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LSB Industries, Inc. (NYSE:LXU)

Q3 2010 Earnings Call

November 04, 2010 05:15 pm ET

Executives

Carol Oden, IR

Jack Golsen - Chairman & CEO

Tony Shelby - CFO & EVP, Finance

Barry Golsen - Vice Chairman, President, Climate Control Business

Analysts

Dan Mannes - Avondale Partners

Joe Mondillo - Sidoti & Company

Brian Kremer - Roth Capital Partners

David Kaizer - Robotti & Company

Dan Mazur - Harvest Capital

Revis Lewis - Private Investor

Operator

Greetings and welcome to the LSB Industries Incorporated third quarter conference call. At this time, all participants are currently in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

And then now I will turn the call over to Carol Oden. Thank you, Ms. Oden you may begin.

Carol Oden

Thank you, Stark. Again, we would like to welcome you to the LSB Industries, Inc. third quarter 2010 conference call. Today LSB’s management participants are Jack Golsen, Chairman and Chief Executive Officer; Barry Golsen, President and Chief Operating Officer; and Tony Shelby, our 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. 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, November 4, 2010, and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay. After the Q&A, I will have some important comments and disclaimers about forward-looking statements and our references to EBITDA. We suggest that you stay on the call long enough to hear them.

Now I will turn the conference call over to Mr. Jack Golsen.

Jack Golsen

Thank you, good afternoon. Thanks for joining our conference call this afternoon. Today, we released results of our third quarter. The third results were better then the third quarter of 2009, although they are still not yet up to our potential. Despite this improvement, nine months earnings ends in 2010 remained below 2009 primarily due to the costs associated with starting our Pryor Oklahoma chemical plant. However, we think that Pryor is now in a position to contribute to future earnings.

In this conference call, Barry and Tony will discuss the current climate control and chemical business and our financial results in more detail. I believe that we are still moving in the right direction, in both of our businesses although not quickly enough to satisfy us. The big picture is that the overall economic activity on our businesses during the first nine months of this year has slightly improved.

In our Climate Control business, commercial construction in our markets has recently shown a slight improvement, although residential construction is again lower than prior years, we continued to increase sales of our geothermal products over the past periods in the face of the declining residential market.

Recently, in our chemical operations product demand and pricing have been good, especially in the agricultural markets we serve. And the agricultural market is projected to be strong in the coming year. The primary reformer rebuild in our Pryor plant which was damaged by fire was completed at the end of the third quarter.

Today reduction of anhydrous ammonia is strong and on target. The nitric acid in urea plants are positioned to produce UAN to meet customer orders. We have some late news, climate control business is beginning modification and repurposing of an existing facility to house our modular geothermal chiller manufacturing operations. This facility will build recently developed, high efficiency modular aircooled chillers in addition to hydronic geothermal chillers.

Another item that is positive, we have recently concluded a three-year labor contract with the second union at our El Dorado, Arkansas plant. This plant has two separate unions and we previously announced that we had concluded a contract with the first union. Also we have reached agreement with the union at our Cherokee Alabama plant with the subject to confirmation by the bargaining group.

And now for the details of the third quarter, I will turn this call over to Tony Shelby. At the end of our review, we will open this conference call to questions. Thank you.

Tony Shelby

Thanks Jack. As reported in our earnings announcement this afternoon, the financial results for the third quarter 2010 compared to the third quarter of 2009 included sales, a 138.9 million compared to 127.8 million, operating income 8.5 million compared to 4.3 million, net income 3.8 million compared to 1.1 million, diluted earnings per share $0.17 compared to $0.05 and EBITDA chemical 4.4 million versus negative 500,000, climate control 10.9 versus 11.8 and consolidated EBITDA 12.9 versus 8.5. For the trailing 12 months consolidated EBITDA was 46 million.

The following comments are all related to the third quarter. Under sales, climate control sales were 64.5 million or 4.3% below 2009 and elaborately product order intake was $67 million during the quarter compared to 49 million in the 2009 quarter. Chemical sales were 72.6 million or 21.5% higher than 2009. The increase was primarily a result of stronger customer demand for industrial and mining products and an increase of selling pricing due in part to higher raw material input costs.

Agricultural product sales in tons were more that the prior year due to a number of unusual events including the effects of dry water conditions in certain key market, low beginning inventories of UAM, a extended plant maintenance activities incurred to these turnarounds.

However looking forward, agricultural supply demand fundamentals are very favorable for nitrogen fertilizer producers and farmers alike. Operating income, as mentioned consolidated operating income for the third quarter increased from 4.3 million in 2009 to 8.5 million in 2010 or an increase of $4.2 million.

Climate Control’s operating income for the quarter was 10.1 million or 15.7% of sales compared to 10.9 million or 16.2% of sales in 2009. The $830,000 reduction of operating income was a result of lower sales volume and to a lesser extent, higher raw material costs offset by a decrease in certain operating expenses.

Chemical’s operating income for the quarter was 1.2 million compared to a loss of 3.3 million in 2009, a $4.5 million improvement. Chemical’s gross profit increased from 5.7 million to 5.9 million, a decline from 9.5& of sales to 8.1%. The lower margin as a percentage of sales is primarily attributable to the lower mix of agricultural product shipped to total sales. Below the gross profit line, chemicals 2010 operating income benefited from a reduction of prior operating cost from $6.1 million in 2009 to $4.9 million in 2010 and from insurance recoveries, a $3.1 million include in other income.

