LSB Industries Q3 2007 Earnings Call Transcript

LSB Industries, Inc. (LXU)

Q3 2007 Earnings Call

November 05, 2007 11:00 am ET

Executives

Carol Oden - IR

Jack Golsen - Chairman and CEO

Barry Golsen - President

Tony Shelby - CFO

Analysts

Dan Mannes - Avondale Partners

Rick Nelson - J Giordano Securities

Presentation

Operator

Good day everyone and welcome to the LSB Industries' Third Quarter 2007 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. Please, go ahead, Ms. Oden.

Carol Oden

Thank you. Good morning and welcome to the LSB Industries Inc. 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, November 5, 2007 and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay. We will not make any projections as to the future results as to revenues, income or earnings per share of the company during this conference call. However, comments today may contain certain forward-looking statements, including but not limited to the strategy of our Climate Control to develop and introduce products that use EarthPure non-ozone-depleting refrigerants. That we do expect to increase our market share because of growing demand for our Climate Control products; increased output at ClimateMaster, historical shipping as the Climate Control backlog returning, developing product lines within our Climate Control, exposure of our Climate Control to the downturn in a single family residential market is not great, impact of certain legislation on the Climate Control geothermal market.

Our Climate Control is on-track towards the continued long-term growth near-term growth curve of our business is flattening. Our products are necessary for the future of our country. Our facilities can handle substantial increases. We expect to continue to perform well, compared to other companies in our industry. We have concluded that it is more likely than not that our NOL will be used in 2008, we estimate that our turnaround cost for our Chemical business will be approximately $2.4 million in the fourth quarter 2007, and improvement in our balance sheet and capital structure will continue to be a management strategy.

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 measurement of financial performance under GAAP and should not be considered as an alternative to GAAP measurements.

All statements other than statements of historical facts are forward-looking as more fully discussed in our 2006 10-K, as amended by our recent Amendment Number 1 to our 10-K and our 10-Q for the quarter ended September 30, 2007 under Special Notes Regarding Forward-Looking Statements. A more comprehensive listing of risk factors, which could cause results to vary from any forward-looking statements made during this conference call, is also included in our 2006 10-K, as amended by our recent Amendment Number 1 to our 10-K and our 10-Q for the quarter ended September 30, 2007 under Special Notes Regarding Forward-Looking Statements. 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 Golsen

Thank you, Carol. Good morning, everybody and welcome to LSB's third quarter conference call. On the call with me today are Barry Golsen, LSB's President and Tony Shelby, our CFO. After we update you about the company, we will be available to answer your questions about the business.

We have noted that the vast majority of persons on our conference calls have been on several previous calls, so we are going to minimize the background information and assume that you know what our company does. We hope this satisfies those of you who have commented that our previous calls were too long. Any call participants have questions about the nature of our businesses, we will happy to send you information upon request.

You will hear today that our third quarter results of sales and earnings were the best in recent history. We released third quarter and year-to-date numbers to the public this morning and the 10-Q was also filed this morning.

Consolidated sales year-to-date were $451.7 million up 22.6% over last years $368.2 million. Net income to common shares this year was over six times at $18.1 million from the $3 million in last year's third quarter. In the third quarter, fully diluted earnings were $0.77 per common share, compared to $0.18 last year and year-to-date earnings were $1.67 compared to $0.65 in 2006.

Overall, our core businesses have been very strong this year. So far, neither the Climate Control business nor the Chemical business has been affected by the slowing US economy, which we all see taking place. Although each day more experience of forecasting in economic slowdown, we are not forecasting the future in our business, which has been on a very steep rising trajectory. But we expect to see the near term growth curve flattening.

As we have said many times in the past, our decisions are made for the long-term and for the long haul. We believe that we are in the right spot because of our energy savings and green products and the country's quest for energy independence. Products of both of our businesses are a necessity for the future of our country, and we expect the segments of the specific markets that we are in to continue to grow.

Our market share of key products has continued to increase and we continue to dominate in niche markets that we serve. Our facilities are in place to handle substantial volume increases in the future, if they materialize. On the subject of facilities, please keep in mind that our major plant turnaround will occur in the fourth quarter this year. Under the new accounting rule, cost of the turnaround will be expensed as incurred.

