subsidiary, EDNC operates a nitric acid plant (the
“Baytown Facility”) at a Baytown, Texas chemical facility in accordance with a series of
agreements with Bayer Corporation (“Bayer”) (collectively, the “Bayer Agreement”). Under the
terms of the Bayer Agreement, EDNC is leasing the Baytown Facility pursuant to a leveraged
lease (the “Baytown Lease”) from an unrelated third party with an initial lease term of ten years.
Upon expiration of the initial ten-year term in 2009, the Bayer Agreement may be renewed for
up to six renewal terms of five years each; however, prior to each renewal period, either party to
the Bayer Agreement may opt against renewal. The total amount of future minimum payments
due under the Baytown Lease is being charged to rent expense on the straight-line method over
the initial ten-year term of the lease. The difference between rent expense recorded and the
amount paid is charged to deferred rent expense which is included in accrued and other liabilities
in the accompanying consolidated balance sheets. The Company and its subsidiaries have not
provided a residual value guarantee on the value of the equipment related to the Baytown Lease
and Bayer has the unilateral right to determine if the fixed-price purchase option is exercised in
2009. If Bayer decides to exercise the purchase option, they must also fund it. EDNC’s ability to
perform on its lease commitments is contingent upon Bayer’s performance under the Bayer
Agreement. One of our subsidiaries has guaranteed the performance of EDNC’s obligations
under the Bayer Agreement. Discussions with Bayer have begun regarding a renewal in 2009.

F-41

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

Purchase and Sales Commitments - Under an agreement, as amended, with its principal
supplier of anhydrous ammonia, the El Dorado Chemical Company (“EDC”) will purchase a
majority of its anhydrous ammonia requirements using a market price-based formula plus
transportation to the chemical production facility located in El Dorado, Arkansas (the “El Dorado
Facility”) through at least December 31, 2008.

In 1995, EDC entered into a product supply agreement with a third party whereby EDC is
required to make monthly facility fee and other payments which aggregate $87,000. In return for
this payment, EDC is entitled to certain quantities of compressed oxygen produced by the third
party. Except in circumstances as defined by the agreement, the monthly payment is payable
regardless of the quantity of compressed oxygen used by EDC. The initial term of this agreement
is through August 2010. If the agreement is not terminated as of the end of the initial term, the
agreement automatically renews for a 5-year term and on a year-by-year basis thereafter. EDC
can currently terminate the agreement without cause at a cost of approximately $1.4 million.
Based on EDC’s estimate of compressed oxygen demands of the plant, the cost of the oxygen
under this agreement is expected to be favorable compared to floating market prices. Purchases
under this agreement aggregated $1,078,000, $1,052,000 and $1,035,000 in 2007, 2006, and
2005, respectively.

At December 31, 2007, our Climate Control Business had purchase commitments under
exchange-traded futures for 3,875,000 pounds of copper through December 2008 at a weighted
average cost of $3.02 per pound and a weighted average market value of $3.04 per pound. At
December 31, 2007, our Chemical Business had purchase commitments under exchange-traded
futures for 530,000 MMBtu of natural gas through April 2008 at a weighted average cost of
$7.98 per MMBtu and a weighted average market value of $7.51 per MMBtu.

At December 31, 2007, we also had standby letters of credit outstanding of $.8 million of which
$.2 million related to our Climate Control Business.

At December 31, 2007, we had deposits from customers of $9.5 million for forward sales
commitments including $8.7 million relating to our Chemical Business and $.6 million relating
to our Climate Control Business.

In 2001, EDC entered into a long-term cost-plus industrial grade ammonium nitrate supply
agreement (“Supply Agreement”) with a third party. Under the Supply Agreement, as amended,
EDC will supply from the El Dorado Facility approximately 210,000 tons of industrial grade
ammonium nitrate per year, which is approximately 92% of the plant’s manufacturing capacity
for that product, for a term through 2010.

Employment and Severance Agreements - We have employment and severance agreements
with several of our officers. The agreements provide for annual base salaries, bonuses and other
benefits commonly found in such agreements. In the event of termination of employment due to
a change in control (as defined in the agreements), the agreements provide for payments
aggregating $9.0 million at December 31, 2007.

F-42

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

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

A. Environmental Matters

We are required to recognize a liability for the fair value of a conditional asset retirement
obligation if the fair value of the liability can be reasonably estimated in accordance with FIN
47. We are obligated to monitor certain discharge water outlets at our Chemical Business
facilities should we discontinue the operations of a facility. We also have certain facilities in our
Chemical Business that contain asbestos insulation around certain piping and heated surfaces
which we plan to maintain in an adequate condition to prevent leakage through our standard
repair and maintenance activities. Since we currently have no plans to discontinue the use of
these facilities and the remaining life of the facilities is indeterminable, an asset retirement
liability has not been recognized. Currently, there is insufficient information to estimate the fair
value of the asset retirement obligations. However, we will continue to review these obligations
and record a liability when a reasonable estimate of the fair value can be made.

1. Discharge Water Matters

F-43

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

The El Dorado Facility has demonstrated its ability to comply with the more restrictive permit
limits, and the rules which support the more restrictive dissolved minerals rules have been
revised to authorize a permit modification to adopt achievable dissolved minerals permit limits.
The ADEQ has agreed to issue a consent administrative order to authorize the El Dorado Facility
to continue operations without incurring permit violations pending the modification of the permit
to implement the revised rule and to dispose of the El Dorado Facility’s wastewater into the
creek adjacent to the El Dorado Facility. A draft of the proposed consent administrative order has
been prepared by the ADEQ and submitted to the El Dorado Facility for review. We are
currently reviewing the proposed consent administrative order.

In addition, the El Dorado Facility has entered into a consent administrative order (“CAO”) that
recognizes the presence of nitrate contamination in the shallow groundwater at the El Dorado
Facility. A new CAO to address the shallow groundwater contamination became effective on
November 16, 2006 and requires the evaluation of the current conditions and remediation based
upon a risk assessment. The CAO requires the El Dorado Facility 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. The final remedy for shallow
groundwater contamination, should any remediation be required, will be selected pursuant to the
new CAO and based upon the risk assessment. As an interim measure, the El Dorado Facility has
installed two recovery wells to recycle groundwater and to recover nitrates. The cost of any
additional remediation that may be required will be determined based on the results of the
investigation and risk assessment and cannot currently be reasonably estimated. Therefore, no
liability has been established at December 31, 2007.

2. Air Matters

F-44

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

In December 2006, the El Dorado Facility entered into a new CAO (“2006 CAO”) with the
ADEQ to resolve a problem with ammonia emissions from certain nitric acid units. The catalyst
suppliers had represented the volume of ammonia emissions anticipated. The representation was
the basis for the permitted emission limit, but the representation of the catalyst suppliers was not
accurate. Under the 2006 CAO, the ADEQ allowed the El Dorado Facility to re-evaluate the
catalyst performance and required the El Dorado Facility to submit a permit modification with
the appropriate ammonia limits. The permit modification was submitted to ADEQ on June 11,
2007, and is currently under review. Until the permit is modified, the 2006 CAO authorizes the
El Dorado Facility to continue to operate certain nitric acid units (even though the El Dorado
Facility is in non-compliance with the permitted emission limit for ammonia), provided that
during this period of time, the El Dorado Facility monitors and reports the ammonia on a
monthly basis.

3. Other Environmental Matters

In December 2002, Slurry and Universal Tech Corporation (“UTeC”), both subsidiaries within
our Chemical Business, sold substantially all of their operating assets 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,
UTeC leased the real property to the buyer under a triple net long-term lease agreement.
However, Slurry retained the obligation to be responsible for, and perform the activities under,
the Slurry Consent Order. In addition, certain of our subsidiaries agreed to indemnify the buyer
of such assets for these environmental matters. The successor (“Chevron”), the prior owner of
the Hallowell Facility has agreed, within certain limitations, to pay and has been paying one-half
of the costs incurred under the Slurry Consent Order subject to reallocation.

As a result of meetings with the KDHE, we recorded a provision of $644,000 for our share of
these additional estimated costs for 2005. In addition, during 2006, additional costs were
estimated due to requirements by the KDHE to further investigate and delineate the site. As a
result, for 2006, we recorded provisions totaling $203,000 for our share of these estimated
additional costs. Based on additional modeling of the site, Slurry and Chevron are pursuing a

F-45

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

course with the KDHE of long-term surface and ground water monitoring to track the natural
decline in contamination, instead of the soil excavation proposed previously. On September 12,
2007, the KDHE approved our proposal to perform two years of surface and groundwater
monitoring and to implement a Mitigation Work Plan to acquire additional field data in order to
more accurately characterize the nature and extent of contaminant migration off-site. The two-
year monitoring program will terminate in February 2009. As a result of receiving approval from
the KDHE for our proposal, we recognized a reduction in our share of the estimated costs
associated with this remediation by $377,000 in 2007. This reduction is included in the net
income from discontinued operations of $348,000 for 2007 (in accordance with SFAS 144).

B. Other Pending, Threatened or Settled Litigation

1. Climate Control Business

2. Chemical Business

In 2005, EDC sued the general partners of Dresser Rand Company, Ingersoll-Rand Company
and DR Holdings Corp., and an individual employee of Dresser Rand Company, in connection
with its faulty repair of a hot gas expander of one of EDC’s nitric acid plants. As a result of
defects in the repair, on October 8, 2004, the hot gas expander failed, leading to a fire at the

F-46

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

nitric acid plant. The lawsuit was styled El Dorado Chemical Company, et al v. Ingersoll-Rand
Company (NJ), et al. in the Union County Arkansas Circuit Court. A trial was held in October
2006 resulting in a jury verdict awarding EDC approximately $9.8 million in damages. The
Defendants filed a Notice to Appeal and filed a $10.7 million bond. EDC will pay attorneys fees
equal to approximately 32% of any recovery. We will recognize the jury award if and when
realized.

3. Other

Zeller Pension Plan

MEI Drafts

F-47

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

Agreement was rescinded by the Company, Summit, and MEI at the request of MEI, and
replaced with an agreement purportedly substantially similar to the Settlement Agreement
between MEI and Aerobit, pursuant to which MEI agreed to replace the original $1,533,000 of
Summit’s obligations with Aerobit bank drafts totaling $1,533,000, endorsed by LSB Corp.
Aerobit previously advised us that MEI has not fulfilled the requirements under the bank drafts
for payment thereof. All of the Company’s ownership interest in LSB Corp. was sold to an
unrelated third party in September 2002. Further, all of the Company’s interest in Aerobit was
sold to a separate unrelated third party, in a transaction completed on or before November 2002.
Accordingly, neither Aerobit, which was the issuer of the bank drafts, nor LSB Corp., which was
the endorser of the bank drafts, are currently subsidiaries of the Company.