Focusing on Pryor, during the third quarter the Pryor facility was down while the only plant gas reformer being rebuilt. As a result of the plant being down during the entire quarter and the assets of any production, the overhead and another costs of $6.2 million were expensed as incurred. Plant maintenance turnaround costs of $1.3 million were charged to cost of sales and the remaining $4.9 million were below the gross profit line classified primarily as SG&A. The rebuilt was completed by the end of September at a cost of approximately $7 million.

The rebuild costs were capitalized as property equipment. We estimate that our property damage insurance claims will be approximately $8 million for the repair and other costs subject to a $1 million deductible. Included in other income is $2.8 million resulting from the initial insurance against the property damage insurance claim. Any additional insurance proceeds resulting from the property damage claim represents a gain contingency and will be recognized as other income if and when realized.

Barry will complete the discussion of the Pryor facility operations during the review of Chemical’s results. Below the consolidated operating line, interest expense was $1.9 million for the third quarter of 2010 compared to $2.2 million for 2009, included in interest expense our charges of $400,000 in the 2010 quarter and $700,000 in the 2009 quarter, both attributable to the mark-to-market adjustments in 2010 and 2009 and our LIBOR interest rate swap of the floating rate to a fixed rate that runs into 2012, into the year of 2010. Our fixed rate swap fixes LIBOR at approximately 3.4% compared to a current market of below 0.5. Current LIBOR market is less than 0.5%

The tax provision for the third quarter was $2.9 million or 43% of pre-tax income. The tax provision for the nine months ended September 30, 2010 was 43.4% pre-tax income and include the impact of the increased domestic manufacturer’s deduction, the Advanced Energy credits and additional income tax provision related to the non-deductible expenses in prior years.

Capital expenditures: During the quarter we had total capital expenditures of $17.2 million, including $720,000 for the Climate Control business, and $16 million for the Chemical business, which include $11 million from the Pryor plant. At September 30th, we had committed and planned capital expenditures of $11.4 million, Chemical plant spending was 9.1including 4.8 million for Pryor and Climate Control was $2.3 million.

Focusing on liquidity and capital resources, cash provided by operations for the third quarter 2010 was $10.2 million which include net income of $3.8 million, depreciation of $4.3 million and seasonal changes in the current assets and liabilities. After capital expenditures of $15.3 million, proceeds from property and shares were 3.6 million and various other items, cash and short-term investments decreased $3.8 million of the quarter.

At September 30th, our cash on hand totaled $51.4 million and short-term investments totaled $10 million. Our borrowing availability under our $50 million working capital revolver was $49.2 million. At September 30, 2010 our long-term debt including a current portion was 101 million and stockholders equity was 161 million. The ratio of long-term debt to stockholder’s equity is approximately 0.63 to 1. Based on our present financial position in our outlook, we have adequate working capital to finance our ongoing operations as well as organic growth opportunities.

During this extended period of uncertainty in a global economy, we have intensely maintained a significant liquidity position, we’ve focused on our long term debt maturities due in 2010 and are developing our capital plan to address those obligations as well as our growth opportunities. That will conclude the financial review and Barry will cover operational highlights and the outlook for the company.

Barry Golsen

Thanks, Tony. Today I'll discuss the Climate Control business first. Tony mentioned, our total Climate Control business sales during the third quarter of 2010 were lower than the third quarter of last year by 4.3%. Sales to commercial and institutional customers were 73% of our total business during the third quarter and were down 12% from the third quarter of 2009. Sales of products used in single family residences, all geothermal heat pumps were the remaining 27% of our third quarter sales and were up 25% from the same period last year.

Focusing on major product lines, total heat pump sales, both commercial and residential were up 6%, fan coil sales were down 15% and sales of other product and services were down 25%. Total new product orders during the third quarter were 67.5 million, a 37% increase compared to the third quarter of 2009. New orders of products for commercial and institutional applications were up 51% compared to the same quarter last year while new orders for our geothermal heat pumps that are used in single family residences were up 7%.

Year-to-date as of September 30, new orders for commercial and institutional applications were up 20% and new orders for residential geothermal heat pumps were up 27% over the same period last year. At September 30, we had a backlog of product orders of 54.8 million, up from 48.2 million at June 30 and 59.4 million at September 30 2009.

October 2010, new product orders totaled 19.4 million, up 3% over October of 2009 and our backlog at the end of the month was 53.5 million compared to 40.3 million at the same time last year. We are encouraged to see our overall new order bookings and backlog increase whereas we can’t predict it will actually happen in the future, our current sense is that the commercial sectors we serve have passed the low point in construction activity. Forecasting data I will cover later supports this.

As of the end of the third quarter, we continued to maintain leading market shares for geothermal and water source heat pumps and for hydraulic fan coils. Our gross profit during the third quarter of 2010 was 23 million or 35.6% of sales, down from 24.7 million or 36.7% of sales in the same period in 2009. The reduction in gross profit was primarily the result of lower sales and increased material costs. You will note that we had an improvement in gross profit as a percentage of sales, 35.6% in the third quarter as compared to 31.5% in the second quarter of this year.

This was primarily related to gains realized on our commodity hedging contracts, favorable product mix and physical inventory adjustments as well as better absorption and labor and overhead due to volume increases. Our climate control segment operating profit during the third quarter of 2010 was 10.1 million compared to 10.9 million in the 2009 quarters. The decline was primarily the result of a lower gross profit that I just discussed.

