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LSB Industries, Inc. (NYSE:LXU)

Q4 2008 Earnings Call

March 12, 2009 5:15 pm ET

Executives

Carol Oden – Investor Relations

Jack E. Golsen - Chairman of the Board & Chief Executive Officer

Tony M. Shelby - Chief Financial Officer, Executive Vice President, Finance & Director

Barry H. Golsen - Vice Chairman of the Board, President & President, Climate Control Business

Analysts

Steve Denault – Northland Securities

Eric Prouty – Canaccord Adams

Richard Hoss – Roth Capital Partners, LLC.

Daniel Mannes – Avondale Partners, LLC

Steve Burns – Merrill Lynch

Gregg Hillman – First Wilshire Securities

Michael Coleman – Sterne, Agee & Leach

Operator

Welcome to the LSB Industries, Inc. fourth quarter 2008 conference call. At this time I would like to inform you that this conference is being recorded and that all participants are currently in a listen only mode. I will now turn the conference over to Carol Oden.

Carol Oden

Welcome to the LSB Industries fourth quarter 2008 conference call. Today LSB’s management participants are Jack Golsen, Chairman and Chief Executive Officer; Barry Golsen, President; and Tony Shelby, Chief Financial Officer. This conference call is being broadcast live over the Internet and is also being recorded. An archive of the webcast will be available shortly after the call on our website at www.LSB-OKC.com and will be accessible for one month.

After comments by management a question-and-answer session will be held. Instructions for asking questions will be provided at that time. Information reported on this call speaks only as of today, March 12th, 2009 and therefore you are advised that time-sensitive information may no longer be accurate as of the time of any replay. Comments today may contain certain forward-looking statements.

All statements other than statements of historical facts are forward-looking statements. Statements that include the words expect, intend, plan, believe, project, anticipate, estimate and similar statements of a future or forward-looking nature identify forward-looking statements including but not limited to start up of Pryor, Oklahoma chemical plant and the amount of capital expenditures to begin operations at the Pryor plant, amount of production at the Pryor plant, the effects of the current recession on our businesses during 2009.

Our future depends on the return of some stability in the credit and capital markets, sales of our chemical products to power plants expected to increase, we have liquidity and available credit needed to continue with investments required for our planned long term growth, minimized controllable or variable costs during downturns, initiatives we have begun that we will not curtail during the economic downturn such as start up of the Pryor chemical plant and expansion of the geothermal heat pumps as they represent long term growth potential, borrowing availability under our working capital revolver, amount of capital expenditures related to our chemical and climate control businesses, outlook for and effects on the commercial and residential construction due to the recession, effect of Stimulus Package on our sales of geothermal heat pumps and certain other products produced by our climate control business, lower sales in 2009 and our chemical control business and 2008 sales of geothermal heat pumps, optimistic about long range growth potential for our geothermal products, sales of products by our chemical business during 2009, prospects for growing our climate control business over the long term and long term outlook for our chemical business.

You should not rely on forward-looking statements because actual events or results may differ materially from those indicated by these forward-looking statements as a result of a number of important factors.

These factors include but are not limited to a decline in general economic conditions, interest rate changes, competitive pressures, changes in working capital and the risks and uncertainties discussed under the heading Special Note Regarding Forward-Looking Statements in our annual report on Form 10-K for the fiscal year ended December 31st, 2008 and the reports we file from time to time with the Securities and Exchange Commission.

We do not intend to and undertake no duty to update the information contained in this conference call. The term EBITDA as used in this presentation is net income plus interest expense, depreciation, amortization, income taxes and certain non-cash charges unless otherwise described. EBITDA is not a measure of financial performance under GAAP and should not be considered as an alternative to GAAP measurement.

We will post on our website a reconciliation to GAAP of any EBITDA numbers discussed during this conference call. Now I will turn the conference call over to Mr. Jack Golsen, the company's Board Chairman.

Jack E. Golsen

Welcome to LSB’s fourth quarter year end 2008 conference call. Today our Chief Financial Officer and Executive Vice President, Tony Shelby, will review our overall financial results for the year, then our President and Chief Operating Officer, Barry Golsen, will discuss both of our businesses. After these presentations Tony, Barry and I will be available to answer your questions.

First I would like to make a few general comments. We continuously get questions about the economy. We do not have any special knowledge about our economy. However we can give you information on what we are experiencing in our markets at this time. Stating the obvious future growth in some of our businesses depend on the return of some stability in the credit and capital markets.

However there are some exceptions to this. In addition to our geothermal heat pump sales our chemical company sales to power plants of products which are used by them to abate objectionable emissions are expected to increase. Some of the chemicals we produce our helping to clean up the environment. This is a small but growing market segment for us and is expanding beyond power plants into cleaning the exhaust from diesel engines.

All indications are the general level of future activity in the near term will be less than it has been in certain areas. At this time we believe that the short term general economy will be negative but we also believe that we’re doing the right things to position LSB to improve and grow as the current economy and markets allow and just as importantly prepare for the business opportunities ahead once the economy turns around.

We also believe that we have the liquidity and available credit we need to continue with the investments required for our planned long term growth. We reported our fourth quarter and year end results in a news release this afternoon and I believe we’ve already filed our 10-K in the last few minutes, haven’t we Tony?

Tony M. Shelby

We should momentarily, yes.

Jack E. Golsen

If we haven’t it should be coming over the wire now. In previous years there were tax benefits that reduced our income tax expense. In 2008 our earnings were taxed at regular corporate rates. Hitting the high points our sales for 2008 were $749 million with the highest pre-tax operating profit and EBITDA in company history. Our diluted earnings per share were $1.58.

Since we have used up our net operating loss carry forward we are now a taxpayer so our earnings per share were lower than the $1.84 in 2007. Tony and Barry will fill you in on the details about the fourth quarter and the full year. Chemicals operating income in 2008 was adversely affected by approximately $7.2 million due mainly to unprecedented volatile commodity markets during the year.

Tony will also discuss this in more detail. We previously disclosed that we were consider activating a portion of the Pryor plant subject to securing a sales agreement with a strategic customer to distribute the majority of the planned UAM production. We have now received the necessary permits to operate the plant.

We have hired key personnel to operate the facility and have positioned the additional necessary personnel to be hired at appropriate intervals during preparation for start up. Barring unforeseen delays and subject to deciding on a sale or distribution arrangement that satisfies us we expect production to be implemented in the third quarter of 2009.

This plant is expected to add 325,000 tons of UAN and 35,000 tons of anhydrous ammonia to our overall annual production. We can expect these numbers to fluctuate according to market conditions. We are also considering the addition of other industrial products to our production at this plant and are discussing this possibility with industrial users. At this point I would like to give you some insight into our planning.

The initial reaction to times like these by many companies is to absolutely minimize all expenses in an effort to maximize current earnings to the detriment of future growth and earnings. We will attempt to minimize most controllable or variable costs during the downturn. However we will stop short and will not adopt a slash and burn approach for the sake of increasing current earnings.

We believe that there are certain initiatives that we have undertaken that are strategically important to the long term continued growth of LSB and we will not curtail these programs in an effort to boost profits in the short term. A couple of good examples of programs like these are the Pryor plant start up and our continued expansion of our geothermal heat pump manufacturing facilities and our more intensified geothermal heat pump sales and marketing efforts.

These initiatives represent significant medium and long term growth potential for LSB but also bear costs that could diminish short term earnings and of course we will not interrupt our ongoing new product development efforts. There are numerous other initiatives that I will discuss at a later date at other conference calls.