You may be interested to know that our El Dorado, Arkansas facility, El Dorado Chemical, was recently awarded the 2007 Diamond Award for its efficient quality improvement program based on its overall impact and the benefits to the environment and the example that it has set for the community.

On Wednesday of this week, November 7th, Barry and Tony will address Pacific Growth Equities Clean Technology and Industrial Growth Conference in San Francisco, where they will also conduct one-on-one institutional meetings on both Wednesday and Thursday. The webcast of their presentation will be posted on our website.

We are also very pleased to report that Dan Mannes of Avondale Partners initiated research coverage on us last month, joining Rick Nelson of J Giordano Securities.

Now, I will turn this call over to Barry and Tony, who will go over our financial conditions and the specific numbers in details about our businesses. Tony, you take it.

Tony Shelby

Thank you, Jack. Today we issued an earnings release and filed the 10-Q for the third quarter of 2007. Both of these documents either are or will be available on our website. Before we get on to the numbers, I might comment that this is somewhat of an unusual quarter in that the consolidated results of operations include three separate income items that require explanations.

Chemical's operating income and EBITDA include two settlement gains totaling $4.8 million and the consolidated [earnings] includes a significant credit related to the net operating loss tax credit. These three items I just referred to will be explained more fully during this financial review and there will be more extensive explanation in 10-Q, which we encourage you to read.

The financial results for the quarter ended September 30, 2007, third quarter results in other words. Our two core businesses both had a good third quarter. Sales were $147.6 million, an increase of 19% over the third quarter of last year. Climate Control sales were up 24%, Chemical sales were up 14%, both as compared to last year.

Operating income; Climate Control's operating income was $9.8 million compared to $6.9 million for the same quarter last year. Chemicals' operating income was $11.5 million compared to $2.4 million last year. After allocation of corporate costs, the consolidated operating income for the third quarter of 2007 was $19.1 million compared to $6.8 million in last year's third quarter.

EBITDA. Climate Control's EBITDA increased by $2.9 million to $10.5 million and Chemical increased by $9.2 million to $13.8 million. The consolidated EBITDA for the third quarter of '07 was $23.3 million. This was an increase of $13.2 million compared to the 2006 third quarter. As indicated above, the operating income and EBITDA for the third quarter includes the two settlement gains totaling $4.8 million.

Net income for the third quarter was $18.3 compared to $3.5 million for the third quarter of 2006. The diluted income for common shares for the third quarter 2007 was $0.77 versus $0.18 last year.

In the net income as -- I don't know, I mentioned regarding the net operating loss carry-forward. The third quarter 2007 includes a provision for income tax of $1.1 million for AMT, alternative minimum taxes, and $500,000 for state income taxes. Those two offset by benefit of $3.2 million due to the expected utilization of remaining net operating loss carry-forward.

Under GAAP, an entity is not permitted to recognize the future tax benefits of NOLs and other temporary book-tax differences unless it is more likely than not that the entity will be able to utilize those tax benefits. In prior periods, we've provided valuation allowances against those deferred tax assets, including net operating loss carry-forwards. But in the third quarter of this year, based upon the 2007 earnings to-date and the earnings outlook, management is concluding that it is more likely or not that we will be able to utilize the NOLs in 2008. Let me restate that. It's more likely or not that we will be able to utilize the NOLs in 2008 and realize the other net deferred tax assets. As a result, we have reversed $3.2 million of the valuation allowance and recognized income tax benefit of the same amount shipped in September 30, 2007. This is explained in more detail in the footnotes within Q.

With respect to the settlement gains that we mentioned earlier, as indicated, Chemical's operating income EBITDA included two settlements totaling $4.8 million and [$0.19] per share as follows. There is a $3.3 million gain from the settlement of the Dynegy litigation, which was outlined previously in our previous filings. There was a settlement of $1.5 million of the business interruption claim. The settlement with Dynegy is related litigation for alleged price manipulation of natural gas market affecting the price maturity, which charged the natural gas from 2000 to 2003. This gain is included in other operating income.