Looking to the future, what’s the construction outlook. One Source, the latest McGraw-Hill Construction Research and Analytics construction market forecasting service forecast that new contract awards in 2010 that is for the full year, of this year will be approximately 7% lower than 2009 awards were for the specific building types that accounted for most of our commercial business and accounted for approximately 64% of our total Climate Control business sales in 2009.

McGraw-Hill also forecasts that this will be followed by year-over-year increases of approximately 8%, 25% and 35% in 2011, 2012 and 2013 respectively for these building types in the aggregate. Keep in mind, the contract awards occurred several months before we actually received orders for and shipped the products we produced.. During 2009 construction contract awards for the primary commercial sectors we served declined approximately 38%. In addition, it should be noted that as that although commercial orders are up 20% year-to-date, our sales levels are 19% below those of 2009 year-to-date.

This disparity is due to the beginning backlog carried forward at the start of each year in 2009 beginning backlog for commercial products was $58.8 million whereas in 2010 beginning backlog was only 28.8. We also tracked the Architectural Buildings Index which is an indicator of future commercial and institutional construction activity nine to 12 months in the future.

The ABI increased to 50.4 in September, this is the first time the index has nudged above 50, the points that indicates expansion since January of 2008. Based on all the information we have available, we believe that there will be a gradual recovery in commercial construction and we intend to participate in that as it occurs. In the mean time, we will continuing to do those things that we believe will make us stronger and more competitive.

Moving on to residential geothermal heat pumps or GHPs, on a more positive note single family residential new construction contract awards are currently forecast by McGraw-Hill to increase 6% this year. It is however a decrease from the 22% expected gain I reported a quarter ago reflecting the mid-year stall in residential construction.

Total new housing starts for single family houses are forecast by McGraw-Hill to be 590,000 units in 2010, McGraw-Hill also forecast increases of 27% in 2011, 56% in 2012 and 40% in 2013. To meet this demand, we have significantly increased our GHP sales and marketing efforts. These projected increases by McGraw-Hill do seem large, but it should be noted that even these projected increases, the singe family residential market will still not return to the 2005 level of 1.6 million new homes built.

As discussed earlier, our sales of residential GHPs were up approximately 25% in the third quarter of 2010 compared to the third quarter of 2009, while new orders were up 7% compared to last year’s third quarter. Year-to-date as of September 30, our residential GHP new orders were up 27% over the same period in 2009. We believe that a combination of our intensified sales and marketing efforts, the 30% federal income tax credit for GHPs, increase on construction and the trends toward more energy efficient construction has had a positive impact on GHP sales and new orders for us.

We have also seen a recent trend toward more use of GHP systems in replacement application which now approaches half of our residential heat pumps built. Returning to the total Climate Control business, despite the fact that our current commercial sales were soft, we are optimistic about the future. Throughout this downturn we continue to do the same that we believe will build this business for the long term, we believe this will put us in a strong competitive position as the market rebounds.

We also believe there is a long-term trend toward energy efficient and green construction and we are positioned with a right products to take advantage of this trend. Turning to our chemical business, as Tony reported for the third quarter of 2010, total sales of our chemical products were 72.6 million compared to 59.7 million in 2009. The increase in our chemical business sales was primarily due to increased demand for our mining products and the increase in selling prices of all products partially driven by higher raw material input costs.

Sales of our industrial and mining products were a combined 54.1 million while sales of our ag products were 18.5 million. Typically, agricultural sales are lower in the third quarter than the first two quarters due to seasonality. This year ag sales were also impacted by hot and dry weather in certain markets that we serve and an extended plan to maintenance turnaround at our Cherokee facility.

Gross profit and operating income were both improved as compared to the third quarter of 2009 for all the reasons that Tony pointed out earlier. Focusing on the agricultural part of our chemical business, as I just mentioned during the third quarter ag product sales were 18.5 million or 9% lower than the third quarter of 2009. Total ag product ton shipped were 30% lower than 2009. Dollar sales did not decline as much as tons shipped due to higher sales prices for our ag products.

During the third quarter, our ship tonnage of UAN fertilizer which came primarily from our Cherokee Alabama plant was approximately 37% lower in the third quarter of 2009. Decreased volumes were partially offset by increased sales prices and therefore revenues decreased 24%. Lower tonnage sold in the current third quarter was due to plant turnaround in 2010 and lower inventory on hand at the beginning of the 2010 third quarter.

Turning to ag grade ammonium nitrate or AN, our third quarter 2010 revenues were lower than the third quarter of 2009 by 24%, as a result of a 36% decrease in tons shipped. However, during the third quarter of 2010, the published sales prices for AN was approximately $60 per ton higher than one year earlier. The significant decrease in our agricultural AN product sales volume in the third quarter was due to hot dry weather conditions in the markets we serve.

The current outlook according to most market indicators including reports in Green Markets, Fertilizer Week and other industry points to positive supply and demand fundamentals for the type of fertilizer products we produce and sell for both the short and long term. Recent reductions in grain production estimate have increased grain prices. Strong grain value should be favorable to increase fertilizer demand and prices.

Again, demand from the markets we serve is strong and we are optimistic about the near term. We also remain bullish about the long-term demand for the agricultural products we produce. The price of anhydrous ammonia, the raw material feedstock for our El Dorado facility as quoted at the Tampa price point averaged $386 per metric ton during the third quarter compared to $206 in the third quarter of 2009.