At LSB we have historically made our decisions based on a long term perspective when we have been able to do so. We will continue to do what we believe is in the best long term interest of our shareholders. I will now turn this conference to Tony for a financial review.

Tony M. Shelby

We made our earnings announcement approximately one hour ago reporting diluted earnings per share of $0.16 for the fourth quarter of 2008 versus $0.20 in the 2007 fourth quarter. The details of the fourth quarter 2008 compared to the fourth quarter of 2007 were sales rose to $179.5 million up from the $134.7 million. Operating income declined to $1.8 million from $11.2 million.

Net income applicable to common stock was $3.6 million compared to $4.5 million. Diluted earnings per share $0.16 versus $0.20 for the same quarter. Consolidated EBITDA was $11.7 million compared to $15.3 million. Before proceeding to review the full year results there are some significant unusual items in the fourth quarter of both year affecting the comparability of operating income and net income that requires explanation.

As mentioned GAAP operating income declined from $11 million to $1.8 million. However included in the fourth quarter 2008 were two loss items totaling $7.2 million that are due to the steep decline in commodity prices and the effects of the general economic slowdown. There were two loss items in the fourth quarter totaling $7.2 million. In 2008 unrealized losses from commodity contracts still held at year end were $3.6 million.

The chemical commodity losses were $3 million and climate control copper hedging were $600,000. The second write down was chemical inventories to the lower cost of market and was also $3.6 million so those two items totaled about $7.2 million in our fourth quarter.

Additionally the fourth quarter of 2007 included a net $2.1 million resulting from a $2.3 million gain from a business interruption recovery so the $7.2 million in the fourth quarter of ’08 write down plus the $2.1 million gain in the fourth quarter that was non-recurring would be a total of $9.3 million of unusual non-recurring items negatively affecting the comparability of the two quarters.

Excluding the unusual items from the fourth quarter 2008 and form the fourth quarter 2007 the pro forma operating income for the 2008 quarter would be approximately the same as in 2007. We will discuss the sales and operating income relationship later in the call when we review the results of each of business segment.

Pre-tax income for the fourth quarter of 2008 was $2.5 million compared to $8.1 million or a decline of $5.6 million. The $2.5 million pre-tax income is after the unusual losses of $7.2 million in addition to a $3 million loss on interest rate hedge positions which is included in interest expense partially offset by $5.5 million gain from the repurchase of a portion of the company’s subordinated debentures.

Comparability of the net income between the two quarters was also affected by income taxes. We recorded a tax benefit or income of $1.0 million in the 2008 quarter whereas we had a tax provision or expense of $3.6 million in the 2007 quarter.

The benefit in the fourth quarter of ’08 consisted of a tax provision at statutory rates offset by state tax credits, certain true ups for the actual tax for 2007 after the returns were filed and a $1.3 million deferred tax asset for state net operating loss carry forwards not previously reflected. Income taxes are fully explained in our 10-K which I believe is being filed as we speak.

Our climate control business performed well during the fourth quarter. Climate control sales of $81.81 million were 25% higher. Operating income increased 25% to $7.9 million and EBITDA increased $8.7 million compared to $7.1 million in 2007’s fourth quarter.

For the fourth quarter chemicals reported sales of $94.8 million compared to $66.4 million however chemicals reported operating income decreased from $7.9 million to a loss of $3.1 million and EBITDA decreased from $10.1 million to an approximate break even both decreases due to the unusual loss I mentioned earlier and certain other higher costs in 2008 for maintenance turnarounds in the quarter.

Turning the full year 2008 as compared to 2007 sales were $749 million up from $586 million, operating income was $59.2 million or approximately the same as $59 million the prior year. Net income applicable to common stock was $36.2 million compared to $41.3 million a decrease of $5.1 million. Provisions for income taxes in 2008 were $18.8 million as compared to only $2.5 million in 2007.

During 2007 we were able to utilize net operating loss carry forwards, however in 2008 were taxed at full rates. Diluted earnings per share were $1.58 versus $1.84 in 2007. Consolidated EBITDA was $80.8 million compared to $73.7 million in 2007. For the full year our climate control business improved both its top and bottom line, sales were up 9% to $311 million, segment operating income was up 14% to $38.9 million and EBITDA was up 13% to $42 million.

The chemical business also had higher sales at $424 million for the full year a 47% increase. However both its segment operating profit and EBITDA were lower than 2007. Operating income was $31.3 million a 10% reduction and EBITDA was $41.8 million down 6% from 2007.

Moving to the balance sheet we were able to repurchase 19.5 million principal amount of our subordinated debentures due 2012 for $13.2 million and recognized a gain from the extinguishment of debt of $5.5 million net of $800,000 unamortized debt issuance costs associated with those subordinated debentures.

Our credit liquidity and capital resources reflect a sound financial position. At December 31st, 2008 after the repurchase of the debentures our long term debt was $105 million and stockholders’ equity was $130 million. The long term debt to stockholders’ equity was approximately .8 to 1.

Cash on hand at December 31st was $46.2 million and is currently approximately the same amount. Our borrowing availability under our $50 million working capital revolver was and is $49.5 million. Based upon our present financial position and our business plan we have adequate working capital to finance ongoing operations as well as organic growth opportunities.

We do however plan to finance certain of our planned expenditures. For 2008 net cash provided by operating activity was $32 million after income taxes of $18.8 million and after increases of $16.5 million in receivables and inventories. Cash used for capital expenditures was $32.6 million.

We used cash of $13.2 million to repurchase the subordinated debentures and $4.8 million to purchase 400,000 shares of our common stock in 2008. Including those and other sources and uses of cash net cash for 2008 was $12 million. A $32.6 million capital expenditures include $8.7 million for climate control and $23.6 million for chemical.

For 2009 we have planned capital expenditures for both our climate control and chemical business that would utilize a significant amount of our existing cash on hand if not separately financed. At this date we have planned capital expenditures of $16 million in our chemical business for process and reliability improvements and $13 million in our climate control business primarily for production equipment and facilities upgrades.

If we restart Pryor we will spend another $6 million to $8 million on capital equipment. We will continue to monitor our business activity level and to the extent possible adjust our capital spending appropriately. In addition as has been widely and frequently discussed we are considering the activation of the Pryor, Oklahoma facility. At December 31 we had committed capital expenditures of $2.9 million for Pryor.

If we proceed with the start up we anticipate spending another $13 million to $17 million to complete the start up including the $6 million to $8 million for capital expenditures and to borrow $7 million to $9 million that would be expensed as incurred.

If we do restart Pryor the $7 million to $9 million that will be expensed before that business generates sales or income will affect our results from ongoing operations during the first three quarters of 2009 and until Pryor is up and running. This year in our quarterly reports and conference calls we will keep you updated relative to this potential start up.

That concludes the financial review. Barry will now cover operational highlights and the outlook for the company.

Barry H. Golsen

Before I get started today I wanted to say that this operational review is going to be a little longer than usual. Because of the volatility in the economy right now we’ve spent more time discussing what’s actually going on in the markets than we usually do and it’ll be a little more extensive in that area of the review.

First let’s talk about the climate control business. As Tony mentioned our climate control business sales during the fourth quarter were higher than the same period last year by about 25%. Total heat pump sales were up 45%, fan coil sales were down 13% and sales of other product and services were up 27%.

As discussed in prior conference calls our shipments in the first half of 2007 were unusually high because we were in the process of working off excessively high backlogs. Despite these high sales levels in 2007 our 2008 sales were still higher than 2007 by 9%. For the full year heat pump sales were up 16%, fan coil sales were down 3% and other sales were up 4%.