The Jayhawk Group

As discussed in Note 15 - Non-Redeemable Preferred Stock, during July 2007, we mailed to all
holders of record of our Series 2 Preferred a notice of redemption of all of the outstanding shares
of Series 2 Preferred. The redemption of our Series 2 Preferred was completed on August 27,
2007, the redemption date. The terms of the Series 2 Preferred required that for each share of
Series 2 Preferred so redeemed, we would pay, in cash, a redemption price equal to $50.00 plus
$26.25 representing dividends in arrears thereon pro-rata to the date of redemption. There were
193,295 shares of Series 2 Preferred outstanding, net of treasury stock, as of the date the notice
of redemption was mailed. Pursuant to the terms of the Series 2 Preferred, the holders of the
Series 2 Preferred could convert each share into 4.329 shares of our common stock, which right
to convert terminated 10 days prior to the redemption date. If a holder of the Series 2 Preferred
elected to convert his, her or its shares into our common stock pursuant to its terms, the
Certificate of Designations for the Series 2 Preferred provided, and it is our position, that the
holder that so converts would not be entitled to receive payment of any dividends in arrears on
the shares so converted. The Jayhawk Group, a former affiliate of ours, converted 155,012 shares
of Series 2 Preferred into 671,046 shares of common stock. The Jayhawk Group has advised us
that it may bring legal action against us for all dividends in arrears (approximately $4 million) on
the shares of Series 2 Preferred that it converted after receipt of the notice of redemption. The
Company believes the likelihood that the Jayhawk Group may recover the dividends in arrears is
not probable. Therefore, no liability has been established at December 31, 2007. See discussion
under Note 22 – Subsequent Events.

F-48

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

13. Commitments and Contingencies (continued)

Securities and Exchange Commission Inquiry

•
•

Other Claims and Legal Actions

14. Stockholders’ Equity

Qualified Stock Option Plans - At December 31, 2007, we have a 1993 Stock Option and
Incentive Plan (“1993 Plan”) and a 1998 Stock Option Plan (“1998 Plan”). The 1993 Plan has
expired, and accordingly, no additional options may be granted from this plan. Options granted
prior to the expiration of this plan continue to remain valid thereafter in accordance with their
terms. Under the 1998 Plan, we are authorized to grant options to purchase up to 1,000,000

F-49

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

shares of our common stock to our key employees. Effective December 31, 2005, our board of
directors approved the acceleration of the vesting schedule of 61,500 shares of qualified stock
options which would have been fully vested on November 17, 2009. Based on FIN 44, since the
modification to the vesting schedule did not renew or increase the life of these stock options, a
remeasurement of the stock options was not required and no stock-based compensation was
recognized in 2005. At December 31, 2007, there are 8,000 options available to be granted. At
December 31, 2007, there were 26,500 options outstanding related to the 1993 Plan and 429,904
options outstanding relating to the 1998 Plan all of which were exercisable. The exercise price of
options granted under these plans was equal to the market value of our common stock at the date
of grant. For participants who own 10% or more of our common stock at the date of grant, the
exercise price is 110% of the market value at the date of grant and the options lapse after five
years from the date of grant.

The following information relates to our qualified stock option plans:

Outstanding at beginning of year
Granted
Exercised
Cancelled, forfeited or expired
Outstanding at end of year

Weighted
Average
Exercise
Price

Shares
525,304 $
- $
(68,900) $
- $
456,404 $

1.97
-
3.54
-
1.73

Exercisable at end of year

456,404

1.73

2007

2006

2005

Weighted-average fair value of options granted during year

N/A

3.78

Total intrinsic value of options exercised during the year

Total fair value of options vested during the year

1,108,000

$ 1,886,000

333,000

362,000

F-50

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

The following table summarizes information about qualified stock options outstanding and
exercisable at December 31, 2007:

Stock Options Outstanding and Exercisable

Shares
Outstanding and
Exercisable

Weighted
Average
Remaining
Contractual
Life in Years

342,304
93,000
21,100
456,404

1.58
3.92
7.92
2.35

Intrinsic
Value of
Shares
Outstanding
and
Exercisable

$ 9,232,000
2,370,000
488,000
$ 12,090,000

Weighted
Average
Exercise
Price

$
$
$
$

1.25
2.73
5.10
1.73

Exercise Prices

$ 1.25
$ 2.73
$ 5.10
$ 1.25 - $ 5.10

Non-Qualified Stock Option Plans - Our board of directors approved the grants of non-
qualified stock options to our outside directors, our Chief Executive Officer, Chief Financial
Officer and certain key employees, included in the tables below. The option prices are generally
based on the market value of our common stock at the dates of grants. On June 19, 2006, the
Compensation and Stock Option Committee of our board of directors granted 450,000 shares of
non-qualified stock options (the “Options”) to certain Climate Control Business employees
which were subject to shareholders’ approval. The option price of the Options is $8.01 per share
which is based on the market value of our common stock at the date the board of directors
granted the shares (June 19, 2006). The Options vest over a ten-year period at a rate of 10% per
year and expire on September 16, 2016 with certain restrictions. Under SFAS 123(R), the fair
value for the Options was estimated, using an option pricing model, as of the date we received
shareholders’ approval which occurred during our 2007 annual shareholders’ meeting on June
14, 2007. Under SFAS 123(R) for accounting purposes, the grant date and service inception date
is June 14, 2007.

The total fair value for the Options was estimated to be $6,924,000, or $15.39 per share, using a
Black-Scholes-Merton option pricing model with the following assumptions:

•

•
•

•

risk-free interest rate of 5.16% based on an U.S. Treasury zero-coupon issue with a term
approximating the estimated expected life as of the grant date;
a dividend yield of 0 based on historical data;
volatility factors of the expected market price of our common stock of 24.7% based on
historical volatility of our common stock since it has been traded on the American Stock
Exchange, and;
a weighted average expected life of the options of 5.76 years based on the historical
exercise behavior of these employees.

F-51

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

As of June 14, 2007, we began amortizing the total estimated fair value of the Options to SG&A,
which will continue through June 18, 2016 (a weighted-average vesting period of 8.46 years).
As a result, we incurred stock-based compensation expense of $421,000 for 2007. At December
31, 2007, the total stock-based compensation expense not yet recognized is $6,503,000 relating
to the non-vested Options.

Effective December 31, 2005, our board of directors approved the acceleration of the vesting
schedule of 30,000 shares of non-qualified stock options which would have been fully vested on
April 22, 2008 and 15,000 shares of non-qualified stock options which would have been fully
vested on November 7, 2006. Based on FIN 44, since this modification to the vesting schedule
did not renew or increase the life of these stock options, a remeasurement of the stock options
was not required and no stock-based compensation was recognized in 2005.

We have an Outside Directors Stock Option Plan (the “Outside Director Plan”). The Outside
Director Plan authorizes the grant of non-qualified stock options to each member of our board of
directors who is not an officer or employee of the Company or its subsidiaries. The maximum
number of options that may be issued under the Outside Director Plan is 400,000 of which
295,000 are available to be granted at December 31, 2007. At December 31, 2007, there are
54,000 options outstanding related to the Outside Director Plan.

F-52

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

The following information relates to our non-qualified stock option plans:

Outstanding at beginning of year
Granted
Exercised
Surrendered, forfeited, or expired
Outstanding at end of year

Weighted
Average
Exercise
Price

Shares
980,600 $ 1.98
450,000 $ 8.01
(513,100) $ 2.52
- $
-
917,500 $ 4.64

Exercisable at end of year

512,500

$ 1.97

2007

Weighted-average fair value of options granted during year $

15.39

Total intrinsic value of options exercised during the year

$ 10,042,000

Total fair value of options vested during the year

692,000

2006

N/A

2005

N/A

147,000

38,000

257,000

The following tables summarize information about non-qualified stock options outstanding and
exercisable at December 31, 2007:

Exercise Prices

$ 1.25 - $ 1.38
$ 2.62 - $ 2.73
$ 4.19
$ 8.01
$ 1.25 - $ 8.01

Shares
Outstanding

399,000
32,500
61,000
425,000
917,500

Stock Options Outstanding

Weighted
Average
Remaining
Contractual
Life in Years

1.58
4.22
0.33
8.75
4.91

Weighted
Average
Exercise
Price

$
$
$
$
$

1.27
2.70
4.19
8.01
4.64

Intrinsic
Value of
Shares
Outstanding

$ 10,754,000
829,000
1,466,000
8,589,000
$ 21,638,000

F-53

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

Exercise Prices

$ 1.25 - $ 1.38
$ 2.62 - $ 2.73
$ 4.19
$ 8.01
$ 1.25 - $ 8.01

Shares
Exercisable

399,000
32,500
61,000
20,000
512,500

Stock Options Exercisable

Weighted
Average
Remaining
Contractual
Life in Years

1.58
4.22
0.33
8.75
1.88

Weighted
Average
Exercise
Price

$
$
$
$
$

1.27
2.70
4.19
8.01
1.97

Intrinsic
Value of
Shares
Exercisable

$ 10,754,000
829,000
1,466,000
404,000
$ 13,453,000

Preferred Share Purchase Rights - In 1999, we adopted a preferred share rights plan (the
“Rights Plan”). Under the Rights Plan, we declared a dividend distribution of one Renewed
Preferred Share Purchase Right (the “Renewed Preferred Right”) for each outstanding share of
our common stock outstanding as of February 27, 1999 and all further issuances of our common
stock would carry the rights. The Rights Plan has a term of ten years from its effective date. The
Renewed Preferred Rights are designed to ensure that all of our stockholders receive fair and
equal treatment in the event of a proposed takeover or abusive tender offer.

The Renewed Preferred Rights are generally exercisable when a person or group (other than Jack
E. Golsen, our Chairman and Chief Executive Officer (“CEO”), and his affiliates, our company
or any of our subsidiaries, our employee savings plans and certain other limited excluded persons
or entities, as set forth in the Rights Plan) acquire beneficial ownership of 20% or more of our
common stock (such a person or group will be referred to as the “Acquirer”). Each Renewed
Preferred Right (excluding Renewed Preferred Rights owned by the Acquirer) entitles
stockholders to buy one one-hundredth (1/100) of a share of a new series of participating
preferred stock at an exercise price of $20. Following the acquisition by the Acquirer of
beneficial ownership of 20% or more of our common stock, and prior to the acquisition of 50%
or more of our common stock by the Acquirer, our board of directors may exchange all or a
portion of the Renewed Preferred Rights (other than Renewed Preferred Rights owned by the
Acquirer) for our common stock at the rate of one share of common stock per Renewed Preferred
Right. Following acquisition by the Acquirer of 20% or more of our common stock, each
Renewed Preferred Right (other than the Renewed Preferred Rights owned by the Acquirer) will
entitle its holder to purchase a number of our common shares having a market value of two times
the Renewed Preferred Right’s exercise price in lieu of the new preferred stock. Thus, only as an
example, if our common shares at such time were trading at $10 per share and the exercise price
of the Renewed Preferred Right is $20, each Renewed Preferred Right would thereafter be
exercisable at $20 for four of our common shares.