Today’s Tampa price is quoted at $452 per metric ton. During the first nine months of 2010, anhydrous ammonia increased in cost while natural gas cost declined resulting in a competitive cost disadvantage for agricultural ag grade AN produced from purchased ammonia at our El Dorado facility compared to competitors who produce ammonia from natural gas. Conversely, our Pryor and Cherokee operations are benefiting from low gas costs resulting in low cost to produce ammonia and other products.

Turning to our industrial chemical products. During the third quarter, our industrial product sales were 30.2 million, up 14% quarter-over-quarter. However, ton shipped were only up 5%. The increase in revenue per ton was due to the pass-through of higher cost of anhydrous ammonia, the raw material for the El Dorado and Baytown plants. We believe that in the long run, there will be steady requirement for our industrial assets and we are seeing increased demand as the economy improves.

During the third quarter, our mining product sales were 23.8 million, up 83% compared to 2009 third quarter.

Tons shipped were up 72%, the increased ton shipped were due to increased demand for coal and other mining services as economic conditions improved. For the remainder of 2010, we anticipate modest increased demand on certain of our large industrial customers and from our mining customers tempered by the usual end seasonal call off in the mining sector.

Most of our chemical businesses industrial and mining sales are pursuant to cost plus pricing arrangements with our customers assuming the raw material cost fluctuation risks with eliminating much of the risks of a disconnect between raw material cost and the market prices for our products. During the first nine months of 2010, approximately 72% of our industrial mining products were still pursuant to agreements that either have minimum purchase requirements or a fixed total contract profit irrespective of volume taken by our customers.

To that extent we are somewhat insulated from a potential downturn in the end power industrial products.

Now turning to focusing on the prior facility, we know that many of you are following this closely, so I’ll try give you a thorough and detailed update. We reported to you last quarter that we are firing the primary ammonia reformer on June 18th and there would be an approximate 90 day delay, while the reformer would be rebuild.

The rebuild was completed on schedule and we also use that delay period to perform a previously scheduled plant maintenance turnaround. We restarted production of ammonia on September 30th, experienced a few delays in mid October and resume production on October 27th. We are currently producing ammonia. The nitric acid and Urea plants will be activated to produce UREM in proper sequence. We are currently selling ammonia to be used as fertilizer during the fall agricultural season.

Our primary rationale for reopening Pryor was the change in the nitrogen fertilizer industry in United States, over the past several years, coupled with the long-term favorable outlook for fertilizer products. Today we believe those reasons are still valid and the long-term outlook is even stronger. We believe that Pryor is a valuable asset that will contribute to earnings for many years to come. We are enthusiastic about our relationship with Koch chemical on this project, which should facilitate the growth of this business for LSB.

Summing up, all our chemical plants are experiencing good steady even demand, the demand for industrial and mining products has increased, the outlook for ag products demand is strong.

Before closing, I would like to mention that Tony and I will be presenting at the Baird Clean Technology conference in San Francisco on November 30, we would hope to meet some of you there, also since this is the last conference call, before the holidays in New Year we want to end up good wishes for happy holiday season and happy New Year to all of you.

I'll now take your questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will now be conducting a question and answer session. (Operator Instructions). Our first question is coming from the line of Mr. Dan Mannes of Avondale Partners. Your line is now open, you may proceed with your question.

Dan Mannes - Avondale Partners

Couple of quick follow ups here. If we are going to talk about Pryor, your commentary as it relates to the urea and the nitric acid plant. I guess I am just trying to understand, is that different that it had been before, as the commentary about being positioned, I guess the question is, are they actually running at this point or at this point you are just going to sell Ammonia and maybe start some up a little bit later into the spring. If you can just kind of give us little bit more explanation there?

Barry Golsen

Dan as we said we are starting them up in the proper sequence and we first activated the ammonia plant and we are loading the ammonia plant, in the next few weeks we’ll be activating those plants.

Dan Mannes - Avondale Partners

And you have gone through this process before, is that there or is the [ammonia] plant never run at this level?

Barry Golsen

No we have during this whole extended set-up process, we are in each of these plans successfully its jus that during this start-up sequence, this is the sequence that they are using in the operation. So we are confident that these are going to start up and run fine as we start them up in a proper sequence.

Dan Mannes - Avondale Partners

And did you do a turn around on them as well through out.

Jack Golsen

We did a complete re-build on it.

Barry Golsen

Yeah we did.

Dan Mannes - Avondale Partners

And then just briefly could you extend the raw problems with that start up, 1 million margin looked pretty healthy. Would you be able to cover fixed overhead just running the ammonia plant and selling ammonia?

Barry Golsen

Yes

Dan Mannes - Avondale Partners

And be profitable?

Barry Golsen

Yes

Dan Mannes - Avondale Partners

Good okay, briefly on the existing business for the third quarter, I guess I was a little bit surprised by the late level of ag sale. You guys usually do a turn around in Cherokee every year. I guess I had forgotten it was 3 versus 4, but was there anything else going on, did you end the quarter with a lot of inventory of ag chemicals, I guess the numbers looked a lot lower than I would have thought especially given the perception of demand out there.

Tony Shelby

Dan we broke this down and the primary focus here was the fact that we had tremendous third quarter in 2009, because we had some consolidated shipments that went out. This year we began the third quarter with a very large inventory Cherokee. We did a turnaround so go-aheads in the past we would have shipped significantly more UAN in the third quarter than we did, we had limited availability and we were down to turnaround and then on the ammonium nitrate, only agricultural grade ammonium nitrate side, we just have weak demand for that future product due to weather conditions, but it is certainly not indicative of what we expect going forward in the ag side.