New product orders during the fourth quarter were $59.1 million a 10% year-over-year increase and a 42% decline from the third quarter. For all of 2008 our order intake was $305.9 million up 27% over 2007. However as discussed earlier there was a drop off from Q3 to Q4. The fourth quarter is usually weak for new orders in our climate control business.

However we feel that in 2008 the expected lower fourth quarter bookings were further reduced by the general weak economic condition. I will discuss this in more detail later. We ended the year with a backlog of product orders of $68.5 million down from $85.8 million at the end of the third quarter and up from $54.5 million at 12-31-07.

I’m glad to report that as of the end of 2008 we continued to maintain leading market shares for geothermal and water source heat pump and for hydronic fan coils. Our gross margin during the fourth quarter of 2008 was 30% up from 28.6% for the same period in 2007. For the full year 2008 our gross margin was 31% up from 29.2% in 2007.

During 2008 we had gains from copper hedging of $1.3 million in excess of gains during 2007 and this accounted for approximately 25% of the gross margin percentage improvement. With regard to raw materials copper, steel and aluminum since our last conference call we have seen considerable downward movement.

Market prices declined through the fourth quarter and this continued into the beginning of 2009. We will not realize the full impact of these cost decreases during 2009 because during 2008 we bought ahead to a certain extent as we usually do to ensure a supply of materials for our operations.

In addition the market is extremely competitive at this time and this could adversely affect our selling prices and offset savings made from lower raw material costs. We continue to watch commodities very closely and to hedge when we believe it’s appropriate. During the fourth quarter our operating profit improved substantially over the fourth quarter of 2007. It increased 25% the same rate of growth of sales during the period.

For the full year 2008 our operating profit increased 14% over 2007 to $38.9 million. The primary cause for improvement during 2008 was increased sales and profits in our heat pump business. A key question that we are asked frequently is what is the outlook for construction both commercial and residential?

Due to the trauma caused by the worst financial crisis in decades which is still unresolved at this time the availability of credit to our customers going forward is still in question. So with the assumption that credit availability will stabilize at some point and investor confidence will also improve at some point I will attempt to discuss the current outlook.

McGraw-Hill Construction Research Analytics, construction market forecasting service, released its spring construction outlook in late January. To quote some highlights from the McGraw-Hill report and I quote the dire state of the economy continued in [inaudible] and credit markets and inability of housing markets to find bottom have combined to downgrade the outlook for construction.

Continue to quote, the American Recovery and Reinvestment Act of 2009 will have a positive impact on construction starts during 2009 but will not come early enough or be broad enough to bring the market into positive territory. On the positive side the housing market is expected to reach a trough by the end of 2009.

Finally the economic recession and credit market crisis will pull down this year’s nonresidential construction starts. Much of the decline will come from commercial building. Institutional building starts will also pull back in 2009 but by a more modest amount than either commercial or industrial construction thanks to the stimulus packages initiatives for education and dorms as well as transportation and public buildings. That’s the end of the quote.

At LSB we believe that there are certain provisions of the stimulus package that could have a direct effect on the sales of geothermal heat pumps and other products that can be used for education, dorms, public housing, military bases and other government buildings. I will discuss this in more detail later.

The vast majority of our climate control business sales are to commercial and institutional new construction, renovation and replacement. For 2008 commercial and institutional sales accounted for approximately 81% of total climate control business sales. 62% of our total climate control business sales were used in offices, hotels, educational facilities, healthcare, retirement facilities, manufacturing and process plants, apartments and condominiums.

In the same report that I was discussing before in McGraw-Hill’s current outlook as reported in the spring edition is that for those specific building types I just listed in the aggregate there will be a decrease of 17.5% in 2009 followed by increases of 4.6% and 12.8% in 2010 and 2011 and that’s a decrease of new contract awards.

These numbers represent a significant downward revision since the last conference call. The reduction from the prior year is approximately twice as much as they were looking at a quarter ago. In addition to the McGraw-Hill forecast we also look at the Architectural Billings Index which is an indicator of future construction activity nine to 12 months in the future.

For the past few months the ABI as it’s referred to has been at an all time low since the inception of the Index in 1995. In addition to looking at outside surveys and indexes we also of course consider direct input from our sales force and right now the reading we’re getting from the sales force is that there is a pipeline of construction activity at various planning and design phases but that certain markets have been hit very hard.

In addition there is a hesitancy by developers to proceed with new projects and some projects have been put on hold or cancelled. Finally our order level in the first two months of 2009 has been very low averaging $16.2 million per month. Considering all of these inputs we believe that sales in 2009 will be lower than 2008 but we can’t accurately forecast to what extent at this time.

The level of commercial construction, the primary driver of new orders for our climate control business, will largely be determined by what happens in the credit markets and in the confidence level of builders and developers. Because it is an area of importance to many of you I would like to discuss our residential geothermal sales.

It is stating the obvious to describe the dismal situation in the single family residential construction market. According to McGraw-Hill there was a 39% decline in 2008 following a cumulative decline of almost 40% during 2006 and 2007. McGraw-Hill is forecasting another decline of 18% in 2009.

It’s important to focus on the fact that in 2008 our sales into the single family residential market which for us is all geothermal heat pumps represented only 19% of climate control business sales which was up substantially from 11% in 2007. Despite the lagging residential market that I just described our fourth quarter residential geothermal sales increased 157% over the fourth quarter of 2007.

For the full year residential geothermal sales were up 82%. Even more encouraging were bookings for these products. During the fourth quarter they were up 138% over the same period last year. For all of 2008 our residential geothermal bookings were up 147%. To put it another way our single family residential geothermal new order level during 2008 was up approximately 2.5 times over the 2007 level all in the face of a US housing market that has been decimated.

Here are some other interesting metrics about the geothermal market. In 2005 the total geothermal market in the United States was approximately 40,000 units per year about two thirds of that residential and one third commercial and institutional. The market doubled to about 80,000 units in 2008.

During that same time frame the total US shipments for conventional unitary air conditioners and air source heat pumps declined 32% from 8.5 million to 5.28 million units per year according to the Air Conditioning, Heating and Refrigeration Institute. The two key take away points from this are first, so far geothermal heat pump sales have bucked the downward trend in both construction and conventional unit sales.

Second, the size of the potential market for this product is huge. As I reported during the last conference call the Economic Stability Act of 2008 also known as the $700 Million Bailout Package that was enacted in late October included certain tax incentives designed to encourage the purchase of residential and nonresidential geothermal heat pumps, a residential credit capped at $2,000 per installation and Federal tax credits for businesses equal to 10% of the total system cost for nonresidential systems.

As these were enacted very late in the year and at a time when construction is at a seasonal low level during the winter weather there was very little discernible impact during December or the first two months of 2009. However in February the President signed into law the huge economic stimulus package formally known as the American Recovery and Reinvestment Act.

This law extended the tax incentives for businesses that were in the earlier law, eliminated the $2,000 cap for residential geothermal systems bringing the individual tax credit up to 30% of the total installed system cost and also included provisions for several billion dollars of Federal spending on construction with an emphasis on energy efficiency upgrades to existing buildings.

Some highlights are tax credits, both personal and business, will stay in effect for eight years. These tax credits can offset both regular and alternative minimum tax liabilities. The Bill also includes 50% first year bonus depreciation for businesses. The Bill also provides that any property which is described as energy property including for geothermal heat pumps is depreciable over five years.

Small businesses can write off up to $250,000 of capital expenditures in the year the money is spent and finally over $75 billion of direct spending or programs related to building construction and renovation many focusing on energy efficiency upgrades. In addition many states have incentives at this time and we are hopeful that spurred by the new Federal legislations others will get on board and states that currently have incentives will increase them.