The $1.5 million is an advanced payment for an insurance recovery in our business interruption claims for damages to the gas pipeline feeding the Cherokee facility. The damages were caused by the Hurricane Katrina, resulting in curtailment and interruption in the delivery of natural gas to Cherokee. This recovery of $1.5 million was recorded as a credit to Chemical's cost of sales. Both of these settlements and the income tax accounting is explained in more detail in the 10-Q.

Now, with respect to the year-to-date numbers at September 30, 2007 for nine months, the sales year-to-date were $451.8 million, a 23% increase. Operating income year-to-date was $47.8 million compared to $21.2 million last year. For the year-to-date, EBITDA was $58.7 million compared to $31.3 million last year.

Net income year-to-date through nine months was $42.3 million compared to $12.8 million last year. Diluted earnings year-to-date was $1.67 versus $0.65 last year.

A comment or two about the fourth quarter of 2007, as we previously disclosed, we have changed our method of accounting to major plant maintenance activities in our Chemical business, which we'll refer to in this conference call as "plant turnarounds." We have planned certain of those plant turnarounds in fourth quarter of '07, when the seasonal cultural demand is normally at the lowest level. And we are slight that we will incur approximately $2.4 million in the fourth quarter for turnaround cost, which we will be experienced for and as incurred. The addition to tax cost for the turnarounds will be cost of an (inaudible) overhead, while the plants were down from the turnaround. This is a normal occurrence when we are doing the turnaround.

In addition, we will expense approximately $960,000 in the fourth quarter, a deferred cost related to a $50 million turnaround that we anticipate prepaying this week. And I will provide more details in just a minute on that refinancing that we are referring to.

With respect to balance sheet, at September 30, 2007, the company's total interest-bearing debt was $123.4 million, compared to $124.5 million at June 30 of '07. The total long-term debt includes various mortgages and equipment loans of $12.4 million. It includes a five year, 5.5%, $60 million convertible debenture due 2012 and ThermaClime's $50 million senior secured loan due 2009.

The $50 million senior secured loan due 2009 bears interest of 11%, and is secured by first lien on the majority of the chemical plant assets in Arkansas and Alabama, certain equipment of the climate control business, the stock of ThermaClime and certain ThermaClime subsidiaries and a second lien on the assets securing the working capital revolver loan.

We have negotiated a new five-year $50 million term loan with a major USA money share bank with funding not to occur until certain conditions are satisfied, which we anticipate will occur on/or before Thursday of this week. If the loan is closed as schedule, the proceeds will be used to prepay the senior secured loan due 2009. The new loan will be secured by only the chemical plants in Arkansas and Alabama with accrue interest in LIBOR plus 300 basis points with principal payable at maturity. So, that’s a significant improvement in that $50 million term loan.

Cash flow for the third quarter of 2007 was a positive $10.4 million and includes the following components. The net cash provided by operations was $18.5 million. We used $1.4 million for investing, $1.3 million to redeem the Series 2 preferred stock, $2.9 million to pay dividends on preferred stocks, to bring everything correct and $2.6 million for net reductions, long-term debt and other items. So, a net increase of $10.4 million.

In summary, regarding our financial statements, our stockholders' equity has increased to $87 million from $44 million at year end 2006. There's no outstanding borrowings on the $50 million working capital revolver loan and cash on hand was $41 million. Our total long-term debt trailing 12-months EBITDA, these are all numbers at September 30. Our long-term debt trailing 12-months EBITDA was approximately 1.8 times with a series of exchanges, conversions and redemptions of Series 2 preferred stock and all accrued and unpaid dividends should be eliminated. There are 20.6 million common shares outstanding and approximately 4.9 million additional common shares issuable upon the conversion and/or exercise of all dilutive securities options launched.

Earnings per share reflected significant increase quarter versus quarter and year versus year. The improvement in our balance sheet and capital structure will continue to be a management strategy.

That concludes the financial overview of our results of operation and financial position. Barry will now review the Climate Control business.

Barry Golsen

Thanks Tony. I am pleased to report that for both the third quarter and first nine months of 2007 our Climate Control business's overall results improved dramatically over the same periods last year. I planned to elaborate on that later, however, for those of you who are new to LSB here is some basic information about our Climate Control business albeit somewhat abbreviated from past conference calls. The companies in our Climate Control business design, manufacture and market a broad range of high quality air conditioning, heating and heat pump products used in commercial, industrial and residential climate control systems.