Dan Mannes - Avondale Partners

But it’s more indicative of just the aggregate amount of volume you have available just given what your sales were in the second quarter?

Tony Shelby

Just sort of we have a perfect store and it came together with that limited product available and downtime and so not really reflective of the demand for products.

Dan Mannes - Avondale Partners

Got it, real quick the margin structure on Q3 and Barry you talked about the sequential uptick. I know you guys don’t give guidance on margins, but there’s been a lot of (inaudible) margin this year. I mean anywhere from that low 35 all the way back up to mid. I guess I am just trying to think about what’s the sustainable level we are going forward.

Barry Golsen

I said this before and I will say this again, we still think of the Climate Control business as being in the low 30s, 30-31 generally speaking in the kind of markets that we are in at least right now and we had some unusual things in the third quarter which I outlined and I am not giving you guidance but I certainly wouldn’t count on this level of GP going forward.

And then on the chemical side, I might point out for you sequentially that our ag sales in the second quarter of 2010 were in the 50 million range and only 19 million in the third quarter. So, that was really the main difference in gross profit procedures regarding the quarter over quarter sequentially.

Dan Mannes - Avondale Partners

I didn’t get a full view on your Q, but it did look like you would up some of your hedging for natural gas, can you give us any color, give how attractive pricing is for ag chemicals? Are you pre-selling at this point for delivery next year?

Tony Shelby

No as a matter of fact, we have laid back little bit on pre-selling because we have expected prices to go up, so we have done a limited amount of pre-selling.

Dan Mannes - Avondale Partners

I think Jack you'd mentioned some updated news about maybe changing over one of your climate site, could you give a little bit more color, is this a new product line you guys are getting into?

Jack Golsen

It’s not a new product line, we've developed a geothermal module a geothermal chiller that’s been very successful in the market place. And it’s got to the point where it needs its own plant, we were manufacturing in some of our other facilities and this section will make those chillers and it will also make a cool modular chillers. So to really do it and do it right, we are setting up this additional facility.

Barry Golsen

Yes, it’s a dedicated facility and all the expertise will be focused and dedicated on this kind of product as opposed to being mixed in with other products, so, we just feel it will operate more efficiently and this is not entirely, I mentioned this in the last conference call and we are just updating you on it, the fact that we are actually kicking off the refurbishment of that plants and the repurposing of it.

Dan Mannes - Avondale Partners

And did you have similar module issue, that’s primarily a commercial product.

Barry Golsen

Yes.

Operator

Ladies and gentlemen our next question is coming from the line of Mr. Eric Stine with Northland Capital.

Unidentified Analyst

Just two quick questions, can you provide an update on the distribution agreement with (inaudible).

Barry Golsen

We have the distribution agreement, it’s in place and they are proceeding to sell the product and we’re preceding to supply them the product. As to any specifics of quantities, we don’t disclose that.

Jack Golsen

They are an OEM.

Barry Golsen

They are an OEM customer.

Unidentified Analyst

Second question, can you provide kind of, directionally where the agricultural technique could go in 4Q, is the outcome in 4Q due to seasonality or recovery due to lower 3Q levels?

Jack Golsen

I didn’t hear the last part of it.

Barry Golsen

Is the direction going to be considerably higher based on the low third quarter volume?

Jack Golsen

We are expecting a reasonably strong fourth quarter in ag product because this is the time of the year where they use a lot of ammonia and that’s the first thing they use and after that they use UAN and after that they use pro nitrate, ammonium nitrate.

Barry Golsen

So if you look at all the information written in the trade publications, you will see that there should be a very strong demand for most of those products Jack mentioned.

Jack Golsen

Sometimes weather is such that they can't put down ammonia, because it’s too wet and so they go, they wait and they go to UAN and those cases the volumes with UAN are greater if they have not applied straight ammonia.

Operator

Our next question is coming from the line of Mr. Joe Mondillo with Sidoti & Company. Your line is now open you may proceed with your question.

Joe Mondillo - Sidoti & Company

First, I wanted to talk about the prior facility a little bit. I was wondering if you would care to comment on sort of an outlook or guidance, what that plan can contribute to your topline, flat bottomline given full capacity, running at full capacity and maybe flat pricing?

Tony Shelby

We can’t obviously give guidance that in our previous releases and disclosures, we have disclosed that we plan to produce 325,000 tons of UAN and had a mere of 35,000 tons in excess of Ammonia sale, and so if you look at gas process now and the (inaudible) plus range and UAN process and a $300 plus range due to a significantly better spread that existed there and there has been in the last 18 months. So we have really good spread drop now but we cannot really forecast, you know there is about 14 MMBTUs of gas in a ton of UAN.

Barry Golsen

And the other thing I will point out that’s correct that Tony is talking about in the basic economics of producing a ton of UAN are significantly better than it were when you make the design to pull the trigger, and reactivate this plant. So we are feeling good about the outlook there

Jack Golsen

There is one more thing that has contributed somewhat to our protracted startup and that’s we are going to be able to produce more ammonia than we originally projected, and we’ll have more excess ammonia to sell in the market in addition to the 325,000 tons of UAN. We were shocked we are going to have 35,000 tons of ammonia we are going to have substantially more than that itself.

Barry Golsen

Okay, so that also contributes to the better overall economics group plan.

Joe Mondillo - Sidoti & Company

Could you address excluding the prior, how would your gross margin on the chemical side of the business attracts from the second quarter to the third quarter?

Tony Shelby

The gross profit was substantially less in the third quarter than the second quarter, was that your second question?