We believe that our geothermal products are an important part of the solution to the environmental and energy issues facing the country and we remain very optimistic about the long range growth potential for these products. Whereas our historic business model has not been predicated on any tax incentives we certainly plan to take advantage of these to the extent possible to promote sales of these products.

To that end we have substantially intensified our sales and marketing programs for geothermal products and will continue to do so. We’re also preparing our manufacturing facilities to handle any increased volume that may result from these efforts. In the last two years we’ve doubled our heat pump manufacturing floor space and added production equipment and we are in the planning stages for another significant plant addition of 78,000 square feet.

We have also doubled the capacity of our air coil manufacturing facility and are planning another expansion to that facility to allow for additional growth and increase the operational efficiencies of that operation. Turning to our chemical business as Tony reported this business got off to a great start in the first half of the year but hit road bumps in the third quarter and it was severely impacted by the worldwide economic crisis in the fourth quarter.

The volatility in commodity prices and generally low confidence level both impacted this business sector. During the fourth quarter total sales of our chemical products were up 43% over the fourth quarter of 2007. The increased sales were driven by substantially higher raw material costs that translated into higher sales prices. However gross profit and operating income were down.

Gross profit decreased from $11 million in the fourth quarter of 2007 to $800,000 in 2008 and operating income decreased from $7.9 million in 2007 to a loss of $3.1 million in the fourth quarter. Backing out the $6.6 million impact of the unusual loss items Tony discussed in detail operating income from the 2008 quarter would have been $3.5 million. During the fourth quarter we were in a very volatile market as the following information will indicate.

During the fourth quarter our shipped tonnage of UAN fertilizer, urea ammonium nitrate, was 17% higher and our revenues from these sales increased 103%. The published sales price per ton as quoted in Green Markets for the Southern Plains during the fourth quarter ranged from $260 to $485 per ton as compared to a range of $270 to $365 a year ago.

The average sales price per ton for UAN was slightly higher than two years ago and natural gas prices were approximately the same resulting in improved margins for UAN. Currently the published prices for UAN are $230 to $250 per ton while the NIMEX spot market natural gas price is approximately $4 per NMBTU.

Our revenues for ammonium nitrate fertilizer were lower than the fourth quarter of 2007 by 10% reflecting increased sales price per ton but lower tons shipped in 2008. During 2007 the Green Market Southern Plains range of public prices for UAN was $315 to $365 per ton compared to $275 to $570 in 2008. The price of anhydrous ammonia, the raw material feedstock for our El Dorado facility, which manufactures this AN escalated significantly during the first nine months of the year after being relatively stable during 2007.

Published prices at the Tampa Price Point increased from an average of the mid $400s per metric ton in January to a range of $585 to $931 per metric ton during the third quarter. Since that time ammonia has tumbled and during the fourth quarter the published price declined from $931 to $135 per ton. Today’s price is $275 per metric ton.

Remember that the majority of El Dorado sales are to customers who accept the cost of ammonia as a pass through. The global grain stock to demand ratio including corn and wheat are still at very low levels and are driving the demand for nitrogen fertilizers. These favorable supply/demand fundamentals were the catalyst for significantly higher fertilizer selling prices and better margins in 2007 which continued into the first part of 2008.

However during the third and fourth quarters there was a sudden price drop for most global commodities and the price of fertilizer in the market also declined. Fortunately the price of both the feedstocks we use, anhydrous ammonia at El Dorado and natural gas at Cherokee, have also declined and we’re able to produce our fertilizer products at profitable levels at current market prices.

Summarizing what has happened in the Ag market for products during 2008 and the current outlook this is our perspective and this is kind of a complicated scenario that occurred this year so we’re taking some extra time to try to explain it to you in great detail. At the beginning of the third quarter prices for UAN which we produce at Cherokee, Alabama plant climbed to record high levels approaching $500 per ton.

This was driven by the perception in the market that worldwide demand exceeded supply for urea and that grain prices would remain high. As urea prices rose this had the effect in the market of dragging up the other nitrogen product prices including UAN. During this period the distribution chain, distributors and dealers, loaded up with very high levels of high priced inventory.

At the time urea and UAN prices were increasing the cost of other fertilizer nutrients also increased dramatically. Prices of fertilizers became so high that farmers and ranchers reduced or curtailed fertilizer applications. During September and October prices of nitrogen fertilizer began to fall at a very rapid rate as grain prices also began to decrease.

Going into the fourth quarter the distribution chain was loaded with inventory it had purchased at very high prices and which was losing value quickly. The decline in fertilizer selling prices and inventory value continued throughout the fourth quarter. By the end of the year UAN published prices were $230 to $250 per ton.

Our tons shipped were actually up in the fourth quarter over the same period in 2007 but this was driven primarily by pre-purchases made in the third quarter for delivery in the fourth quarter. generally in the industry at large fourth quarter was not a good quarter of forward UAN sales. In fact several of our competitors reduced or curtailed production during that period.

Going into 2009 this is our current view of the situation for UAN. UAN prices seem to have bottomed out and stabilized. Currently the price is $230 to $250 per ton. There will be slightly less acreage planted in 2009 than 2008. According to recently published USDA forecasts corn will be the same as 2008, 86 million acres, wheat will be down 8% from 63 million acres to 58 million, cotton will be down 11% from 9.5 million to 8.5 million.

The total combined acres planted for these crops will be down 3.8% from 158.5 to 152.5 million acres. Pre-plant nitrogen applications in the fall of 2008 were lower than usual so more nitrogen will be required during the growing season. This could compensate to a certain extent for lower acreage planted.

We expect that the spring fertilizer sales season will get off to a late start until the pipeline of over inventory is depleted. We expect that after the late start the demand will be strong given reasonable weather conditions. At current market prices for UAN and costs for natural gas the feedstock to make the UAN we can operate our UAN plant profitably at a reasonably full rate of output.

Turning to Ag grade ammonia nitrate which we produce at our El Dorado plant in 2008 there was an excess of imported AN relative to market demand. As a result in the spring planting season there was too much AN available. This year there are fewer imports so the market supply demand fundamentals are much more favorable for US producers of AN.

Based on the current outlook and again assuming acceptable weather conditions we expect to run at full capacity through the spring season. Current pricing for AN is $260 per ton FOB production point. Again at current market prices for AN and cost for anhydrous ammonia we can operate our AN plant profitably at a reasonably full rat of output.

Focusing on our industrial chemical products based on the general economic conditions we are anticipating softening in demand. We believe that many of our customers are in a wait and see mode with regard to their production levels. However we believe that in the long run there will be steady demand for both our industrial acids and our industrial grade ammonium nitrate used for surface mining.

In the meantime most of our chemical businesses, industrial and mining sales which were 63% of total chemical sales during 2008 are pursuant to cost plus arrangements with our customers assuming the feedstock cost fluctuation risk. This eliminates much of the risk of a disconnect between raw material costs and the market prices for our products.

Approximately 85% of the industrial and mining business is sold pursuant to agreements that have either minimum purchase requirements or a fixed total contract profit irrespective of volume taken by our customer. To that extent we’re insulated from a potential downturn in demand for our industrial chemical products. Summing up both fourth quarter and full year climate control business ales and income were up.

New orders were very strong through the third quarter declining in the fourth quarter. Generally indicators are negative for commercial construction. The future of credit availability coupled with the level of uncertainty about the future could adversely affect our commercial business. As in most soft markets the competitive environment in our commercial business is intense.