We are the US market leader in our core products, which are geothermal heat pumps, water source heat pumps and hydronic fan coils. We also manufacture and market small air handlers, large custom air handling units, modular water chillers, coaxial heat exchangers and tube and fin heat exchangers.

In addition, we complete large scale geothermal installations throughout the United States. We have an installed base of millions of units and our products are used in many different types of buildings for new construction, renovation and replacement. Historically, our business has not been dependent on the health or weakness of any single construction sector.

We currently have five manufacturing facilities and a distribution facility all totaling over 700,000 square feet and all located in Oklahoma City.

Moving on to third quarter Climate Control financial highlights. As compared to the third quarter of last year sales were up 24% to $75.6 million and operating income was $9.8 million as compared to $6.9 million, a 41% quarter-over-quarter increase. For the nine months our sales were up 38% to $221.5 million and operating income was $27.9 million compared to $18.5 million last year, a 51% period over period increase.

The improvement in profitability was primarily the result of higher sales volumes, principally in our heat pump and fan coil businesses. This mirrored increases in 2006 and the first half of 2007. Additionally, sales price increases we implemented earlier took effect in the third quarter resulting in a gross margin of 29.7%, up from 29.2% in last year's third quarter and up slightly from the second quarter gross profit of 29.4%.

Year-to-date this September, our US market share for heat pump products and fan coils was approximately 43% and 41%, respectively, up from 38% for heat pumps and 40% for fan coil in the same period last year.

During the third quarter of 2007, bookings of product orders reached an all-time quarterly record of $65.8 million this was up 8% over the same period last year. We closed the quarter with a backlog of $61.6 million as compared to $66.3 million at June 30th and $80.4 million at December 31, 2006.

In our business, working down backlog while growing sales and new bookings is a good thing and as some of your know our backlogs had increased substantially during 2006 to levels that we consider to be too high. As our lead-times have pushed out beyond what we consider to be optimum for a good customer service. We've worked hard to reduce our factory lead-times and they have improved substantially.

Prior 2006, our Climate Control business had been slightly seasonal shipping more in the second and third quarters than the first and fourth quarters, corresponding to the seasonality of the construction industry that we served.

For the past two years, our shipments didn’t follow this pattern due to the large backlogs we were carrying in extended factory lead-times. Now, that we have reduced our backlogs and lead-times, I would expect to see our historical shipping seasonality return.

With regard to manufacturing capacity, we've substantially completed an expansion in plant-wide reconfiguration at ClimateMaster and a reconfiguration of the assembly area at International Environmental. We also continue to make good progress toward our goal of doubling our total air coil production volume and bringing all heat pump coil production in-house.

In previous calls, we discussed that material price increases during 2006 were in many cases more than those incurred during 2004 and 2005. Although, we implemented across the board sales price increases last year, due to the large backlogs we were carrying, the full impact of these price increases was delayed. While we're trying to recoup all of the material cost increases, we are operating in a very price-competitive environment and the majority of our business is subject to a competitive bid process.

During the last conference call, I reported that we had seen some softening in the price of copper and steel, but that raw material prices were continuing to fluctuate. At this time, raw material costs have stabilized somewhat, albeit at a high level. Based on current information, we expect overall unit material costs for 2008 to be approximately the same as 2007. However, we've seen that these can change rapidly and we continue to monitor material costs very closely.

As many of you know, we have a number of developing product lines and activities that have not yet achieved sustained profitability, but which we believe are investments in the future growth of the business. Within this group are Trison Construction, which specializes in large scale geothermal installations, and ClimateCraft, which manufactures large custom air handlers. During the first nine months of this year, combined sales of these operations increased, and correspondingly, these operations improved slightly over the same period last year.

On a very positive note, I am pleased report that ClimateCraft recently entered into an agreement with Kaiser Permanente, one of the nation's largest healthcare providers to supply Kaiser with large custom air handlers for its facilities. ClimateCraft is one of only two companies on Approved Provider lists, and Kaiser medical facilities may now have the option of using our air handler products. In addition to the incremental business for ClimateCraft, this indicates the high level of acceptance its products have achieved in the marketplace.