Joe Mondillo - Sidoti & Company

Excluding Pryor?

Tony Shelby

The reason is exactly what Oden told that in the second quarter we had $50 million worth of agricultural sales and the third quarter only 18 million and agricultural product is most profitable because it is only market versus a formula basis. So that’s really the primary difference.

Joe Mondillo - Sidoti & Company

Okay, I am sorry. I sort of heard that. I guess in terms of operating income line and excluding Pryor it seems like its been sort of stable over the last couple of quarters, why is that down?

Tony Shelby

What part of the business are you referring to?

Joe Mondillo - Sidoti & Company

The chemical, operating income line.

Tony Shelby

Rephrase the question I am sorry.

Joe Mondillo - Sidoti & Company

On an operating income line in the chemical business does the margin has been somewhat explicable excluding Pryor given the trends why is that what’s going on there?

Tony Shelby

As Barry indicated we got 70% of our business more or less is contractual. 72% of the non-agricultural business is contractual. So we have the advantage of being able to pass through our calls for most of these contractual business which tends to lever after margin and then the plus or minus the major variation comes from the level of your agricultural sales and the market condition so its time to ship it so, the stability and that operating margin in chemical is primarily a result of the fact that we got a heavy footstep of contraction and industrial business.

Jack Golsen

And I’d like to add to that to make it clear. In the future that percentage is going to drop, not the volume, but the percentage because as we saw product from Pryor, that price now will be agricultural product. And so the next time we are talking to you probably will not be the same percentage it be substantial less, it might be like 60-40 or something like that whatever it turns out to be, it’ll be less. The volume will be higher and the percentage of that will be higher and the percentage of industrial will be lower.

Joe Mondillo - Sidoti & Company

In terms of the third quarter the margin was late because of a later agricultural isn't that sort of…?

Jack Golsen

That’s exactly what I was saying

Joe Mondillo - Sidoti & Company

So what you are saying is in the fourth quarter when we get more agriculture the margins are going to be lighter, this seems sort of conservative.

Tony Shelby

No, no the third quarter this year gross profit was down some because we had a very low mix of agricultural product which tends to be more profitable.

Joe Mondillo - Sidoti & Company

Right okay. And then Jack was saying as we get Pryor online which is more agricultural, should be more profitable, margins should be up right?

Tony Shelby

Right now you have a very good market to (inaudible) the fertilizer which we produce and as long as that continues you should be favorable to the overall.

Jack Golsen

Based upon everything today, something you have to watch everyday.

Joe Mondillo - Sidoti & Company

I guess just follow up, just a comment on Tony's answer to my original question, your growth margins are being more reflected in the lower ag volume however the operating combine does still seem to stable and your answer sort of had to do with contractual agreement with the cost, cost plus on the industrial mining, that should be reflected in the gross margin?

Barry Golsen

That’s true.

Joe Mondillo - Sidoti & Company

So there must be something else in the operating income line that’s sort of stabilizing that.

Jack Golsen

What happened is we have changed a lot of the cost Pryor and the operations. Do you recall the fact that we are taking the product cost down in the SG&A?

Joe Mondillo - Sidoti & Company

I'm excluding that. All right, I'll follow up. I guess the other question I had was how much of a benefit on the Climate Control, it’s from the hedging that you have had that propped up those margins so much?

Barry Golsen

I don’t know off the top of my head. Tony do you have that number for the third quarter? What the benefit was from climate hedging?

Tony Shelby

We can come back, we will get that number and give it to you.

Joe Mondillo - Sidoti & Company

Okay, and then I guess my last question just had to do with the tax rate, I don’t know if you address that, might have missed that.

Barry Golsen

The tax rate is 43% and a normal tax rate would be closer to 40%, but as we’ve mentioned in our footnotes, we had, catch up adjustments on non-deductible expenses that took our tax rate higher this year. So, you have a 43% tax rate which more normalized will be 40.

Operator

(Operator Instructions). Our next question is coming from the line of Mr. Brian Kremer with Roth Capital Partners.

Brian Kremer - Roth Capital Partners

Couple of things that haven’t been touched on yet, the operating expenses, obviously Pryor has made a proportion of that over the last few quarters, in the last year, year and a half. 6.1 in this most recent quarter, how do you see that in the fourth quarter?

Tony Shelby

I believe it was 4.8 million in the recent quarter.

Barry Golsen

If you could rephrase your question, we will come back to it.

Brian Kremer - Roth Capital Partners

I just want to understand looking forward obviously that’s a big difference, you’re looking at 40 million or less on a go forward basis if you pull Pryor out of this and what should we expect in terms of any additional expense within the fourth quarter related to Pryor?

Barry Golsen

Are you talking about below the gross profit margin?

Barry Golsen

Yes.

Tony Shelby

Let me just quote you the numbers for Pryor first. Year-to-date we have got $13 million below the line and $11 million last year. In the third quarter, we got $4.6 million versus $6.1 million last year and those numbers show go away if we are successful in covering all of our cost in the fourth quarter in certain periods. That should included in cost of sales aligned up with the sales volumes.

Jack Golsen

In plain English, we have been expensing the cost of Pryor without production. Now that we are getting production, they should absorb their own overhead and contribute a profit.

Brian Kremer - Roth Capital Partners

When you hit full production or the point, will you announce that during the quarter, how are we going to approach that?

Barry Golsen

It will be in our fourth quarter SEC filings because right now we already made the announcement that we are running ammonia at a sustained rate. So, and that we will pick up urea and nitric acid in proper sequence, so I don’t think there is announcement necessary.