We are particularly glad to see strong shipments and new orders for our geothermal products which have so far bucked the trend. We believe the recently enacted Federal incentives will help our geothermal sales and that planned government spending to modernize buildings could benefit many of our products.

Whereas the short term outlook is hard to predict, we’re very excited about our prospects for growing all of LSB’s climate control businesses and particularly our geothermal heat pumps over the long term. Turning to chemical 2008 sales were up but profits were down primarily as a result of the unusual items we discussed. The Ag market was very volatile in the second half of the year but seems to have stabilized.

We believe the long term outlook for our Ag market is good because of the continuing demand for farm crops which we believe will be strong. At this time both sales prices for our Ag products and feedstock costs are lower than in the first half of 2008 however the current sales price results in positive cash margin.

Our industrial chemical business demand has declined due to the general economic conditions however we’re insulated from this due to the reasons I just discussed. This business should remain profitable as long as we run our plants at economic levels. Finally we should make a decision about whether to proceed with the start up of Pryor very soon.

That’s really the conclusion of the operational review but before we take your questions Jack, Tony and I and the rest of LSB senior management would like to acknowledge and thank the nearly 1,900 employees who have who make up the LSB team for their contribution in making 2008 the success that it was. With that we will open up the call to questions.

Question-And-Answer Session

Operator

(Operator Instructions) Our first question comes from Steve Denault – Northland Securities.

Steve Denault – Northland Securities

First question, did I hear you correct, you said residential geothermal revenues were 19% of the fourth quarter climate control?

Tony M. Shelby

No we said they were 19% for the full year of the climate control business, that’s the residential geothermal only. That does not include the commercial geothermal part.

Steve Denault – Northland Securities

Which is another what?

Tony M. Shelby

I don’t have that number exactly in front of me but it’s probably about another 5% to 7%.

Jack E. Golsen

Two thirds, one third usually.

Steve Denault – Northland Securities

The comments about Pryor, are you incurring expenses in the first quarter as a result of the start up or planned start up?

Jack E. Golsen

Yes we are.

Steve Denault – Northland Securities

What did you say? Was it a couple million dollars that you’ll spend?

Jack E. Golsen

For the fourth quarter?

Steve Denault – Northland Securities

For the first quarter.

Steve Denault – Northland Securities

Did you say what the expenses would be?

Jack E. Golsen

We didn’t but we’re probably running $400,000 or $500,000 a month.

Steve Denault – Northland Securities

From a hedging standpoint both natural gas and copper, being that we’re almost finished with the first quarter, what do you think the net impact will be there?

Jack E. Golsen

For the first quarter?

Steve Denault – Northland Securities

Yes.

Jack E. Golsen

We can’t really comment on that, Steve as far as the hedging. As Barry indicated we have a natural hedge on 63% of our chemical business and copper prices have moderated but we can’t really comment on what our first quarter numbers look like.

Steve Denault – Northland Securities

How well hedged are you on natural gas or are you just?

Barry H. Golsen

We’re not hedged on natural gas.

Jack E. Golsen

We have a natural hedge because we have 60 odd percent of our product passes through the price of gas then that’s a hedge that we don’t have to put on. So, we are only concerned about the balance which is say 35% and to that extent right now we’re not hedged.

Tony M. Shelby

Now, on the ag side as I mentioned we’ve got derivatives that we hold that we took a $3.6 million write down adjustment mark-to-market but those are primarily for customers that we have locked in margins based on those hedges. Primarily utility companies that because of regulatory issues don’t do their own hedges so we do it on this end but they are done as we indicated to lock in margins on subsequent orders to be shipped.

Steve Denault – Northland Securities

If I switch back to climate control again you’ve got obviously a nice secular trend here on the geothermal side. Do you continue to believe that can be $100 million business next year?

Barry H. Golsen

I don’t think I said it would be a $100 million business next year. We’ve never made any forecast as to the size of the business because that’s our long standing policy not to make any forward-looking statements or forecasts about the future business level of the business.

Steve Denault – Northland Securities

I guess I was just referencing your comments to a question on the last conference call when it was asked.

Tony M. Shelby

Steve, as you know, what Barry means is we can’t provide guidance and don’t.

Steve Denault – Northland Securities

So we can make some assumptions about what we think geothermal will do next year. You’re still adding capacity on the hydronic fan coils?

Barry H. Golsen

No, I didn’t say that. We said we added capacity for our coil operation which makes air coils for both our hydronic fan coil business and our geothermal business and our regular water source heat pump business. We have one plant that supplies all three of those businesses.

Steve Denault – Northland Securities

Do you think it’s safe to assume although you’ve got energy efficient offerings on the non-res side that you would follow McGraw-Hill expectations for non-residential starts next year?

Barry H. Golsen

I think everyone is going to be subject to what happens in the market. But, as to whether we’re going to follow them exactly it really depends on a lot of factors. As you said, there is this secular trend towards more energy efficient products. We have extremely energy efficient products. We believe that in the era that we’re in now that gives us a leg up relative to other system types that are not as energy efficient.

It is possible and I’m not forecasting this but, it is possible to see that the market share of those products could increase relative to other types of products for the business level that’s out there. I think historically we’ve seen that to be the case but I’m not forecasting that will happen. I’m just saying that we are not necessarily bound in to a direct relationship with what goes on with construction starts.

Barry H. Golsen

We view those McGraw-Hill numbers as an opportunity. The question is how much of that opportunity can our people grab on to.

Steve Denault – Northland Securities

When you make reference to the expansion of the geothermal facility, I think it’s a 70,000 odd square foot expansion.

Barry H. Golsen

78,000.

Steve Denault – Northland Securities

What does that translate in terms of total capacity expansion from a throughput standpoint?

Barry H. Golsen

I don’t have that number. We’re not looking at it exactly that way. It’s to facilitate future expansion when we need it. We’ll have to do a little reconfiguring in the operation. It gives us the ability to further expand that operation as we go beyond the current expansion capability. So the answer is I can’t give you a direct answer. I do not have a direct percentage answer to your question.

Jack E. Golsen

Steve, we have to have the facility available to grow in to as the business moves up.

Barry H. Golsen

Another way of looking at this is, as you’re operating this business –

Jack E. Golsen

You don’t want to hit the wall.

Barry H. Golsen

There are things that we can react very quickly too. We can add assembly lines, we can add fabrication equipment on very short notice as we watch the business level. The one thing that’s out there that has a significantly long lead time for growth is real estate, is square footage. So, we’re putting it in place to enhance and facilitate sufficient operations at our current volume and to give us the room to grow in to as we go.

Operator

Your next question comes from Eric Prouty – Canaccord Adams.

Eric Prouty – Canaccord Adams

A question on the backlog number in climate control was listed at $68.5 million. I’m wondering is there any geothermal backlog or is geothermal primarily built to order?

Barry H. Golsen

We do have a geothermal backlog but we do not break it out and disclose it for public consumption.

Eric Prouty – Canaccord Adams

Could you say just generally whether it was up or down?

Barry H. Golsen

I’d have to go check my numbers but when you look at the order input level – look at the order input level but, we’re not going to disclose the specific levels.

Jack E. Golsen

That’s information our competition would love to have.

Eric Prouty – Canaccord Adams

Second question is I was wondering if you could just comment then on the trends in the geothermal heat business so far in the first quarter particularly in the commercial retrofit market?

Barry H. Golsen

In the commercial retrofit market, I don’t have a specific breakout number on commercial retrofit available to me as we sit here.

Eric Prouty – Canaccord Adams

I’m not looking for a specific number, just any trends you’re seeing?

Jack E. Golsen

Well, the trend is down.