If after the Renewed Preferred Share Rights are triggered, we are acquired, or we sell 50% or
more of our assets or earning power, each Renewed Preferred Right (other than the Renewed
Preferred Rights owned by the Acquirer) will entitle its holder to purchase a number of the

F-54

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

14. Stockholders’ Equity (continued)

acquiring company’s common shares having a market value at the time of two times the
Renewed Preferred Right’s exercise price, except if the transaction is consummated with a
person or group who acquired our common shares pursuant to a Permitted Offer, the price for all
of our common shares paid to all of our common shareholders is not less than the price per share
of our common stock pursuant to the Permitted Offer and the form of consideration offered in the
transaction is the same as the form of consideration paid pursuant to the Permitted Offer. As
defined in the Rights Plan, a “Permitted Offer” is an offer for all of our common shares at a price
and on terms that a majority of our Board, who are not officers, or the person or group who could
trigger the exerciseability of the Renewed Preferred Rights, deems adequate and in our best
interest and that of our shareholders. Thus, only as an example, if our common shares were
trading at $10 per share and the exercise price of a Renewed Preferred Right is $20, each
Renewed Preferred Right would thereafter be exercisable at $20 for four shares of the Acquirer.

Prior to the acquisition by the Acquirer of beneficial ownership of 20% or more of our stock, our
board of directors may redeem the Renewed Preferred Rights for $.01 per Renewed Preferred
Right.

Other – In November 2007, the Jayhawk Group exercised a warrant to purchase 112,500 shares
of our common stock for $3.49 per share.

In March 2005, the holders exercised certain warrants, under a cashless exercise provision, to
purchase 586,140 shares of our common stock.

As of December 31, 2007, we have reserved 4.5 million shares of common stock issuable upon
potential conversion of convertible debt, preferred stocks and stock options pursuant to their
respective terms.

15. Non-Redeemable Preferred Stock

Series B Preferred -The 20,000 shares of Series B Preferred, $100 par value, are convertible, in
whole or in part, into 666,666 shares of our common stock (33.3333 shares of common stock for
each share of preferred stock) at any time at the option of the holder and entitle the holder to one
vote per share. The Series B Preferred provides for annual cumulative dividends of 12% from
date of issue, payable when and as declared.

Series 2 Preferred -The Series 2 Preferred had no par value and had a liquidation preference of
$50.00 per share plus dividends in arrears and was convertible at the option of the holder at any
time, unless previously redeemed, into our common stock at an initial conversion price of $11.55
per share (equivalent to a conversion rate of approximately 4.329 shares of common stock for
each share of Series 2 Preferred), subject to adjustment under certain conditions. Upon the
mailing of notice of certain corporate actions, holders had special conversion rights as discussed
below. The Series 2 Preferred was redeemable at our option, in whole or in part, at $50.00 per
share, plus dividends in arrears to the redemption date. Dividends on the Series 2 Preferred were
cumulative and payable quarterly in arrears.

F-55

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

15. Non-Redeemable Preferred Stock (continued)

Completion of Tender Offer in 2007

Because the exchanges under the tender offer were pursuant to terms other than the original
terms, the transactions were considered extinguishments of the preferred stock. Also the
transactions qualified as induced conversions under SFAS 84. Accordingly, we recorded a
charge (stock dividend) to accumulated deficit of approximately $12.3 million which equaled the
excess of the fair value of the common stock issued over the fair value of the common stock
issuable pursuant to the original conversion terms. To measure fair value, we used the closing
price of our common stock on March 13, 2007.

Included in the amounts discussed above and pursuant to the Jayhawk Agreement and the terms
of the tender offer, the Jayhawk Group and Jack E. Golsen (Chairman of the Board and CEO of
the Company), his wife, children (including Barry H. Golsen, our President) and certain entities
controlled by them (the “Golsen Group”) tendered 180,450 and 26,467 shares, respectively, of
Series 2 Preferred for 1,335,330 and 195,855 shares, respectively, of our common stock. As a
result, we effectively settled the dividends in arrears on these shares of Series 2 Preferred
tendered totaling approximately $4.96 million with $4.33 million relating to the Jayhawk Group
and $0.63 million relating to the Golsen Group.

No fractional shares were issued so cash was paid in lieu of any additional shares in an amount
equal to the fraction of a share times the closing price per share of our common stock on the last
business day immediately preceding the expiration date of the tender offer.

Completion of Redemption in 2007

On July 11, 2007, our board of directors approved the redemption of all of our outstanding Series
2 Preferred. We mailed a notice of redemption to all holders of record of our Series 2 Preferred
on July 12, 2007. The redemption date was August 27, 2007, and each share of Series 2
Preferred that was redeemed received a redemption price of $50.00 plus $26.25 per share in
dividends in arrears pro-rata to the date of redemption.

F-56

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

15. Non-Redeemable Preferred Stock (continued)

The holders of shares of Series 2 Preferred had the right to convert each share into 4.329 shares
of our common stock, which right to convert terminated 10 days prior to the redemption date. If
a holder converted its shares of Series 2 Preferred, the holder was not entitled to any dividends in
arrears as to the shares of Series 2 Preferred converted. As a result, 167,475 shares of Series 2
Preferred were converted (of which 155,012 shares were converted by the Jayhawk Group) into
724,993 shares of our common stock (of which 671,046 shares were issued to the Jayhawk
Group).

As a result of the conversions, only 25,820 shares of Series 2 Preferred were redeemed (of which
23,083 shares were held by the Golsen Group) for a total redemption price of $1,291,000 (of
which approximately $1,154,000 was paid to the Golsen Group). In addition, we paid
approximately $678,000 in dividends in arrears (of which approximately $606,000 was paid to
the Golsen Group). The shares of the Series 2 Preferred were redeemed using a portion of the
net proceeds of the 2007 Debentures.

Exchange Agreements in 2006

During October 2006, we entered into Exchange Agreements with certain holders of our Series 2
Preferred. Pursuant to the terms of the Exchange Agreements, we issued 773,655 shares of our
common stock in exchange for 104,548 shares of Series 2 Preferred and the waiver by the
holders of their rights to all unpaid dividends. As a result, we effectively settled the dividends in
arrears on the Series 2 Preferred exchanged totaling approximately $2.4 million ($23.2625 per
share). Because the exchanges were pursuant to terms other the original terms, the transactions
were considered extinguishments of the preferred stock. In addition, the transactions qualified as
induced conversions under SFAS 84. Accordingly, we recorded a charge (stock dividend) to
accumulated deficit of approximately $2.9 million which equaled the excess of the fair value of
the common stock issued over the fair value of the common stock issuable pursuant to the
original conversion terms. To measure fair value, we used the closing price of our common stock
on the day the parties entered into an Exchange Agreement.

Jayhawk Agreement in 2006

During November 2006, the Company entered into an agreement (“Jayhawk Agreement”) with
the Jayhawk Group. Under the Jayhawk Agreement, the Jayhawk Group agreed to tender
(discussed above) 180,450 shares of the 346,662 shares of the Series 2 Preferred, if the Company
made an exchange or tender offer for the Series 2 Preferred. In addition, as a condition to the
Jayhawk Group’s obligation to tender such shares of Series 2 Preferred in an exchange/tender
offer, the Jayhawk Agreement further provided that the Golsen Group would exchange only
26,467 of the 49,550 shares of Series 2 Preferred beneficially owned by them. As a result, only
309,807 of the 499,102 shares of Series 2 Preferred outstanding would be eligible to participate

F-57

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

15. Non-Redeemable Preferred Stock (continued)

in an exchange/tender offer, with the remaining 189,295 being held by the Jayhawk Group and
the Golsen Group.

Other Series 2 Preferred Transactions

During 2007, we cancelled 18,300 shares of Series 2 Preferred previously held as treasury stock.
As the result of the cancellation, no shares of Series 2 Preferred were issued and outstanding at
December 31, 2007. During 2006, we purchased 1,600 shares of Series 2 Preferred in the open
market for $95,000 (average cost of $59.74 per share). These shares were cancelled by the
Company. During 2005, we purchased 13,300 shares of Series 2 Preferred in the open market for
$597,000 (average cost of $44.90 per share). These shares were being held as treasury stock.

Series D Preferred -The Series D Preferred have no par value and are convertible, in whole or
in part, into 250,000 shares of our common stock (1 share of common stock for 4 shares of
preferred stock) at any time at the option of the holder. Dividends on the Series D Preferred are
cumulative and payable annually in arrears at the rate of 6% per annum of the liquidation
preference of $1.00 per share but would be paid only after dividends in arrears were paid on the
Series 2 Preferred. Each holder of the Series D Preferred shall be entitled to .875 votes per share.

Cash Dividends Paid – In addition to the settlement of the dividends in arrears relating to the
tender offer in 2007 and the exchange agreements in 2006 as discussed above, during 2007, we
paid the following cash dividends on our non-redeemable preferred stock:

•
•
•

$1,890,000 on the Series B Preferred ($94.52 per share);
$678,000 on the Series 2 Preferred ($26.25 per share); and
$360,000 on the Series D Preferred ($0.36 per share).

During 2006, we paid the following cash dividends on our non-redeemable preferred stock:

•
•

$30,000 on the Series B Preferred ($1.48 per share); and
$231,000 on the Series 2 Preferred ($0.40 per share).

At December 31, 2007, there were no dividends in arrears.

Other - At December 31, 2007, we are authorized to issue an additional 229,415 shares of $100
par value preferred stock and an additional 4,000,000 shares of no par value preferred stock.
Upon issuance, our board of directors will determine the specific terms and conditions of such
preferred stock.