Returning to our core products, sales of ClimateMaster's water source and geothermal heat pumps continues to be strong. Total heat pump sales during the third quarter were up 21% over the same period in 2006 and heat pump sales for the first nine months were up 30% over last year. Sales of our geothermal heat pump product line continue to increase as well. During the first nine months of 2007, our total geothermal unit shipments were up 26% over the first nine months of 2006.

ClimateMaster continues to develop and introduce water source heat pump and geothermal products, which use EarthPure non-ozone depleting refrigerants. This is a continuation of our strategy to provide the most comprehensive leading-edge environmentally responsible product line in the HVAC industry.

During the third quarter of 2007, our sales of hydronic fan coil products, manufactured by International Environmental, were up substantially, approximately 44% over the third quarter of last year. Year-to-date through September, our hydronic fan coil sales were up 51% over the first nine months of 2006. This increase is primarily due to higher demand for our modular high-rise fan coil products.

Also during the third quarter, International introduced its new [U-MOD] fan coil product line. This is a product very similar to the mod or vertical high-rise products International has been so successful with in markets all over the US. It's an integrated system, including the basic fan coil unit plus valves, controls, thermostats, discharge air ducts, supply air grills, return air grills and water piping, all factory installed, only a need to install these items on the job site and reducing contractors total installed cost. U-MODs are also designed to minimize factory lead times and to facilitate field configuration as required.

Looking forward, I am sure that a question most of you have is, what's the outlook for construction, both commercial and residential, and what are the implications for future sales? From our understanding of the most recent data available, here is our current view.

As you know the vast majority of our Climate Control business sales are to commercial and institutional construction and renovation. In 2006, commercial and institutional sales accounted for approximately 80% of total Climate Control business sales, and over 90% of these sales, or 73% of our total Climate Control business sales, were to these building types, offices, hotels, educational facilities, healthcare and retirement facilities, manufacturing plants, apartments and condos. So that's the group of construction sectors that we focus on since most of our sales are to those sectors.

During the last conference call, I reported that according to McGraw-Hill these construction sectors in the aggregate were at all-time highs in 2006 and were expected to continue at that level or slightly increased for the next five years. The current McGraw-Hill Construction Market Forecast Service report that we're on 2007 Eighth Edition, which was just released last week, had actually upgraded the forecast very slightly for 2007 for these sectors and downgraded the forecast slightly for 2008.

McGraw-Hill is forecasting that building contract activity for these combined segments will decrease by 3% in 2008 and increase 4%, 7% and 5% respectively in 2009, '10 and '11. For all practical purposes, the updated numbers do not represent a meaningful change. The commercial and institutional constructions sectors, which are important to LSB, are forecast to remain strong for the foreseeable future.

Turning to single-family residential, we're all aware of the sharp decline that has occurred in the market at large. According to McGraw-Hill there was a 14% decline in 2006 from 2005 and a 25% decline forecast for 2007.

2008 is forecast to decline another 3% followed by very robust increases of 20% and 19% in 2009 and 2010, respectively.

Focusing more specifically on the HVAC industry, total unitary equipment shipments of air conditioners and air source heat pumps as reported by the air conditioning and refrigeration institute were down 18% in 2006 from 2005, and year-to-date through August, shipments were down 12% from the same period last year. Industry-wide August shipments were actually 19% lower this year than August of 2006.

However, fortunately, our residential sales had so far, buck these trends. During 2006, our residential geothermal sales increased approximately 50% over 2005.

Year-to-date through September, our residential business was approximately 5% higher than the same period in 2006. Whereas, we have managed to outpace the residential HVAC market for the past seven quarters, the depth of the current market slump had impacted our rate of growth.

As you know, geothermal heat pumps are a green form of renewable energy that reduces energy consumption and greenhouse gas emissions. And by the way, I'm focusing on that because all of our single-family residential sales are geothermal heat pumps. So, may be I repeat that, geothermal heat pumps are a green form of renewable energy that reduce energy consumption in greenhouse gas emissions. We believe that the market drivers for our residential geothermal products are somewhat different than the market at large. High energy prices, environmental issues, energy security concerns drive the demand for geothermal systems. The overall size of the residential market approximately 6 million units per year even in its reduced state after the reductions that I mentioned before, also represents huge upside potential for geothermal products.