Barry H. Golsen

The general market is down as Jack said. But, to give you subset on that particular subset that you asked for, I just don’t have that information.

Tony M. Shelby

The thing is we expect the stimulus plan to have some impact on retrofit.

Barry H. Golsen

Typically on the breakout between retrofit and new construction we don’t really track that on a monthly basis because it’s not meaningful on a monthly basis. We typically don’t look at that to the end of a quarter, that’s why I don’t have that information. Because, the way the orders happen to flow is very lumpy from a month-to-month basis.

Operator

Your next question comes from Richard Hoss – Roth Capital Partners, LLC.

Richard Hoss – Roth Capital Partners, LLC.

On the new versus retrofit breakout, I think you had mentioned two thirds, one third and that is residential versus commercial, correct?

Barry H. Golsen

In the past what we have said is generally for the commercial business that what we’ve seen the last few years has been that about 70% of the business has been for new construction and about 30% has been for retrofit. But, we’ve also said that historically in past down economic cycles when construction wasn’t as robust as it has been in the last three years, we’ve seen that percentage much higher approaching 50% of the business. That’s for commercial.

Richard Hoss – Roth Capital Partners, LLC.

Is that due to a function of new coming down that much or retrofit going up or a combination?

Barry H. Golsen

It’s a combination of both. What happens typically is there will be an increase of renovation and retrofit activity during a down cycle or historically that’s the way it has been. I don’t know if that’s what will happen in this cycle but, historically that’s what’s happened. It’s a combination of the two things.

Richard Hoss – Roth Capital Partners, LLC.

What about the lagging affect of the incentives? In Canada we saw incentives of similar magnitude and it seems like there was maybe six to nine months before it really picked up steam. Do you see the US market as demonstrating a similar lag?

Barry H. Golsen

Well, I think there definitely will be some kind of lag. It’s hard to draw a direct parallel between the US and Canada and it’s for this reason, Canada there was a tremendous amount of red tape involved. First of all, the installer had to be specifically certified to be qualified, in other words to be eligible to get the credit you had to have it done by an installer with a certain certification. Then, in addition to that the red tape from a tax standpoint and forms and all this was I understand substantial.

In the United States there is no stipulation as to the installer having any special certification other than the normal. Normally we train our installers very well, etc. But, also there’s just one tax form, it’s a special form, they had published it for last year and I don’t know if it’s published yet for this year, you can download it off the Internet from the IRS website and fill it out, it’s very simple and get your tax credit. So, I would expect there to be some lag, not as much as Canada but that’s just a speculation on my part because of the circumstances I just described.

Barry H. Golsen

Rick, I think the biggest lag will be in everyone learning about it. Not everybody is focused on it. Analysts are focused on it, people in the industry are focused on it but users are not all focused on it yet.

Richard Hoss – Roth Capital Partners, LLC.

That’s always been the challenge with geothermal correct, just a lack of awareness of it?

Barry H. Golsen

Yes.

Richard Hoss – Roth Capital Partners, LLC.

What about on the chemical side of business, this would be for Tony, prior you had talked about previously funding prior the startup or prior the combination of debt, cash on hand and I think earlier you may have mentioned it was all going to be cash on hand, is that correct?

Tony M. Shelby

Yes. It will probably be all cash, most of it.

Richard Hoss – Roth Capital Partners, LLC.

Then I think if I remember correctly, the last conference call you had talked about some of the fertilizer inventory I think out of Cherokee hadn’t shipped and there were still sort of a latten inventory that you were expecting it to still ship out in the fourth quarter. Is that all gone?

Tony M. Shelby

Yes. We had some pre-sold barges that have sense gone out.

Richard Hoss – Roth Capital Partners, LLC.

Then on the assumption of lower feedstock prices throughout 2009 factoring in a lower demand from your industrial customers, is it safe to assume that your gross margin and your operating margins on the chemical side of things all else being equal should show improvement?

Barry H. Golsen

Let me make sure that we understand, you’re saying that since we have cost less arrangements and with the feedstock cost down, the selling price will be down but since the margin is on a per ton basis and not as a percent, that we would see the percentage of gross profit increase relative to sales, is that what you’re asking?

Richard Hoss – Roth Capital Partners, LLC.

Yes. Or, even just operating income is another way to filter down further with a gross dollar profit factored in to 55% of the chemical business, the assumption is your operating margins would be up.

Tony M. Shelby

As a percentage?

Richard Hoss – Roth Capital Partners, LLC.

Yes.

Tony M. Shelby

There’s a couple of things that really affect that. The primary thing is selling those process plants out at practical capacity as opposed to running a turndown rate. So, if we’re able to keep the plants running at what we would consider to be a practical capacity level and if the mix of ag and industrial remain about the same 63%/37% and if raw material inputs stay down we should see percentage wise an improvement. We’re not forecasting that but logically that follows.

Richard Hoss – Roth Capital Partners, LLC.

Then last question, I don’t have an order volume for climate control for the fourth quarter ’07 to compare fourth quarter ’08?

Barry H. Golsen

I said what it was, if I recall I’d have to look back at my numbers but I believe it was $54 million in ’07.

Richard Hoss – Roth Capital Partners, LLC.

I have a backlog of $54.5.

Barry H. Golsen

I think by coincidence it was almost the same. Yes, the two numbers by coincidence are the same. The booking in the fourth quarter of ’07 were $53.9 in change as opposed to the backlog which was $54.5.

Operator

Your next question comes from Daniel Mannes – Avondale Partners, LLC.

Daniel Mannes – Avondale Partners, LLC

A couple of quick follow up questions, the first one just on Cherokee, given the issue at the [inaudible] acid plant, can you give us any update on where that’s standing and if the repairs have been completed?

Jack E. Golsen

There was a fire in number one acid plant. That has not been repaired yet, they’re still trying to determine what the cause was. It had to be sent out to the expert to be analyzed but it’s not affecting us because that acid plant was really a backup for the main acid plant and the main acid plant is able to produce all we need. We haven’t been able to get that backup plant in operation.

However, we went the last two years without that backup plant in operation before we had it rebuilt. It was rebuilt before we had this fire and so we’ve gotten along without that plant for a couple of years. We had hoped to have it for some extra volume but we’re not going to have it for a while.

Tony M. Shelby

A couple of other points too is that we have the capability to ship acid in from our other plants.

Jack E. Golsen

We can ship in from our other plant if we need to.

Tony M. Shelby

And Dan, keep in mind that the business interruption and extra expense kicks in after the first 30 days. A lot of the delay is that we’re proceeding very cautiously and carefully with the insurance company so that we optimize our outcome.

Daniel Mannes – Avondale Partners, LLC

Second question, on Cherokee and this relates to Q4, if memory serves, you guys took a fairly sizeable maintenance outage in the fourth quarter of ’08 as well as in the fourth quarter of ’07. Can you give any indication on the relative increase in cost year-over-year in the quarter?

Barry H. Golsen

You mean due to the maintenance outage?

Daniel Mannes – Avondale Partners, LLC

How much more expensive was the ’08 maintenance outage versus ’07 in the fourth quarter?

Barry H. Golsen

He’s talking about in October.

Daniel Mannes – Avondale Partners, LLC

Yes, turnaround. I’m sorry different lingo same question.

Tony M. Shelby

Fourth quarter for the chemical business as a whole, not just for Cherokee but for the chemical business as a whole you know we expense our turnarounds as they are incurred. We believe that the turnaround cost of close to $6 million this year versus about $3 million last year in the fourth quarter. I think that’s in our 10K results of operations.