16. Executive Benefit Agreements and Employee Savings Plans

In 1981, we entered into individual death benefit agreements with certain key executives (“1981
Agreements”). Under the 1981 Agreements, should the executive die while employed, we are

F-58

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

16. Executive Benefit Agreements and Employee Savings Plans (continued)

required to pay the beneficiary named in the agreement in 120 equal monthly installments
aggregating to an amount specified in the agreement. At December 31, 2007, the monthly
installments specified in the 1981 Agreements total $34,000 and the aggregate undiscounted
death benefits are $4.1 million. The benefits under the 1981 Agreements are forfeited if the
respective executive’s employment is terminated for any reason prior to death. The 1981
Agreements may be terminated by the Company at any time and for any reason prior to the death
of the employee.

In 1992, we entered into individual benefit agreements with certain key executives (“1992
Agreements”) that provide for annual benefit payments for life (in addition to salary) ranging
from $16,000 to $18,000 payable in monthly installments when the employee reaches age 65. As
of December 31, 2007 and 2006, the liability for benefits under the 1992 Agreements is
$1,040,000 and $979,000, respectively, which is included in current and noncurrent accrued and
other liabilities in the accompanying consolidated balance sheets. The liability reflects the
present value of the remaining estimated payments at discount rates of 5.70% and 6.01% as of
December 31, 2007 and 2006, respectively. Future estimated undiscounted payments aggregate
to $2.1 million as of December 31, 2007. For 2007, 2006 and 2005, charges to SG&A for these
benefits were $106,000, $75,000 and $110,000, respectively. As part of the 1992 Agreements,
should the executive die prior to attaining the age of 65, we will pay the beneficiary named in the
agreement in 120 equal monthly installments aggregating to an amount specified in the
agreement. This amount is in addition to any amount payable under the 1981 Agreement should
that executive have both a 1981 and 1992 agreement. At December 31, 2007, the aggregate
undiscounted death benefit payments specified in the 1992 Agreements are $456,000. The
benefits under the 1992 Agreements are forfeited if the respective executive’s employment is
terminated prior to age 65 for any reason other than death. The 1992 Agreements may be
terminated by the Company at any time and for any reason prior to the death of the employee.

In 2005, we entered into a death benefit agreement (“2005 Agreement”) with our CEO. The
Death Benefit Agreement provides that, upon our CEO’s death, we will pay to our CEO’s
designated beneficiary, a lump-sum payment of $2.5 million to be funded from the net proceeds
received by us under certain life insurance policies on our CEO’s life that are owned by us. We
are obligated to keep in existence life insurance policies with a total face amount of no less than
$2.5 million of the stated death benefit. As of December 31, 2007, the life insurance policies
owned by us on the life of our CEO have a total face amount of $7 million. The benefit under the
2005 Agreement is not contingent upon continued employment and may be amended at any time
by written agreement executed by the CEO and the Company.

As of December 31, 2007, the liability for death benefits under the 1981, 1992 and 2005
Agreements is $2,051,000 ($1,446,000 at December 31, 2006) which is included in current and
noncurrent accrued and other liabilities. We accrue for such liabilities when they become
probable and discount the liabilities to their present value.

F-59

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

16. Executive Benefit Agreements and Employee Savings Plans (continued)

To assist us in funding the benefit agreements discussed above and for other business reasons,
we purchased life insurance contracts on various individuals in which we are the beneficiary. As
of December 31, 2007, the total face amount of these policies is $21 million of which $2.5
million of the proceeds is required to be paid under the 2005 Agreement as discussed above.
Some of these life insurance policies have cash surrender values that we have borrowed against.
The cash surrender values are included in other assets in the amounts of $1,151,000 and
$917,000, net of borrowings of $1,859,000 and $2,084,000 at December 31, 2007 and 2006,
respectively. Increases in cash surrender values of $548,000, $432,000 and $574,000 are netted
against the premiums paid for life insurance policies of $836,000, $837,000 and $1,037,000 in
2007, 2006 and 2005 respectively, and are included in SG&A.

We sponsor a savings plan under Section 401(k) of the Internal Revenue Code under which
participation is available to substantially all full-time employees. We do not presently contribute
to this plan except for EDC and CNC’s union employees and EDNC employees which amounts
were not material for each of the three years ended December 31, 2007.

17. Fair Value of Financial Instruments

The following discussion of fair values is not indicative of the overall fair value of our assets and
liabilities since the provisions of SFAS 107 do not apply to all assets, including intangibles.

As of December 31, 2007 and 2006, due to their short-term nature, the carrying values of
financial instruments classified as cash, restricted cash, accounts receivable, accounts payable,
short-term financing and drafts payable, and accrued and other liabilities approximated their
estimated fair values. Carrying values for our interest rate cap contracts and exchange-traded
futures contracts approximate their fair value since they are accounted for on a mark-to-market
basis. Carrying values for variable rate borrowings are believed to approximate their fair value.
Fair values for fixed rate borrowings, other than the 2007 and 2006 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. The estimated fair value of the 2007 and 2006
Debentures are based on the conversion rate and market price of our common stock at December
31, 2007 and 2006, respectively.

F-60

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

17. Fair Value of Financial Instruments (continued)

December 31, 2007

December 31, 2006

Estimated
Fair Value

Carrying
Value

Estimated
Fair Value

Carrying
Value

(In Thousands)

Variable Rate:

Secured Term Loan
Working Capital Revolver Loan
Senior Secured Loan (1)
Other bank debt and equipment financing

$ 50,000 $ 50,000
-
-
155

-
-
155

-
26,048
53,774
2,517

-
26,048
50,000
2,517

Fixed Rate:

5.5% Convertible Senior Subordinated Notes
Other bank debt and equipment financing
7% Convertible Senior Subordinated Notes

61,632
12,298
-

60,000
11,952
-
$ 124,085 $ 122,107

-
14,853
6,543
$ 103,735

-
15,127
4,000
$ 97,692

(1) The Senior Secured Loan had a variable interest rate not to exceed 11% or 11.5% depending on

ThermaClime’s leverage ratio.

18. Property and Business Interruption Insurance Recoveries

El Dorado Facility - Beginning in October 2004 and continuing into June 2005, the Chemical
Business’ results were adversely affected as a result of the loss of production due to a mechanical
failure which led to a fire at one of the four nitric acid plants at the El Dorado Facility. The plant
was restored to normal production in June 2005. We filed insurance claims for recovery of
business interruption and property losses related to this incident. For 2006 and 2005, we realized
insurance recoveries of $882,000 and $1,929,000, respectively, relating to the business
interruption claim which is recorded as a reduction to cost of sales. For 2005, we recognized
insurance recoveries totaling $1,618,000, of which most were under our replacement cost
insurance policy relating to this property damage claim which are recorded as other income.

Cherokee Facility - As a result of damage caused by Hurricane Katrina, the natural gas pipeline
servicing the chemical production facility located in Cherokee, Alabama (the “Cherokee
Facility”) suffered damage and the owner of the pipeline declared an event of Force Majeure.
This event of Force Majeure caused curtailments and interruption in the delivery of natural gas to
the Cherokee Facility. CNC’s insurer was promptly put on notice of a claim and during 2006,
CNC filed a business interruption claim relating to this incident. In 2007, we realized insurance
recoveries of $3,750,000 relating to this business interruption claim which are recorded as a
reduction to cost of sales.

F-61

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

19. Other Expense, Other Income and Non-Operating Other Income, net

2007

Year ended December 31,
2006
(In Thousands)

2005

Other expense:

Losses on sales and disposals of property and

equipment

Impairments of long-lived assets (1)
Settlement of litigation and potential litigation (2)
Other miscellaneous expense (3)

Total other expense

Other income:

Settlement of litigation (4)
Rental income
Property insurance recoveries in excess of losses

incurred

Arbitration award
Gains on the sales of property and equipment, net
Other miscellaneous income (3)

Total other income

378
250
350
208
1,186

$ 3,272
17

-
-
-
206
$ 3,495

-
286
300
136
722

-
25

-
237
-
95
332

-
142

-
1,217
12
305
$ 1,559

1,618
-
714
208
$ 2,682

2007

Year ended December 31,
2006
(In Thousands)

2005

Non-operating other income, net:

Interest income
Gains on sale of certain current assets, primarily

precious metals

Net proceeds from certain key individual life

insurance policies (5)
Miscellaneous income (3)
Miscellaneous expense (3)

Total non-operating other income, net

$ 1,291

523

174

237

-
61
(100)
$ 1,264

-
199
(98 )
624

1,162
137
(149)
$ 1,561

(1) Based on estimates of the fair values obtained from external sources and estimates made
internally based on inquiry and other techniques, we recognized the following impairments:

F-62

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

19. Other Expense, Other Income and Non-Operating Other Income, net (continued)

2007

Year ended December 31,
2006
(In Thousands)

2005

Chemical Business assets
Corporate assets

250 $
-
250 $

286 $
-
286 $

117
120
237

(2) During 2007, a settlement was reached relating to alleged damages claimed by a customer
of our Climate Control Business. During 2006, a settlement was reached relating to an
asserted financing fee.

(3) Amounts represent numerous unrelated transactions, none of which are individually

significant requiring separate disclosure.

(4) During 2007, our Chemical Business reached a settlement with Dynegy, Inc. and one of its
subsidiaries, relating to a previously reported lawsuit. This settlement reflects the net
proceeds of $2,692,000 received by the Cherokee Facility and the retention by the Cherokee
Facility of a disputed $580,000 accounts payable.

(5) Amount relates to the recognition in net proceeds from life insurance policies due to the

unexpected death of one of our executives in January 2005.

F-63

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

20. Segment Information

Factors Used by Management to Identify the Enterprise’s Reportable Segments and
Measurement of Segment Income or Loss and Segment Assets

We have two reportable segments: the Climate Control Business and the Chemical Business. Our
reportable segments are based on business units that offer similar products and services. The
reportable segments are each managed separately because they manufacture and distribute
distinct products with different production processes.

We evaluate performance and allocate resources based on operating income or loss. The
accounting policies of the reportable segments are the same as those described in the summary of
significant accounting policies.

Description of Each Reportable Segment

Climate Control – The Climate Control Business segment manufactures and sells the

following variety of heating, ventilation, and air conditioning (“HVAC”) products:

•
•
•

geothermal and water source heat pumps,
hydronic fan coils, and
other HVAC products including large custom air handlers, modular chiller systems
and other products and services.

These HVAC products are primarily for use in commercial and residential new building
construction, renovation of existing buildings and replacement of existing systems. Our various
facilities located in Oklahoma City comprise substantially all of the Climate Control segment’s
operations. Sales to customers of this segment primarily include original equipment
manufacturers, contractors and independent sales representatives located throughout the world.