Jack Golsen

It will be handled like all our other chemical operations.

Barry Golsen

Improving our [portfolio].

Tony Shelby

I would like to just interject to come back on answering the question that was asked by the previous caller. During the three months, during the quarter, the last quarter we had approximately a $500,000 gain on futures contract in the Climate Control business. Q3 of 2009 and based on reported sales of 64.5 million, that’s less than 1%, I mean that’s like less than eight tenths of 1% of impact so that will help finances the reviews. I am talking about 2010.

Jack Golsen

Okay, Brian, do you have another question.

Brian Kremer - Roth Capital Partners

Yeah, just might have missed the (inaudible) in the remarks, the prepared remarks but what does the UAN did you give the UAN whether it was an average price during the quarter or the current stock price?

Tony Shelby

I don’t we disclose that and as our relation before UAN sales like that swiftly but right now with the pricing here in the $300 range.

Jack Golsen

$300 a ton. And on the product...

Tony Shelby

Based on green market southern plains, during the third quarter there was a range of pricing it was increasing and it increased from 215 to 285 within that range that’s higher now, but that’s published prices.

Brian Kremer - Roth Capital Partners

Now on the climate control side, I think in going to the queue quickly although residential was up for the first nine months pretty nicely, I think this quarter was only up 6% year-over-year, is there something going on there, is it timing what, how should we look at that?

Tony Shelby

Well, we know that it was kind of a mid year, stall and new construction pretty much well publicized. We know that new constructions will not increase as much as we expected it this year anybody expected it to.

We know that we are dealing with a lot of [reminiscent software] in the current economic conditions for people to spend money, this is geothermal is our residential product it’s a high end product, there is less financing available out there in the world today than it was a few years ago, potentially like home equity loans. So, basically we do have the advantage right now of the tax credit which will extend until the end of 2016, so as the recovery occurs we feel that we’d be getting a significant benefit from that, but we just feel that there is some headwinds out there and has impacted us from the third quarter.

Jack Golsen

Well, wait a minute that’s impacted all geothermal.

Tony Shelby

I am getting there. In fact our view is from the data that we have available to us that the overall market for geothermal is or product in unit shipment is off year-to-date approximately 5% on last, where our sales are up, in unit sales I believe, 11%. So, we have actually gained market share this year. That’s how view the picture.

Brian Kremer - Roth Capital Partners

And one other, did I hear some of the prepared remarks related to CapEx that there is expected CapEx going prior in the fourth quarter?

Tony Shelby

Yes you did.

Brian Kremer - Roth Capital Partners

So I am assuming that's related to the other parts as you start those up?

Tony Shelby

Probably that is the rebuild cost there is (inaudible).

Jack Golsen

And it does not include recoveries from interns.

Operator

Ladies and gentlemen our next question is coming from the line of Mr. David Kaizer with Robotti & Company. Your line is now open you may proceed with your question.

David Kaizer - Robotti & Company

Part of my question was just answered just wanted you to go over the number with the geothermal heat pumps and it is evident that you gave market share, I just want to confirm that.

Jack Golsen

We believe we did yes.

David Kaizer - Robotti & Company

And then in terms of the split, you said that close to 50 - 50 in terms of new homes and retrofit.

Tony Shelby

I think was approaching 50%. We don’t have the exact number because we actually can’t obtain that through out distribution, but we know that a few years ago, we used to save 30 about roughly a third retrofit and mostly in construction and we are seeing it approach 50% to that.

David Kaizer - Robotti & Company

And do you think that trend can continue or do you think once new homes starts pick up that it returns or its something in between.

Tony Shelby

I really don’t know, I can’t really spectate on that.

David Kaizer - Robotti & Company

And just you focused on Pryor a lot, you mentioned, I just want to confirm it, the 13 million was spent on Pryor this year?

Jack Golsen

CapEx?

David Kaizer - Robotti & Company

With expense. Is that right or do I have that wrong?

Tony Shelby

That’s right, let me clarify that. That’s how much we have (inaudible) as SG&A expense.

David Kaizer - Robotti & Company

That’s what I am referring to.

Tony Shelby

They had some sales and cost sales and some (inaudible) cost sales but we were referring to below the group profit lines.

David Kaizer - Robotti & Company

Just taking a broader picture and not worrying about like next quarter. You have to be very optimistic about the future that you have grown geothermal heat pumps in the tough environment, the commercial markets are starting to pick up, so the climate control business, it seems like it’s poised for growth and in the mean time Pryor’s kind of behind you and if you were to add back what you spent on Pryor this past year, you would have had a nice year in a very tough environment. So, I kind of answered the question for you but you have to be very confident in what's coming in the future.

Barry Golsen

We feel confident, yes we do.

Operator

Our next question is coming from the line of Mr. Dan Mazur with Harvest Capital.

Dan Mazur - Harvest Capital

Just with the agreement with coke, you get the published prices on UAN, is it just as simple taking the 325 times 300 assuming full capacity for full production?

Tony Shelby

We do a marketing fee to coke, so you’d have to net that out from the sales price, from whatever the market price is.

Barry Golsen

And Dan also remember and realize that we haven’t really pulled the trigger on that, yes if we have really started shipping under that agreement.

Jack Golsen

Right, but nothing to speak off.

Dan Mazur - Harvest Capital

And then given estimate for what above the 35 million ammonia that they you think you could produce?

Tony Shelby

You mean the 35000 tons per year?

Dan Mazur - Harvest Capital

30000, yeah, it sounds like it will be more than 30,000.