And this is a point that I would like to focus on. I would like to emphasize that it's important to note that LSB's overall exposure to a downturn in single-family residential market is not great. In 2006, only 6% of LSB's total sales were to this market. Year-to-date through September 2007, single-family residential sales were only 5% of LSB's total revenue.

One final comment about geothermal, while we are on the subject. Recently Canada, enacted legislation which when implemented will provide a federal grant of $3,500 for the installation of geothermal heat pumps in existing homes, this has been matched by several Canadian provinces including Ontario, the largest, bringing the total incentive package up to $7,000. Due to the development of implementation procedures by the government we've not yet felt the effect of this incentive, but we are optimistic about its impact.

Also at this time, there are several thesis of legislation pending in the United States, which could also benefit geothermal sales if enacted. Some of these have by-products as sponsorship and support, whereas our results today and our business model going forward do not rely on governmental incentive. If the current pending legislation is enacted, it could impact the growth of the geothermal market positively, however, to what extent is speculative.

Summing up, 2007 has thus far been a record year for our Climate Control business. We have continued the trend of improved top and bottom-line results. The investments we have made in product innovation sales and marketing and on the production side of our business have achieved and should continue to achieve the desired result. Whereas, we continue to have challenges, we believe we are on the track toward the continued long-term growth of this business segment.

Tony, I will turn it over to you to discuss Chemical.

Tony Shelby

Okay. Thanks Barry. Our Chemical business produces market with chemical products of industrial mines and then agricultural markets and holds a leading position in the manufacturing and marketing of natural gases.

On a historical annual basis, approximately two-thirds of our business is industrial and mining and one-third is agricultural. The majority of industrial and mining products are sold pursuant to sales agreement and price arrangements that provide either direct or indirect pass through of raw material cost.

The agricultural products are sold at the market price in effective time of the sale. And this agricultural business is seasonal and cyclical and is currently a strong up-cycle driven by low growing inventories and increased crop production required in nitrogen fertilizers.

We have the ability to increase our fertilizer sector sales above one-third, when these margins are favorable. There are three production facilities: The Baytown, Texas facility a single trading world steel nitric acid plant. The El Dorado, Arkansas and Cherokee, Alabama facilities which are multi-plant sites producing industrial acids, industrial grade ammonium nitrate and nitrogen-based fertilizers including ammonium nitrate, UAN or urea ammonium nitrate.

Cherokee consumes natural gas as a raw material feedstock. El Dorado and Baytown both consume anhydrous ammonia which is delivered by our pipeline.

Summary of the financial results for the third quarter; overall, our Chemical business performed extremely well in the third quarter of 2007. As indicated in the financial review, the operating income is $11.5 million including the two settlement gains totaling $4.8 million.

The operating income excluding $4.8 million was $6.7 million compared to $2.4 million in the 2006 third quarter. Sales prices were up significantly for agricultural fertilizer and slightly up for mining products and industrial assets. Gross profit margins and operating income including the settlement gains were significantly higher as a result of stronger fertilizer demand, resulting in higher sales prices relative to the raw material cost and continued improvement in plant reduction rates.

Agricultural products account for most of the improvement in operating profit over the third quarter of 2006, due to the strong performance and outlook for the farming economy. Assay has been highly publicized, global grain stocks including foreign wheat at low levels and are driving the demand for fertilizer products.

Due to abnormally high amounts of rainfall in '07 in mid-South coupled with drought conditions in Southeast, sales volumes were well below our estimates than the potential for fertilizer volumes. However, higher prices and better margins allowed for significantly improved results when compared to last year.

In addition to the higher gross margins in the nitrogen fertilizer sector, margins were also favorably affected by the steady demand for our assays for industrial applications and our industrial-grade ammonium nitrate for surface mining consumption.

The strong demand for all products resulted in production efficiencies associated with higher operating levels of the plant.

The Baytown facility continue to generate consistent positive results and turning in another good quarter. Cherokee's operating income for the third quarter of 2007 benefited from the two settlement gains and from the strong demand and expanding margins for urea ammonium nitrate, published UAM prices in the market area were approximately 65% higher in the third quarter of 2007, than in the third quarter of 2006.