Chemical –The Chemical Business segment manufactures and sells:

•

anhydrous ammonia, ammonium nitrate, urea ammonium nitrate, and ammonium
nitrate ammonia solution for agricultural applications,
concentrated, blended and regular nitric acid, mixed nitrating acids, metallurgical and
commercial grade anhydrous ammonia, sulfuric acid, and high purity ammonium
nitrate for industrial applications, and
industrial grade ammonium nitrate and solutions for the mining industry.

Our primary manufacturing facilities are located in El Dorado, Arkansas, Baytown, Texas and
Cherokee, Alabama. Sales to customers of this segment primarily include industrial users of
acids throughout the United States and parts of Canada; farmers, ranchers, fertilizer dealers and
distributors located in the Central and Southeastern United States; and explosive manufacturers
in the United States.

F-64

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

20. Segment Information (continued)

The Chemical Business is subject to various federal, state and local environmental regulations.
Although we have designed policies and procedures to help reduce or minimize the likelihood of
significant chemical accidents and/or environmental contamination, there can be no assurances
that we will not sustain a significant future operating loss related thereto.

As of December 31, 2007, our Chemical Business employed 360 persons, with 138 represented
by unions under currently unexecuted negotiated agreements, which the parties expect to execute
in the near future. Assuming the union agreements are executed in their current form, the
agreements will expire in July through November of 2010.

Other - The business operation classified as “Other” sells industrial machinery and related

components to machine tool dealers and end users located primarily in North America.

F-65

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

20. Segment Information (continued)

Segment Financial Information

Information about our continuing operations in different industry segments for each of the three
years in the period ended December 31, is detailed below:

2007

2006
(In Thousands)

2005

Net sales:

Climate Control:

Geothermal and water source heat pumps
Hydronic fan coils
Other HVAC products

Total Climate Control

$ 165,115 $ 134,210
59,497
27,454
221,161

85,815
35,435
286,365

$ 85,268
53,564
18,027
156,859

Chemical:

Agricultural products
Industrial acids and other chemical products
Mining products

Total Chemical
Other

Gross profit:

Climate Control
Chemical
Other

Operating income (loss):
Climate Control
Chemical
General corporate expenses and other business

operations, net (1)

Interest expense
Non-operating income, net:

Climate Control
Chemical
Corporate and other business operations

Provisions for income taxes
Equity in earnings of affiliate - Climate Control
Income from continuing operations

F-66

117,158
95,754
75,928
288,840
11,202

89,735
95,208
75,708
260,651
10,140
$ 586,407 $ 491,952

83,638 $ 65,496
22,023
44,946
3,343
4,009
$ 132,593 $ 90,862

80,638
80,228
72,581
233,447
6,809
$ 397,115

$ 48,122
16,314
2,330
$ 66,766

34,194 $ 25,428
9,785
35,011

$ 14,097
7,591

(10,194)
59,011
(12,078)

(8,074)
27,139
(11,915)

(6,835)
14,853
(11,407)

2
109
1,153
(2,540)
877

1
311
312
(901)
821
46,534 $ 15,768

-
362
1,199
(118)
745
$ 5,634

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

20. Segment Information (continued)

(1) General corporate expenses and other business operations, net consist of the following:

Gross profit-Other
Selling, general and administrative:

Personnel costs
Professional fees
Office overhead
Advertising
Shareholders relations
Property, franchise and other taxes
All other

Total selling, general and administrative

Other income
Other expense
Total general corporate expenses and other business

2007

2006
(In Thousands)

2005

4,009 $

3,343 $

2,330

(6,879)
(4,299)
(646)
(244)
(154)
(314)
(1,626)
(14,162)

53
(94)

(5,862 )
(3,004 )
(598 )
(188 )
(58 )
(198 )
(1,221 )
(11,129 )

28
(316 )

(5,258)
(2,398)
(598)
(118)
(34)
(250)
(1,272)
(9,928)

883
(120)

operations, net

$ (10,194)

(8,074)

(6,835)

Information about our property, plant and equipment and total assets by industry segment is
detailed below:

Depreciation of property, plant and equipment:

Climate Control
Chemical
Corporate assets and other

Total depreciation of property, plant and equipment $

Additions to property, plant and equipment:

2007

2006
(In Thousands)

2005

3,195 $
8,929
147
12,271 $

2,591
8,633
157
11,381

2,223
8,503
149
$ 10,875

Climate Control
Chemical
Corporate assets and other

Total additions to property, plant and equipment

6,778 $
9,151
294
16,223 $

7,600
6,482
37
14,119

4,322
11,617
232
$ 16,171

Total assets at December 31:

Climate Control
Chemical
Corporate assets and other (A)

Total assets

$ 102,737 $
121,864
82,953

97,166
109,122
13,639
$ 307,554 $ 219,927

$ 60,970
111,212
16,781
$ 188,963

(A) At December 31, 2007, the amount includes cash and cash equivalents of $55.9 million,
deferred income taxes of $10.0 million and debt issuance and other debt-related costs, net of $4.6
million.

F-67

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

20. Segment Information (continued)

Net sales by industry segment include net sales to unaffiliated customers as reported in the
consolidated financial statements. Net sales classified as “Other” consist of sales of industrial
machinery and related components. Intersegment net sales are not significant.

Gross profit by industry segment represents net sales less cost of sales. Gross profit classified as
“Other” relates to the sales of industrial machinery and related components.

Our chief operating decision makers use operating income (loss) by industry segment for
purposes of making decisions which include resource allocations and performance evaluations.
Operating income (loss) by industry segment represents gross profit by industry segment less
SG&A incurred by each industry segment plus other income and other expense earned/incurred
by each industry segment before general corporate expenses and other business operations, net.
General corporate expenses and other business operations, net consist of unallocated portions of
gross profit, SG&A, other income and other expense.

Identifiable assets by industry segment are those assets used in the operations of each industry.
Corporate assets and other are those principally owned by the parent company or by subsidiaries
not involved in the two identified industries.

All net sales and long-lived assets relate to domestic operations for the periods presented.

Net sales to unaffiliated customers include foreign export sales as follows:

Geographic Area

Canada
Mexico, Central and South America
Europe
South and East Asia
Caribbean
Middle East
Other

2007

2005

2006
(In Thousands)
$ 14,206 $ 14,869 $ 12,077
581
1,148
1,502
282
2,647
365
$ 32,317 $ 23,158 $ 18,602

2,053
3,069
2,218
1,119
9,523
129

3,240
1,732
1,271
968
688
390

Major Customer

Net sales to one customer, Orica USA, Inc., of our Chemical Business segment represented
approximately 9%, 10% and 11% of our total net sales for 2007, 2006 and 2005, respectively.
Under the terms of the Supply Agreement, EDC will supply from the El Dorado Facility
industrial grade ammonium nitrate through 2010.

F-68

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

21. Related Party Transactions

Jayhawk

During 2006, approximately $1,037,000 of the net proceeds from the 2006 Debentures were used
to purchase from a member of the Jayhawk Group $1,000,000 principal amount of our
subsidiary’s 10.75% Senior Unsecured Notes, plus accrued and unpaid interest due thereon.

F-69

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

21. Related Party Transactions (continued)

offer. As a result, we effectively settled the dividends in arrears totaling approximately $4.96
million, with $4.33 million relating to the Jayhawk Group and $0.63 million relating to the
Golsen Group.

As a holder of Series 2 Preferred, the Jayhawk Group participated in the nomination and election
of two individuals to serve on our board of directors in accordance with the terms of the Series 2

F-70

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

21. Related Party Transactions (continued)

Preferred. As the result of the exchanges, conversions and redemption of the Series 2 Preferred
during 2007, resulting in less than 140,000 shares of Series 2 Preferred being outstanding, the
right of the holders of Series 2 Preferred to nominate and elect two individuals to serve on our
board of directors terminated pursuant to the terms of the Series 2 Preferred. Therefore, the two
independent directors elected by the holders of our Series 2 Preferred no longer serve as directors
on our board of directors and the Jayhawk Group is no longer considered an affiliate of ours.

Golsen Group

Cash Dividends

During 2006, we paid nominal cash dividends to holders of certain series of our preferred stock.
These dividend payments included $91,000 and $133,000 to the Golsen Group and the Jayhawk
Group, respectively.

As discussed above, during 2007, we paid cash dividends to the Golsen Group of approximately
$606,000 related to 23,083 shares of Series 2 Preferred redeemed.

F-71

LSB Industries, Inc.

Notes to Consolidated Financial Statements (continued)

21. Related Party Transactions (continued)

Quail Creek Bank

Bernard Ille, a member of our board of directors, is a director of Quail Creek Bank, N.A. (the
“Bank”). The Bank was a lender to one of our subsidiaries. During 2007, 2006 and 2005, the
subsidiary made interest and principal payments on outstanding debt owed to the Bank in the
respective amount of $.1 million and $3.3 million in 2007, $.3 million and $1.6 million in 2006,
and $.3 million and $1.0 million in 2005. At December 31, 2006, the subsidiary’s loan payable to
the Bank was approximately $3.3 million, (none at December 31, 2007) with an annual interest
rate of 8.25%. The loan was secured by certain of the subsidiary’s property, plant and equipment.
This loan was paid in full in June 2007 utilizing a portion of the net proceeds of our sale of the
2007 Debentures.

22. Subsequent Events (Unaudited)

During the first quarter of 2008, the University of Kansas Endowment Charitable Gift Fund
(“KU”) filed a lawsuit against us in the U.S. District Court, for the District of Kansas at Kansas
City, styled The KU Endownment Charitable Gift Fund vs. LSB Industries, Inc., Case No.
08-CV-2066. KU alleges that we improperly refused to accept 11,200 shares of Series 2
Preferred, which KU received as a gift from the controlling party of the Jayhawk Group, in our
issuer exchange tender offer. Under the issuer exchange tender offer, we offered to exchange
each outstanding share of Series 2 Preferred for 7.4 shares of our common stock and a waiver of
all dividends in arrears, except for certain shares of Series 2 Preferred owned by the Jayhawk
Group (including its controlling party, Kent McCarthy) and the Golsen Group pursuant to an
agreement entered into between us and the Jayhawk Group. The gift to KU by the controlling
party of the Jayhawk Group was made after the announcement of the issuer exchange tender
offer, and it is our position, among other things, that the tender of the shares given as a gift was
made contrary to the agreement between us and the Jayhawk Group and contrary to the terms of
our issuer exchange tender offer. KU alleges, among other things, that it suffered losses because
it was required to convert the 11,200 shares of Series 2 Preferred pursuant to the conversion
terms of the Series 2 Preferred, which was 4.3 shares of our common stock for each share of
Series 2 Preferred, and that the conversion was less favorable than the terms of issuer exchange
tender offer. KU alleges that the refusal to accept the 11,200 shares of Series 2 Preferred was in
violation of §14(d) of the Securities Exchange Act of 1934 (“34 Act”), a violation of §10b and
Rule 10b-5 and §18 of the 34 Act, the Kansas Uniform Securities Act and common law fraud.
We intend to vigorously defend this matter. As of December 31, 2007, no liability has been
established relating to this claim. We have placed the carrier under our Executive Organizational
Liability Insurance Policy Including Securities Liability on notice of this claim and litigation.
Our policy is subject to a $250,000 self insured retention for securities actions.