Jack Golsen

60,000 to 90,000 tons

Barry Golsen

No, that’s in aggregate, that’s not above the 30, that’s in aggregate, in total.

Dan Mazur - Harvest Capital

And then is there a good way to think about the production costs at Pryor on a cost per ton and maybe something as a rule of thumb or maybe what's your key run?.

Barry Golsen

If you’re talking about UAN, we can’t really, we had to run the play, yes, but we don’t have the definite numbers, so we just from industry statistics, some plants were on better conversion than others, but if you use 14.4 MMBTUS of gas and whatever the gas process you could use it in the future or the current and then at 70 or $80 of conversion cost and you'd have a pretty good feel for it. We can’t project that will ready, could be less, could be more.

Operator

Our next question is (inaudible). You line is now open you may proceed with your question.

Unidentified Analyst

Just one question you may have answered it, I may have missed it but just going back to Pryor, you mentioned some production figures and I get confused as to whether those are numbers on ammonia and urea that have to do with the contracts you’ve had in place already or that is the full production capacity of Pryor?

Jack Golsen

Let me clarify for you. Our contracts calls for 325,000 tons a year of UAN. To do that and fulfill that based on our original projections that we make running the ammonia plant at the turndown rate, we had 35,000 excess tons of ammonia that we could sell on the market. But based on what we now know running at, the rate we are running at. Assuming that we continue to run at this rate, we will have between 60,000 and 90,000 tons of ammonia per year put on the market, over what's required for the 325,000 tons of UAN.

Unidentified Analyst

We’ve our contracts to produce 325,000 UAN and then we will have over and above that revenue stream 60,000 to 90,000 tons of ammonia to sell at the open market. And just the plant capacity, it’s going to take on other things above that because you talked about turndown capacity, so is there a way to extend or is that full capacity for Pryor to fulfill the UAN contracts and then you have 60,000 to 90,000 tons of ammonia just on the open market and that’s it.

Jack Golsen

Well, there’s facilities in that we have no plans to activate yet. We want to see the profits coming in from the point and that’s on the table now. We think about starting up additional plants that are on the site.

Unidentified Analyst

And to do that it’s sort of a similar start up deal?

Jack Golsen

To do that we have to spend money, we have extra UAN, we have extra asset plants and we have additional ammonia plants and we have additional urea plants. But we haven't got what the cost would be to activate those, we want to make a profit on this plant, show what it can do and have some history with it before we attempt to activate the rest of them.

Tony Shelby

So kind of summing up we have no plans at this time to activate any future, other part of this plant.

Unidentified Analyst

And I assume you did the easiest one first?

Jack Golsen

Not necessary, we did a lot of these ones first.

Operator

Our next question is coming from the line of Mr. Revis Lewis, a Private Investor. Your line is now open you may proceed with your question.

Revis Lewis - Private Investor

(Question Inaudible)

Tony Shelby

We can’t hear you because you must be static on the line.

Revis Lewis - Private Investor

Are you interested in selling the company?

Tony Shelby

Seriously we can’t you are static on the line, we can’t hear you, we just can’t hear.

Revis Lewis - Private Investor

Selling your company?

Tony Shelby

Are we interested in selling the Company, well the company is not for sale, sir.

Operator

Ladies and gentlemen at this time there are no further questions. I would like to turn the floor back over to management for any closing comments.

Jack Golsen

I would like to thank all of you for listing today and I’d like to urge you to stay on the line to hear some very important information about forward-looking statements that we made during the presentation. And I’ll turn it over to Carol

Carol Oden

Thanks again for listening in today. The comments today contain certain forward-looking statements. All statements other than statements of historical fact 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, all statements about or any forecast pertaining to indicators are trending upward. We are moving in the right direction, we are optimistic about the long term future of our company. We are not yet up to our potential. We have adequate working capital and finance ongoing operations as well as organic growth opportunities. There would be a gradual recovery in commercial consumption and we will participate and be stronger and more competitive. We continue to do things we believe will grow this business for the long term.

We continue to increase sales of geothermal products. We believe there is a long term transform energy efficient and brings consumption and we are positioned with the right product to take advantage of this. Strong grain value should be favorable to increase fertilizer demand and process. We are optimistic and remain bullish about long term demand agricultural products. We just take modest increase demand for our large investor or mine customers. We believe that in the long run there will be a steady requirement for our investor assets, product facility will enhance the production long term outlook for the product facilities, and products are even stronger.

We believe prior to valuable assets it will contribute to earnings, outlook for agricultural product demand is strong. The Pryor facility nitric acid and urea plants will be activated to put this UAN in proper sequence. 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 the number of important factors. We incorporate the risks and uncertainties discussed under the heading special note regarding forward-looking statements in our annual report Form 10-K for the fiscal year ended December 31, 2009 and our quarterly report on Form 10-Q for the quarters ended March 31, 2010 to June 30, 2010 and September 30, 2010 annual reports we file from time to time with the Securities and Exchange Commission. We undertake no duty to update the information contained in the conference call.

The current EBITDA as used in this presentation is net income plus interest expense. Depreciation, amortization, income taxes and certain non-tax charges, unless otherwise described. EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative to GAAP measurement. We will post on our website reconciliation to GAAP of any EBITDA numbers discussed during this conference call.

Thank you. That ends our conference call.

Operator

Ladies and gentlemen, this does end today's teleconference. You may disconnect your lines at this time. Thank you very much for your participating. And have a wonderful evening.

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