Barry H. Golsen

Yes, it is. Tony, you might want to explain to some of the listeners as to why there is a variance from year-to-year in a turnaround.

Tony M. Shelby

You don’t do a turnaround at exactly the same time every year and sometimes you’ll run 16 or 18 months versus 12 months, sometimes 24. It is just really timing and you try to do the turnaround that the most optimum time and sometimes it’s due to your scheduling. It’s not automatically in the same quarters each year.

Daniel Mannes – Avondale Partners, LLC

Well, if I remember right actually Cherokee started early, that actually even started in Q3 this year.

Tony M. Shelby

That’s right because of the downtime we had in the third quarter.

Jack E. Golsen

You’re right Dan.

Daniel Mannes – Avondale Partners, LLC

One last question on chemical and then a quick question on climate, as it relates to prior – I mean you guys are now spending by Tony’s estimate about $500,000 a month. How long can you wait before you make the decision? I know you said it would be quite soon. And, what is the impetus on the people maybe you’re negotiating with for the contract that would sort of require them to make a decision soon i.e. is there a risk this drags out for a couple of quarters?

Jack E. Golsen

First of all we have more than one company that has said that they would like to do this deal with us and we are negotiating with these companies. We’re always looking at that versus other options that we have and we want to get an agreement that’s satisfactory to us that we feel comfortable with. We have to have something in place in the next 45 days.

Tony M. Shelby

The reason Jack says that is because we need to start pre-selling for the fall.

Daniel Mannes – Avondale Partners, LLC

Any long lead time equipment you need to order, is that another constraint?

Jack E. Golsen

No, everything that is needed has been ordered?

Daniel Mannes – Avondale Partners, LLC

That’s the $3 million that’s already committed of capital?

Jack E. Golsen

Yes.

Daniel Mannes – Avondale Partners, LLC

One last question on climate, focusing on the residential geothermal side, since you guys use a good number of distributors do you have any visibility in to what the inventory levels were of the distributors i.e. was some of the order levels that you’ve seen over the last quarter sort of a stocking or is this a fairly normal level of inventory the distributors that sort of equals the end [inaudible].

Barry H. Golsen

I don’t believe at this time that any of the – I have to qualify it to say that a significant number of any of the orders we receive were due to increasing their inventory level. Of course, we have a fairly close read on that but we don’t get a 100% read from each one of our distributors.

Daniel Mannes – Avondale Partners, LLC

I guess the question is not so much that they’re building up inventory but more maybe their restocking, i.e. if the majority of the end sales occurred in Q3 and Q4 are they just refilling and then as sales are slow at the end will that sort of back things up I guess is where I’m going?

Barry H. Golsen

That has the potential, if sales to end users slow down then eventually it backs up in to the factory.

Jack E. Golsen

Dan, you struck a point that has been tension between manufacturers and distributors forever. Manufacturers like to know exactly what is in distributors’ inventory and distributors don’t want to tell them.

Barry H. Golsen

We kind of watch this very closely and to the extent that we can and we interface back and forth to try and get a sense of what the distributors are going to be doing.

Operator

Your next question comes from Steve Burns – Merrill Lynch.

Steve Burns – Merrill Lynch

Can you tell me what’s the logic behind needing a strategic partner for distributing UAN out of hire versus selling it yourselves?

Jack E. Golsen

That’s a good question and the logic is we wanted to assure ourselves that we had full sales – we wanted someone that was going to take a pay for the whole quantity and we did not want to go to the point of having to set up the sales organization which we have in place but would need expansion if we were going to do it ourselves. We’d have to get the railcars ourselves. But, all that is possible. If we couldn’t get a satisfactory agreement that would be our option.

Steve Burns – Merrill Lynch

So how do you set price with this partner and for what duration?

Jack E. Golsen

You set it at market price, it changes all the time. No one is going to be able to sell it above market price so you have to go by market price.

Steve Burns – Merrill Lynch

So how far forward would you sell to them? I mean, you need to make decisions on when to buy gas.

Jack E. Golsen

Let me explain to you how it works okay, I’ll just take a minute. If I’m a customer and I want to buy today for a shipment four months from now, I want to take it four months from now, I put a deposit down and I say fix the price for me today and I price it to you at what I can fix the cost of my raw material at today which is gas. That’s call a hedge. I will hedge the amount of gas needed for your order four months out.

If four months out I’m expecting gas is going to be $5 and if that’s what they’re quoting it in the gas market for four months out gas, I will fix the price at $5 at my cost and price the product to you today at that price. But, I’ll have to hedge it. In other words I have to fix the price of gas. Now, that hedge might turn out to be a winner or a loser but I don’t care because if it’s a loser I have fixed the price and I make up a bigger profit when I sell it than I plan on making to make up for the hedge.

Steve Burns – Merrill Lynch

I certainly understand it, I mean it’s a forward pricing program.

Jack E. Golsen

So I can fix the price any month that I want as long as a customer is willing to pay my quoted price based on what I say –

Barry H. Golsen

Was that your question Steve?

Steve Burns – Merrill Lynch

Well, it does help because it sounds to me like you make the decision as to whether lock in the sale going forward.

Jack E. Golsen

That’s right.

Steve Burns – Merrill Lynch

Whereas I thought you were implying that your partner here had to agree to take the product and thus they were going to buy it from you but it sounds like more they just simply distribute it for you?

Barry H. Golsen

He’s hit the nail on the head, they just distribute it.

Tony M. Shelby

When we reach an agreement we’ll give more detail. Right now we can’t speculate too much beyond what Jack’s all said. I think Jack’s described it adequately.

Steve Burns – Merrill Lynch

Given that you would have to beef up your selling organization, does this sound like a business that might be more valuable to somebody else than to you?

Jack E. Golsen

No, we are in the business now. We sell UAN now, we make it in Cherokee, this is just more production so it’s not new to us.

Steve Burns – Merrill Lynch

It’s just a different region?

Jack E. Golsen

Well, yes but that ships all over the country. I mean, it would just be more business for our sales force to handle, okay.

Barry H. Golsen

This would be a valuable business for us, this would be a valuable business for somebody else. Whether it’s more valuable or less valuable is a relative statement and I guess it’s in the eye of the beholder.

Steve Burns – Merrill Lynch

There’s certainly plenty of M&A activity going on in the space right now and that’s why I asked.

Tony M. Shelby

Most of it unsolicited.

Operator

Your next question comes from Gregg Hillman – First Wilshire Securities.

Gregg Hillman – First Wilshire Securities

Could you talk about in one of your slide decks there’s a slide that shows the adoption of various countries, in Europe how it’s kind of an elongated S shape curve. I was wondering what were the precipitating events that caused the adoption rate to really start to ramp up in some of those countries? Was it government incentives or was it celebrity using one? What was your interpretation?

Barry H. Golsen

First of all I can’t definitively answer that question. I’m not familiar enough with it to be able to give you too much of a nuanced answer. What I can say is that you have a different kind of market in Europe than you have in the United States in that in the United States you have a relatively homogonous and there are some regional differences but it is a relatively [monolithic] kind of distribution structure.

There are fewer manufacturers and they are larger relative to the overall market size. In Europe, because you have a lot of countries, you’ve got different things going on in each country, different distribution chains, different governmental incentives and so from one country to another you have a different situation. Generally speaking, where the adoption in Europe has occurred the fastest is in the northern Europe, Scandinavian areas.

They have just traditionally been very forward thinking when it comes to the environment and energy usage and so they’ve just tended to be way out in front of the United States on all those kinds of issues.