As discussed in Note 13 - Commitments and Contingencies, in October 2007, a law firm
representing a stockholder initiated a lawsuit against the Jayhawk Group pursuing a Section
16(b) short-swing profit claim on our behalf up to approximately $819,000. During the first
quarter of 2008, the parties have agreed to settle this claim by a payment to us by the Jayhawk
Group of $180,000, of which we will receive approximately $125,000 after attorneys’ fees. This
settlement is subject to a definitive settlement agreement.

F-72

LSB Industries, Inc.

Supplementary Financial Data

Quarterly Financial Data (Unaudited)

(In Thousands, Except Per Share Amounts)

March 31

June 30

September 30 December 31

Three months ended

2007

Net sales
Gross profit (1)
Income from continuing operations (1) (2)
Net income (loss) from discontinued operations
Net income
Net income applicable to common stock

$ 147,385
$ 32,052
$ 10,847

(29)

$ 10,818
5,631
$

$ 156,756
$ 34,657
$ 13,221
-
$ 13,221
$ 13,003

$ 147,613
$ 35,172
$ 17,919
377
$ 18,296
$ 18,093

$ 134,653
$ 30,712
4,547
$
-
4,547
4,547

$
$

Income per common share:
Basic:

Income from continuing operations
Income (loss) from discontinued operations, net
Net income

Diluted:

Income from continuing operations
Income (loss) from discontinued operations, net
Net income

.32
-
.32

.28
-
.28

2006

Net sales
Gross profit (1)
Income from continuing operations (1) (2)
Net loss from discontinued operations
Net income
Net income applicable to common stock

Income per common share:
Basic:

Income from continuing operations
Loss from discontinued operations, net
Net income

Diluted:

Income from continuing operations
Loss from discontinued operations, net
Net income

$ 111,857
$ 20,179
3,078
$
(100)
2,978
2,426

$
$

.19
(.01)
.18

.15
(.01)
.14

F-73

$
$

.66
-
.66

.58
-
.58

$ 132,391
$ 24,795
6,290
$

(31)

6,259
5,707

.87
.02
.89

.75
.02
.77

.22
-
.22

.20
-
.20

$ 123,968
$ 24,063
3,650
$
(113 )
3,537
2,986

$
$

$ 123,736
$ 21,825
2,750
$
(9)
2,741
1,766

$
$

.41
-
.41

.32
-
.32

.22
(.01 )
.21

.19
(.01 )
.18

.11
-
.11

.10
-
.10

LSB Industries, Inc.

Supplementary Financial Data

Quarterly Financial Data (Unaudited) (continued)

(1) The following items increased (decreased) gross profit and income from continuing operations:

Business interruption insurance recoveries:

2007
2006

Turnaround costs:
2007
2006

Precious metals, net of recoveries and gains:

2007
2006

Changes in inventory reserves:
2007
2006

March 31

June 30

September 30 December 31

Three months ended

(In Thousands)

$
$

-
554

(163)
(159)

(898)
(430)

317
836

$
$

-
41

(182)
(1,356)

(494)
(1,114)

28
(297)

$
$

1,500
287

(534 )
(262 )

(278 )
(103 )

15
366

$
$

2,250
-

(2,483)
(2,211)

(888)
(1,094)

24
(194)

(2) The following items increased (decreased) income from continuing operations:

Award received related to Trison arbitration:

2006

Settlements of litigation and potential litigation:

2007
2006

Interest expense:

2007
2006

Benefit (provision) for income taxes:

2007
2006

March 31

June 30

September 30 December 31

Three months ended

(In Thousands)

$
$

-
-

(2,588)
(2,875)

(344)
(50)

$
$

-
(300)

(1,992)
(2,886)

(188)
(150)

$
$

3,272
-

(3,482 )
(3,196 )

1,549
(208 )

$
$

1,217

(350)
-

(4,016)
(2,958)

(3,557)
(493)

Note: Effective January 1, 2007, we adopted FIN 48. The effect of this change in accounting principles decreased
income from continuing operations and net income by $511,000 for the three months ended December 31, 2007. In
addition, this change in accounting principles decreased basis and diluted net income per share by $0.03 and $0.02,
respectively, for 2007.

F-74

LSB Industries, Inc.

Schedule I - Condensed Financial Information of Registrant

Condensed Balance Sheets

The following condensed financial statements in this Schedule I are of the parent company only,
LSB Industries, Inc.

December 31,

2007

2006

(In Thousands)

$ 35,051

149
101
-
6,971
29,886
72,158

156
6,400
92,007
3,572
$ 174,293

401

2,582

56
13
3,052

60,002
2,558
3,146

3,000
2,447
123,336
(16,437)
112,346

6,811
105,535
$ 174,293

881
43
2,734
6,950
5,413
-
16,021

192
6,400
42,004
800
$ 65,417

142
1,050
65
44
1,301

4,038
2,558
2,344

28,870
2,022
79,838
(47,962)
62,768
7,592
55,176
$ 65,417

Assets
Current assets:

Cash
Accounts receivable, net
Supplies, prepaid items and other
Investment in senior unsecured notes of a subsidiary
Due from subsidiaries
Notes receivable from a subsidiary

Total current assets

Property, plant and equipment, net
Note receivable from a subsidiary
Investments in and due from subsidiaries
Other assets, net

Liabilities and Stockholders’ Equity
Current liabilities:

Accounts payable
Accrued and other liabilities
Redeemable, noncumulative, convertible preferred stock
Current portion of long-term debt

Total current liabilities

Long-term debt
Due to subsidiaries
Noncurrent accrued and other liabilities

Stockholders’ equity:
Preferred stock
Common stock
Capital in excess of par value
Accumulated deficit

Less treasury stock
Total stockholders’ equity

See accompanying notes.

F-75

LSB Industries, Inc.

Schedule I - Condensed Financial Information of Registrant

Condensed Statements of Income

2007

Year ended December 31,
2006
(In Thousands)

2005

Fees under service, tax sharing and management

agreements with subsidiaries

$ 2,801

$ 1,001

Selling, general and administrative expense
Gain on sale of precious metals
Other income, net

5,361
(4,259)
(402)

4,367
-
(308 )

4,161
-
(708)

Operating income (loss)

2,101

(1,258 )

(2,452)

Interest expense
Net proceeds from certain key individual life insurance

policies

Interest and other non-operating income, net

5,142

4,452

2,553

(3,309)

(1,355 )

(1,162)
(373)

Income (loss) from continuing operations

268

(4,355 )

(3,470)

Equity in earnings of subsidiaries
Net income (loss) from discontinued operations

46,266
348

20,123

(253 )

9,104
(644)

Net income

$ 46,882 $ 15,515

$ 4,990

See accompanying notes.

F-76

LSB Industries, Inc.

Schedule I - Condensed Financial Information of Registrant

Condensed Statements of Cash Flows

2007

Year ended December 31,
2006
(In Thousands)

2005

Net cash flows provided (used) by operating activities

5,953

(985) $ (2,484)

Cash flows from investing activities:

Capital expenditures
Proceeds from sales of property and equipment
Payment (purchase) of senior unsecured notes of a

subsidiary

Notes receivable from a subsidiary
Other assets

Net cash provided (used) by investing activities

Cash flows from financing activities:

Proceeds from 5.5% convertible debentures, net of fees
Proceeds from 7% convertible debentures, net of fees
Payments on other long-term debt
Payments of debt issuance costs
Net change in due to/from subsidiaries
Proceeds from exercise of stock options
Proceeds from exercise of warrant
Excess income tax benefit on stock options exercised
Dividends paid on preferred stock
Acquisition of non-redeemable preferred stock

Net cash provided by financing activities
Net increase (decrease) in cash

(71)
2

(30)
-

6,950
(29,886)
(147)
(23,152)

(6,950)
(6,400)
(209)
(13,589)

(9)
-

-
-
40
31

56,985
-
(4)
(209)
(4,832)
1,522
393
1,740
(2,934)
(1,292)
51,369
34,170

-
16,876
(1,655)
(356)
(1,134)
298
-
-
(262)
(95)

13,672

(902)

-
-
(4)
-
4,475
248
-
-
-
(597)
4,122
1,669

Cash at the beginning of year

881

1,783

114

Cash at the end of year

35,051

881

$ 1,783

See accompanying notes.

F-77

LSB Industries, Inc.

Schedule I - Condensed Financial Information of Registrant

Notes to Condensed Financial Statements

1. Basis of Presentation - The accompanying condensed financial statements of the parent
company include the accounts of LSB Industries, Inc. (the “Company”) only. The Company’s
investments in subsidiaries are stated at cost plus equity in undistributed earnings (losses) of
subsidiaries since date of acquisition. These condensed financial statements should be read in
conjunction with the Company’s consolidated financial statements.

2. Debt Issuance Costs - During 2007, we incurred debt issuance costs of $3,224,000 relating to
the 2007 Debentures. In addition, the remaining portion of the 2006 Debentures was converted
into our common stock. As a result of the conversions, approximately $266,000 of the remaining
debt issuance costs, net of amortization, associated with the 2006 Debentures were charged
against capital in excess of par value in 2007.

In 2006, the Company incurred debt issuance costs of $1,480,000 relating to the 2006
Debentures. During 2006, a portion of the 2006 Debentures were converted into our common
stock. As a result of the conversions, approximately $998,000 of the debt issuance costs, net of
amortization, associated with the 2006 Debentures was charged against capital in excess of par
value.

3. Commitments and Contingencies - The Company has guaranteed the payment of principal
and interest under the terms of various debt agreements of its subsidiaries. Subsidiaries’ long-
term debt outstanding at December 31, 2007, which is guaranteed by the Company is as follows
(in thousands):

Secured Term Loan due 2012
Other, most of which is collateralized by machinery, equipment and real estate

$ 50,000
11,358
$ 61,358

In addition, the Company has guaranteed approximately $6.3 million of our subsidiaries
performance bonds.

See Notes 11 and 13 of the notes to the Company’s consolidated financial statements for
discussion of the long-term debt and commitments and contingencies.