Cherokee's natural gas feedstocks were relatively stable, experiencing very little volatility throughout the 2007 third quarter. Spot natural gas prices, excluding transportation, during the third quarter of 2007 averaged about $6.18, or approximately same as the third quarter of last year. This morning, the spot natural gas price is approximately $6.50 and the 12 months period this quarter in the $8 range, but both of these markets changed daily.

El Dorado, Arkansas benefited from strong agricultural product demand, continued efficient plant performance and favorable sales prices relative to the cost of anhydrous ammonia, all of these resulting in improved margins.

El Dorado purchases were approximately $220,000 tons per year of ammonia, and [formula price] tied to the published Tampa market price.

Anhydrous ammonia published process at Tampa averaged approximately $300 per metric ton in the third quarter, compared to approximately $286 in the third quarter of 2006. Published selling prices from fertilizer grade ammonium nitrate in our market were approximately 28% higher in the third quarter of 2007, than in the third quarter of 2006.

Looking forward for our chemical business, we continue to be encouraged by the market demand for our products and the performance in our production facilities. Our products were sold in a markets that are affected by the general strength in global investor economies, and North American mining sector and agricultural markets, all of which continue to show solid performance. Market publication indicate that nitric fertilizers should continue to see a strong demand due to ethanol driven corn production and lower grain inventories in general, as well as the increased demand for forage crops.

The first and second calendar quarters were generally our strongest quarters in our Chemical business due to the seasonality of agricultural markets. As indicated in the financial review, the plant maintenance turnarounds in the fourth quarter of 2007 costing approximately $2.4 million which will be expensed as incurred will also result in non-productive plant downtime. The objective is to complete these turnarounds in the fourth quarter as efficiently as possible to minimize these costs, including the cost of [loss of short-term].

Our Chemical business will continue to focus on growing our non-seasonal industry customer base with an emphasis on customers, except the risk inherent with raw material cost, while maintaining a strong presence in the agricultural segment. In the meantime, we have the ability to allocate significantly move our capacity to fertilizers when market gives us the kind of margins that we're now seeing. Our strategy emphasizes cost reduction and continues operations of plants at full rate, thereby allowing the fixed cost each year in the production.

That concludes our prepared remarks. I will turn the call over to Jack now to begin the Q&A segment of the call.

Jack Golsen

Thanks, Tony. Thanks, Barry. Okay. Folks, we're now ready to take the call from any of the people who have questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line Dan Mannes with Avondale Partners.

Dan Mannes - Avondale Partners

Good morning, everybody.

Jack Golsen

Good morning Dan.

Dan Mannes - Avondale Partners

A couple of questions for you; just to start quickly on the Chemicals business, you mentioned turnarounds, do we take that as plural or more than one of your plans setting turnarounds in the fourth quarter or am I misreading.

Tony Shelby

Dan, as indicated the plant sites has multiple plant at each locations, for instance, you have four nitric acid plants at El Dorado, Arkansas as well as prilling plant and so forth. And so, yet you have multiple turnarounds but those are scheduled so that they don't occur in the same quarter.

Jack Golsen

Let me indicate, the heavy turnarounds take place in the fourth quarter of this year. That one has always been that way because sometime the extent of the turnaround depends on the condition of the facility.

Dan Mannes - Avondale Partners

I understood. Two follow-up questions to that, the first one being, any indication on the number of days in turnaround or because you're spreading in over multiple plants at the site, it's hard to really adjust.

And then, the second issue there is, were you still experiencing some of the bottlenecking issues, I believe or some of the production issues at Cherokee and are those expected to maybe the effects due to turnaround?

Jack Golsen

Yes, I can say to that. We have just completed our -- and the process is completing the turnaround at Cherokee. And you don't know until you get the plant really ribbed-up real high are successful the turnaround has been. But preliminary it looks like that's going to be a successful turnaround and we will be able to get production up higher than it was prior to the turnaround. What was the other part of your question?

Dan Mannes - Avondale Partners

The other one was, if you can address how long can you engage or anything like that?