Gregg Hillman – First Wilshire Securities

In terms of just trying to increase [inaudible] in the United States, I was just wondering, I know you go through distributors but could you talk about how you’re helping your distributors to do their Internet marketing better? In particular like search engine optimization, banner ads, affiliate marketing?

Barry H. Golsen

You’re just kind of running down a punch list of what basically you do in the age of Internet marketing. Every single one of those, everything that you can do to facilitate that is either currently being done or is in the planning stages.

Jack E. Golsen

A lot of it’s being added and changed as you go along and improved.

Barry H. Golsen

I don’t know if I’ve answered your question. I mean, I’m not going to sit here and tick down every single advertising sales and promotion strategy we have because our competitors tune in to every single conference call we have. I’d rather let them see it when it comes out.

Gregg Hillman – First Wilshire Securities

Just another thing about installers, I think it was on the cover of either the New York Times or the Los Angeles Times a couple of weeks ago about trying to train enough installers to install solar panels. I was wondering even though you might have adequate capacity if demand starts to take off do your distributors, will they have enough installers to install the stuff? And, how are you going to help them to train and certify enough installers?

Barry H. Golsen

That’s a very good question and that’s really the most important question for ramping up the market because we believe we can certainly from a manufacturing standpoint we can keep up with any reasonable growth that the market gets. The way the distribution chain works, just to clarify for those people that are listening for the first time is we sell this product to stocking distributors.

Those stocking distributors resell the product to installing contractor dealers. Those installing contractor dealers on a residential market are the same kind of contractors who do maintenance on individual homes and do installations when that unit wears out and they have to replace it and also do installations and new construction. Those are typically small businesses and whenever they get a new product line that they haven’t installed before or they haven’t used before they are use to going in to the distributors and getting training.

So, what we have is we have first of all at our factory we have training schools and session we’re giving all the time. We bring distributors in and we even bring dealers in but usually distributors. In addition to that we go out in the field and we have our training personnel go out and give seminars out in the field where dealers are so when a dealer signs up on geothermal, he knows that every two months we’re going to be having in his region a training session or every month, whatever it happens to be.

The interesting part of this is that when you look at the installation of the geothermal system, other than the loop in the ground, it is very, very similar to a traditional or conventional unit. So, if a contractor can handle a conventional system, he already knows about 95% of what he needs to know to install a geothermal system. So, the bottleneck becomes really not that contractor, it’s the person who’s putting the heating exchange loop in the ground.

To train those people what we’re doing with is we’re working in conjunction with water well drillers and drilling associations around the country, we’re training those people specifically as well and then what happens in the field is that contractors and distributors develop alliances with those people and some of them that do enough volume in geothermal will even do their own drilling. So, the potential bottleneck is probably more with drilling than any other thing in the whole chain of installations.

Gregg Hillman – First Wilshire Securities

Do you have to have a backhoe to install a geothermal heat pump?

Barry H. Golsen

There are about four ways you can install these but about 95% of them are either installed horizontally or vertically. Now, in a vertical installation what they’ll do is they’ll dig trenches with a backhoe or a trenching device like a large ditch witch, kind of like a device you put a sprinkler system in and then they’ll fill it over. So yes, in that application. Then there’s a small part of the vertical installation where they also need some kind of trencher but it doesn’t necessarily have to be a backhoe.

Gregg Hillman – First Wilshire Securities

Would it make sense for LSB to lend people money to buy some of that equipment or to rent the equipment?

Barry H. Golsen

I think that usually equipment manufacturers that are selling that equipment have financing programs available.

Operator

Your next question comes from Michael Coleman – Sterne, Agee & Leach.

Michael Coleman – Sterne, Agee & Leach

I just want to clarify, you mentioned 19% on the geothermal mix for the year, do you have a mix number for the fourth quarter?

Barry H. Golsen

No, I don’t have it. That was 19% for residential geothermal for the full year. As we said before that did not include the commercial portion of geothermal.

Michael Coleman – Sterne, Agee & Leach

Do you have a feeling for the fourth quarter on the geothermal, was it 25%, was it meaningfully more?

Barry H. Golsen

I just don’t have that number right in front of me, I’m sorry. I can get back to you with that.

Michael Coleman – Sterne, Agee & Leach

Three things I want to do, Trison but before Trison you talked about training schools and so forth, how many of these dealers did you have to train in 2008? And, what are you targeting for the growth in the number of dealers trained in 2009?

Tony M. Shelby

That’s information we can’t give out.

Barry H. Golsen

First of all I don’t have that information available, I can’t give you that.

Michael Coleman – Sterne, Agee & Leach

On Trison, what are you seeing in terms of that business seemed to me would be appropriate for the retrofit of federal buildings and so forth. So, what are you seeing in either the pipeline or the activity for your contracting business?

Barry H. Golsen

Well, you know that is a business where it’s a very long lead time business and they went in to this year really fully booked for the whole year as far as what their forecast was. In other words, their budget was equivalent to their backlog so they pretty much were booked up for the first three quarters with a little opening in the back quarter to add some additional business. But, there’s quite a lot of activity in that area even before the stimulus package and we believe that the stimulus package is just going to increase it and they are focusing in that area.

Jack E. Golsen

They should be a natural for that Michael.

Michael Coleman – Sterne, Agee & Leach

And you’re adding people to that division?

Barry H. Golsen

That division functions as a contractor, as a general contractor so as we gear it up or scale it down depending on the number of projects that we have, and we try to keep the home office staff as lean as we can but adequate to handle what kind of business level we see out there.

Michael Coleman – Sterne, Agee & Leach

On the tax credit, the 30% no limit could you put that in to the context of what that means for the consumer on a dollar basis?

Barry H. Golsen

Well yes, let’s just take – first of all, we all know that the cost of construction varies all over the country so you have to pick something that’s kind of typical or average so what we’ve lately been referring to is kind of a typical house is a 2,500 square foot house located in St. Louis, Missouri.

In a 2,500 foot house in St. Louis, Missouri is typically going to need about four tons of air conditioning and a geothermal hit pump system without an incentive is probably going to run about $17,500, in that range. So, if you look at the incentive that’s about $5,100 would come off that bill with the credit so after the credit that brings you down to about $12,000.

Now, a conventional system in St. Louis is probably going to run around $8,000 or $9,000. That means you’re $3,000 higher, that means probably you’re going to have about a two year payback after the incentive. Those are very rough numbers.

Michael Coleman – Sterne, Agee & Leach

I’ve got one more, you’ve increased your heat pump capacity I think back in ’06, given the trajectory of this residential geothermal business, you’re not concerned that you’ve got capacity limitations here in the next year or year and a half before you get this new capacity up and running?

Barry H. Golsen

No, we’re not.

Michael Coleman – Sterne, Agee & Leach

The second piece, when do you expect the new capacity for the geothermal? Approximately what quarter do you think that would actually come on?

Barry H. Golsen

From when we break ground it will probably be about five to six months before we’ll have use of that. But, as I said between now and then we don’t believe we need that capacity. We don’t even know if we’ll need that capacity this year.

Michael Coleman – Sterne, Agee & Leach

But it would be available this time next year?

Tony M. Shelby

We will have the capacity this year.

Michael Coleman – Sterne, Agee & Leach

You will have it this year?

Tony M. Shelby

Yes.

Operator

There are no further questions. I will now turn the conference back to management.

Jack E. Golsen

Thank you very much. Thanks everybody. That ends our conference call.

Operator

Ladies and gentlemen this concludes our conference for today. Thank you all for participating and have a nice day. All parties may now disconnect.

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Source: LSB Industries, Inc. Q4 2008 Earnings Call Transcript
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