4. Preferred Stock and Stockholders’ Equity - At December 31, 2007 and 2006, a subsidiary
of the Company owns 2,451,527 shares of the Company’s common stock which shares have
been considered as issued and outstanding in the accompanying Condensed Balance Sheets
included in this Schedule I - Condensed Financial Information of Registrant. See Notes 2, 10, 14
and 15 of notes to the Company’s consolidated financial statements for discussion of matters
relating to the Company’s preferred stock and other stockholders’ equity matters.

F-78

LSB Industries, Inc.

Schedule I - Condensed Financial Information of Registrant

Notes to Condensed Financial Statements (continued)

5. Precious Metals - The Company had owned a specified quantity of precious metals used in
the production process at one of its subsidiaries. Precious metals are carried at cost, with cost
being determined using a FIFO basis. During 2007, the Company sold metals the subsidiary had
accumulated in excess of their production requirements. As a result, the Company recognized
gains of $4,259,000 for 2007 (none in 2006 and 2005) from the sale of these precious metals.
These gains included an intercompany profit of $2,248,000, which are eliminated in the
accompanying condensed statement of income through equity in earnings of subsidiaries. The
intercompany profit resulted from differences in the FIFO cost basis of these metals in relation to
the consolidated FIFO cost basis.

6. Interest Income - During 2006, the Company acquired an investment in senior unsecured
notes due 2007 (the “Notes”) of one of its subsidiaries, ThermaClime, of $6,950,000. During
2007, ThermaClime repaid the Notes. During 2007 and 2006, the Company earned interest of
$685,000 and $565,000, respectively, relating to the Notes. In 2006, the Company entered into a
$6,400,000 term loan due 2009 with ThermaClime. During 2007 and 2006, the Company earned
interest of $698,000 and $331,000, respectively, relating to this term loan. During 2007, the
Company entered into two demand notes totaling $29,886,000 with ThermaClime. During 2007,
the Company earned interest of $801,000 relating to these demand notes. In addition, the
Company has currently invested a portion of the net proceeds of the 2007 Debentures in money
market investments. During 2007, the Company earned interest of $752,000 relating to these
money market investments.

F-79

LSB Industries, Inc.

Schedule II - Valuation and Qualifying Accounts

Years ended December 31, 2007, 2006 and 2005

(In Thousands)

Balance at
Beginning of
Year

Additions-
Charges to
(Recoveries)
Costs and
Expenses

Deductions-
Write-offs/
Costs
Incurred

Balance at
End of
Year

Description

Accounts receivable - allowance for
doubtful accounts (1):

2007

2006

2005

Inventory-reserve for slow-moving
items (1):

2007

2006

2005

Notes receivable - allowance for
doubtful accounts (1):

2007

2006

2005

Deferred tax assets - valuation (1):

2,269

2,680

2,332

829

1,028

908

970

1,020

858

426

810

258

121

2007

2006

2005

$ 18,932

$ (18,932)

$ 25,598

$ 27,336

1,819

837

462

398

457

1,308

2,269

2,680

460

829

1,028

970

6,666

$ 18,932

1,738

$ 25,598

(1) Deducted in the consolidated balance sheet from the related assets to which the reserve applies.

Other valuation and qualifying accounts are detailed in our notes to consolidated financial statements.

F-80

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K/A
Amendment No. 1

(Mark One)

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES

EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2007

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

For the transition period from __________ to __________

Commission File Number: 1-7677

LSB INDUSTRIES, INC.
(Exact Name of Registrant as Specified in its Charter)

Delaware
(State of Incorporation)

16 South Pennsylvania Avenue
Oklahoma City, Oklahoma
(Address of Principal Executive Offices)

73-1015226
(I.R.S. Employer)
Identification No.)

73107
(Zip Code)

Registrant's Telephone Number, Including Area Code: (405) 235-4546

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class
Common Stock, Par Value $.10

Name of Each Exchange
On Which Registered
American Stock Exchange

Securities Registered Pursuant to Section 12(g) of the Act: Preferred Share Purchase Rights

(Facing Sheet Continued)

Indicate by check mark if the Registrant is a well-known seasoned issuer, as defined in Rule 405
of the Securities Act. [ ] Yes [X] No

Indicate by check mark if the Registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. [ ] Yes [X] No

Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]

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

As of March 7, 2008 the Registrant had 21,106,292 shares of common stock outstanding
(excluding 3,448,518 shares of common stock held as treasury stock).

Explanatory Note

The Annual Report on Form 10-K for LSB Industries, Inc. for the year ended December 31,
2007, as filed with the Securities and Exchange Commission on March 14, 2008, is being
amended by this Amendment No. 1 solely to reflect the dividends declared on preferred stock on
March 20, 2008 and to revise Part II, Item 5, to include information regarding the sale of
unregistered securities during 2007.

In connection with filing of this Amendment No. 1 and pursuant to Rule 12b-15, certain
certifications are attached as exhibits hereto. The remainder of the Form 10-K is unchanged and
is not reproduced in this Amendment No. 1. Except for the foregoing amended information, the
Form 10-K continues to describe conditions as of the date of the original filing of such Form 10-
K, and we have not updated the disclosures contained therein to reflect events that have occurred
at a later date.

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS

PART II

Market Information

Year Ended
December 31,

2007

2006

High
$ 15.71
$ 23.70
$ 25.25
$ 28.85

Low
$ 11.41
$ 14.76
$ 17.00
$ 20.54

High
$ 7.48
$ 9.19
$ 10.25
$ 13.20

Low

$
$
$
$

5.87
6.95
8.25
8.50

Quarter
First
Second
Third
Fourth

Stockholders

As of March 7, 2008, we had 698 record holders of our common stock. This number does not
include investors whose ownership is recorded in the name of their brokerage company.

Dividends

subsidiaries to pay dividends and to make distributions to us is restricted by certain covenants
contained in the $50 million revolving credit facility (the “Working Capital Revolver Loan”) and
the new $50 million loan agreement due 2012 (the “Secured Term Loan”). Under the terms of
these agreements, ThermaClime cannot transfer funds to us in the form of cash dividends or
other distributions or advances, except for:

•

• the amount of direct and indirect costs and expenses incurred by us on behalf of

•

• Series D Preferred at the rate of $.06 a share payable on October 9, which dividend is

cumulative;

• Non-Cumulative Preferred at the rate of $10.00 a share payable April 1, which are

non-cumulative; and

• Series B Preferred at the rate of $12.00 a share payable January 1, which dividend is

cumulative.

Our board of directors has declared the following dividends, payable on March 31, 2008,

to holders of record on March 21, 2008:

•

$12.00 per share on our outstanding Series B Preferred for an aggregate dividend of
$240,000;

$0.06 per share on our outstanding Series D Preferred for an aggregate dividend of
$60,000; and

$10.00 per share on our outstanding Non-Cumulative Preferred for an aggregate
dividend of $5,845.

All shares of Series B Preferred and Series D Preferred are owned by Jack E. Golsen, our
Chairman of the Board and Chief Executive Officer, members of his immediate family (spouse
and children), including Barry H. Golsen, our Vice Chairman and President, entities owned by
them and trusts for which they possess voting or dispositive power as trustee.

Sale of Unregistered Securities

Following are descriptions of all of our unregistered equity securities issued during 2007,
excluding transactions that were previously reported on Form 10-Q or Form 8-K. No
commissions or other remuneration was paid for these issuances.

On May 17, 2007, the Company issued to Claude Rappaport (a) 5,000 shares of common stock
upon the exercise of a Non-Qualified Stock Option Agreement, dated July 20, 2000, at the cash
exercise price of $5.362 per share, and (b) 80,000 shares of common stock upon exercise of a
Non-Qualified Stock Option Agreement, dated July 20, 2000, at the cash exercise price of $4.538
per share. The Company issued the shares pursuant to the exemption from the registration of
securities afforded by Section 4(2) of the Securities Act, as a transaction by an issuer not
involving a public offering. The purchaser agreed that the shares would be subject to the
standard restrictions applicable to a private placement of securities under applicable state and
federal securities laws, and appropriate legends were affixed to the share certificate issued to the
purchaser. The Company will use the aggregate proceeds of $389,850 for general working
capital purposes.

On November 9, 2007, Jayhawk Institutional Partners, L.P. exercised warrants, dated March 25,
2003, for the purchase of 112,500 shares of common stock at the cash exercise price of $3.49 per
share. The Company issued the shares pursuant to the exemption from the registration of
securities afforded by Section 4(2) of the Securities Act, as a transaction by an issuer not
involving a public offering. The purchaser agreed that the shares would be subject to the
standard restrictions applicable to a private placement of securities under applicable state and
federal securities laws, and appropriate legends were affixed to the share certificate issued to the
purchaser The Company will use the aggregate proceeds of $392,625 for general working
capital purposes.

Signatures

Dated:
March 27, 2008

LSB INDUSTRIES, INC.

By: /s/ Jack E. Golsen
Jack E. Golsen
Chairman of the Board and
Chief Executive Officer
(Principal Executive Officer)

By: /s/ Tony M. Shelby
Tony M. Shelby
Executive Vice President of Finance
and Chief Financial Officer
(Principal Financial Officer)

By: /s/ Jim D. Jones
Jim D. Jones
Senior Vice President,
Corporate Controller and Treasurer
(Principal Accounting Officer)

Dated:

March 27, 2008

Dated:
March 27, 2008

By: /s/ Jack E. Golsen

Jack E. Golsen, Director

By: /s/ Tony M. Shelby

Tony M. Shelby, Director

By: /s/ Barry H. Golsen

Barry H. Golsen, Director

By: /s/ David R. Goss

David R. Goss, Director

By: /s/ Raymond B. Ackerman

Raymond B. Ackerman, Director

By: /s/ Robert C. Brown MD

Robert C. Brown MD, Director

By: /s/ Charles A. Burtch

Charles A. Burtch, Director

By: /s/ Robert A. Butkin

Robert A. Butkin, Director

By: /s/ Bernard G. Ille

Bernard G. Ille, Director

By: /s/ Donald W. Munson

Donald W. Munson, Director

By: /s/ Ronald V. Perry

Ronald V. Perry, Director

By: /s/ Horace G. Rhodes

Horace G. Rhodes, Director

By: /s/ John A. Shelley

John A. Shelley, Director

Exhibit
Number

31.1

31.2

32.1

32.2

Description

Certification of Jack E. Golsen, Chief Executive Officer, pursuant to Sarbanes-
Oxley Act of 2002, Section 302.
Certification of Tony M. Shelby, Chief Financial Officer, pursuant to Sarbanes-
Oxley Act of 2002, Section 302.
Certification of Jack E. Golsen, Chief Executive Officer, furnished pursuant to
Sarbanes-Oxley Act of 2002, Section 906.
Certification of Tony M. Shelby, Chief Financial Officer, furnished pursuant to
Sarbanes-Oxley Act of 2002, Section 906.

Performance Graph

The following table compares the yearly percentage change in the cumulative total
stockholder return of (a) the Company, (b) a composite index ("Peer Group") comprised of a peer
group of entities from two distinct industries which represent the Company's two primary lines of
business (Climate Control and Chemical), and (c) the American Stock Exchange Market Value
Index ("AMEX MVI"). The table set forth below covers the period from year-end 2002 through
year-end 2007.

12/31/02

12/31/03

12/31/04

12/30/05

12/29/06

12/31/07

D
O
L
L
A
R
S

1,050

950

850

750

650

550

450

350

250

150

LSB INDUSTRIES, INC.

PEER GROUP

AMEX MVI

FISCAL YEAR ENDING

12/31/2002 12/31/2003 12/31/2004 12/30/2005 12/29/2006 12/31/2007

LSB Industries, Inc.
PEER GROUP
AMEX MVI

100.00
100.00
100.00

227.86
123.05
136.11

283.93
154.98
155.86

219.64
162.86
171.89

413.57
207.37
192.45

1007.86
266.56
216.06

Assumes $100 invested at year-end 2002 in the Company, the Peer Group, and the AMEX

MVI, and the investment of dividends, if any.

The Peer Group was developed for the Company by Morningstar, Inc. (Hemscott Data) and is
comprised of all companies that have specified Hemscott Data Group General Index Groups
codes, which the company believes correspond to the Company’s primary lines of business. The
Peer Group is comprised of (a) climate control companies having Hemscott Data Group code 634
(general building materials) and (b) chemical companies having a Hemscott Data Group codes

112 (agricultural chemicals) and 113 (specialty chemicals), and is provided for comparison to the
company’s two primary lines of business, Climate Control and Chemical. The companies which
comprise the Peer Group are listed below. The Company has been advised that the cumulative
total return of each component company in the Peer Group has been weighted according to the
respective company’s stock market capitalization as of the beginning of each yearly period. The
AMEX MVI line is provided because the Company believes that those companies listed in the
AMEX MVI most closely resemble the size and composition of the Company. In light of the
Company’s unique industry diversification and current market capitalization, the Company
believes that the Peer Group and AMEX MVI are appropriate for comparison to the Company.
The above Performance Graph shall not be deemed incorporated by reference by any general
statement incorporating by reference this Annual Report into any filing under the Securities Act
of 1933 or the Securities Exchange Act of 1934 (collectively, the “Act”), except to the extent that
the Company specifically incorporates this information by reference, and shall not otherwise be
deemed to be soliciting material or to be filed under such Acts.

AAON INC
ADA-ES INC
ADM TRONICS UNLIMITED
AE BIOFUELS INC
AGRIUM INC
ALLEGRO BIODIESEL CORP
ALTAIR NANOTECHNOLOGIES
AMCOL INTERNATIONAL CORP
AMERICAN PACIFIC CORP
AMERICAN VANGUARD CORP
AMERON INTERNAT CORP
ARMSTRONG WORLD IND INC
AVENTINE RENEWABLE ENRGY
BLASTGARD INTERNAT INC
BRASKEM PFD CL A ADR
CABOT CORP
CALCITECH LTD
CF INDUSTRIES HOLDINGS
CHEMTURA CORP
CHINA CLEAN ENERGY INC
CHINA HUAREN ORGANIC PRD
CHINA YINGXIA INTERNAT
COMPASS MINERALS INTL
CONTINENTAL MATERIALS CP
CYANOTECH CORP
CYTEC INDUSTRIES INC
DIATECT INTERNAT CORP
DREW INDUSTRIES INC
DUPONT E I NEMOURS & CO
DYNAMOTIVE ENERGY SYSTMS
EARTH BIOFUELS INC
ECOLOGY COATINGS INC
EDEN BIOSCIENCE CORP
ETHANEX ENERGY INC
ETHOS ENVIRONMENTAL INC
FASTENAL COMPANY
FERRO CORP
FLEXIBLE SOLUTIONS INTL
FLOTEK INDUSTRIES INC
FUDA FAUCET WORKS INC

PEER GROUP

GREEN PLAINS RENEWABLE
GRIFFON CORP
GULF RESOURCES INC
H.B. FULLER CO
H2DIESEL HOLDINGS INC
HEADWATERS INC
HELIX BIOMEDIX
HERCULES INC
IMPERIAL INDUSTRIES INC
INNOSPEC INC
INTERNAT BARRIER TECHNL
INTREPID TECHNOLOGY&RESR
ISONICS CORP
ITRONICS INC
KMG CHEMICALS INC.
KOLORFUSION INTERNATIONL
KREIDO BIOFUELS INC
KRONOS WORLDWIDE INC
LAPOLLA INDUSTRIES
LUBRIZOL CORP
MACE SECURITY INTERNAT
MARTIN MARIETTA MATERIAL
MDU RESOURCES GROUP INC
METHANEX CORPORATION
METWOOD INC
MOMENTUM BIOFUELS INC
MONSANTO CO
MOSAIC CO
NCI BUILDING SYSTEMS INC
NEVADA CHEMICALS INC
NEW ORIENTAL ENER & CHEM
NEWMARKET CORP
NO FIRE TECHNOLOGIES INC
OIL-DRI CORP OF AMERICA
OM GROUP INC
OMNOVA SOLUTIONS INC
ORION ETHANOL INC
OWENS CORNING INC
PACIFIC ETHANOL INC
PANDA ETHANOL INC

PENFORD CORP
PGT INC
POLY-PACIFIC INTERNAT
PURE BIOFUELS CORP
QEP CO INC
QUAKER CHEMICAL CORP
RENEWAL FUELS INC
RONSON CORP
RPM INTERNATIONAL INC DE
SCOTTS MIRACLE GROW CO
SENSIENT TECHNOLOGIES CP
SHENGDATECH INC
SIGMA-ALDRICH CORP
SOIL BIOGENICS LTD
SYNGENTA AD FOR NVS
SYNTHENOL INC
SYNTHETECH INC
TAT TECHNOL LTD
TECUMSEH PRODUCTS CL A
TECUMSEH PRODUCTS CL B
TERRA INDUSTRIES INC
TERRA NITROGEN CO L.P.
TIGER RENEWABLE ENERGY L
TRANE INC
U.S. LIME & MINERALS INC
UAP HOLDING CORP
UNITED ENERGY CORP
US BIOENERGY CORP
USG CORP
VALSPAR CORP THE
VERASUN ENERGY CORP
VERENIUM CORP
VERIDIEN CORP
VIOSOLAR INC
VULCAN MATERIALS CO
W.R. GRACE & CO
WD-40 CO
WESTLAKE CHEMICAL CORP
WILLIAMS PARTNERS LP

LSB Directors

LSB Ofﬁ cers

Directors and Ofﬁ cers:

RAYMOND B. ACKERMAN
Chairman Emeritus of
Ackerman McQueen, Inc.

MICHAEL G. ADAMS, C.P.A.
Vice President,
Financial Services

Subsidiary
Executive Ofﬁ cers

JOSEPH A. CAPPELLO
President,
ClimateCraft, Inc.

HEIDI L. BROWN, J.D., L.L.M.
Vice President,
Managing Counsel

DAN ELLIS
President,
Climate Master, Inc.

JUDI BURNETT
Assistant Vice President,
Risk Management

JOHN CARVER
Vice President,
Environmental and Safety
Compliance

JIM D. JONES, C.P.A.
Senior Vice President,
Corporate Controller and
Treasurer

ANN MUISE-MILLER, J.D.
Assistant Vice President,
Associate General Counsel

STEVEN J. GOLSEN
Co-Chairman, CEO
Climate Master, Inc. and
COO, Climate Control Business

PHIL GOUGH
Senior Vice President,
Agrochemical Group

BRIAN HAGGART
President,
Trison Construction, Inc.

LARRY L. JEWELL
President,
International Environmental
Corporation

JAMES WM. MURRAY, III, J.D.
Vice President, Senior
Associate General Counsel

ANNE RENDON
President,
El Dorado Nitric Company

BRUCE SMITH
President,
Summit Machine Tool
Manufacturing Corp.

PAUL RYDLUND
Senior Vice President,
Business Development

HAROLD RIEKER, C.P.A.
Vice President,
Financial Reporting

DAVID M. SHEAR, J.D.
Senior Vice President,
General Counsel and Secretary

MIKE TEPPER
Senior Vice President,
International Operations

ROBERT C. BROWN, M.D.
V.P., Plaza Medical Group, P.C.
President and CEO
ClaimLogic, LLC

CHARLES (CHUCK) A. BURTCH
Former Executive Vice President
and West Division Manager
of BankAmerica

ROBERT BUTKIN, J.D.
Professor of Law and former Dean,
University of Tulsa, College of Law
Former Oklahoma State Treasurer

JACK E. GOLSEN
Board Chairman and CEO

BARRY H. GOLSEN, J.D.
Board Vice Chairman, COO and
President, LSB Industries and
President, Climate Control
Business

DAVID R. GOSS, C.P.A.
Executive Vice President
of Operations

BERNARD G. ILLE
Former CEO and Board Chairman
First Life Assurance Company

DONALD W. MUNSON
Former President of Lennox Corp
President Ducane Europe

RONALD V. PERRY
President, Prime Time Travel

HORACE G. RHODES, L.L.B.
Chairman,
Kerr, Irvine, Rhodes and Ables

TONY M. SHELBY, C.P.A.
Executive Vice President
of Finance, CFO

JOHN A. SHELLEY
President, CEO and Chairman,
The Bank of Union

Headquarters
LSB Industries, Inc.
16 South Pennsylvania Ave.
Oklahoma City, OK 73107
Tel: (405) 235-4546
Fax: (405) 235-5067
Email: info@lsb-okc.com

Investor Relations
The Equity Group Inc.
Linda Latman
Tel: (212) 836-9609
Fax: (212) 421-1278
Email: llatman@equityny.com

Independent Auditors
Ernst & Young LLP
Oklahoma City, OK

Security Listing
Common Stock listed on the
American Stock Exchange
AMEX Ticker Symbol: LXU

Transfer Agent &
Registrar
Computershare Trust Company, N.A.
P.O. Box 43078
Providence, RI
02940-3078
Tel: (800) 884-4225 (US & Canada)
(781) 575-4706 (outside US & Canada)

Website
www.lsb-okc.com
Visit our website for details
about our plants, products,
operations and policies.