Jack Golsen

Well, we don't know. They usually doomed as quickly as possible, because not only do we have the costs of turnaround as Tony said, but we have no production taking place during the turnaround. So you have unabsorbed overhead taking place.

Tony Shelby

I'd like if you could use a rule of thumb on 14 to 21 days for a turnaround.

Jack Golsen

Yeah.

Tony Shelby

They vary significantly, set by the (Fortune Canada), when we opened up the plants.

Dan Mannes - Avondale Partners

Make sense to me. Switching gears real quick and talking about the Climate business. You mentioned Canada briefly. I guess you've historically noted that the majority of your Climate sales are domestic, maybe as much as 95%. Will you guys need to bulk up your distribution Canada to take advantage of these extreme changes?

Barry Golsen

No, we actually, when we report sales we actually consider Canada to be domestic.

Dan Mannes - Avondale Partners

Okay. Can you give any historical idea of the relative size of the Canadian market relative to the US and how do you…

Barry Golsen

Well, I don't really run it non-developed proprietary data as to product sales as any particular territory, I guess something (considerable) from a competitive standpoint. However, I will say to one of our bigger markets that we have a really strong distributor.

Dan Mannes - Avondale Partners

Okay. And then, lastly, just on the general commercial market. You noted with Freedonia/McGraw-Hill numbers that they weren't dramatically different than what you've seen before. But as you look across your portfolio of different products that you sell, I mean, the one that seems to stick out for me, it's been surprisingly strong in last year or so, has been the fan coils International Environmental business.

So, when you look at the product portfolio and without giving specific guidance, is it reasonable to assume that while some of the other products maybe better able to buck any slowdown. Is that one that maybe there is a little bit more risk around? Is that something we should be aware of?

Tony Shelby

I am really not going to comment on any future sales projection. I am sorry, I just can't do it. That's, we've decided we're not going to do that.

Dan Mannes - Avondale Partners

I guess more broadly, maybe, can we talk about the lodging market and the strength we've seen in that. Is that reasonable to assume given the numbers and given the outlooks that you have seen in industrial segment, it's more likely to slow or maybe other ones are stronger?

Tony Shelby

Well, I mean there is bubble working (it towards a) lodging market right now. Alliance is last, I am not so sure. But it usually takes a couple of years to three years for that bubble to work its way through because of the gestation period for projects. But we have not concentrated in that sector. As you know from our prior discussions, we have three evenly distributed sales among many different sectors.

And so, typically and historically, what we've been able to do is when one sector is down we focused on other sectors. And that's what we've plan to do. Going forward, there is no guarantee that this sector will be totally counter cyclical but we've attempted to work that angle in the past and that’s what we will do in the future.

Dan Mannes - Avondale Partners

I understood. And then, just one final question, as I look at the backlog, it seems like you have done a pretty good job of bringing that down. Can you talk it all about the make-up of the backlog? That’s a new, different product or is that another area of your focus?

Tony Shelby

No, I will really not do that. We don’t publish that information.

Dan Mannes - Avondale Partners

Okay. Well, thanks for the color and good quarter guys.

Jack Golsen

Okay. Dan, you can ask the guess one on the next write-up.

Dan Mannes - Avondale Partners

I'll do my best.

Jack Golsen

Okay. Thanks.

Operator

(Operator Instructions). Your next question comes from the line of Rick Nelson with J Giordano Securities.

Rick Nelson - J Giordano Securities

Good morning, everyone.

Jack Golsen

Rick, I hope -- we are going to send you a bill for the publicity we have given you today.

Rick Nelson - J Giordano Securities

I appreciate it. But again, very nicely done this quarter, I just had a couple of questions because your review was quite comprehensive. This one goes to Tony first, your interest expense of about $3.5 million seems a little bit high given the amount of debt you have on the books. Were there extra charges in there? Was it a natural higher average debt level during the quarter? Or is this the sort of number we can accept for the fact that you are refinancing $50 million, is there anything unusual about that?

Tony Shelby

No there is nothing unusual.

Rick Nelson - J Giordano Securities

Okay, it just seemed a little bit high to me, but I'll go back over my numbers. And Barry, I've got a question.

Tony Shelby

Oh, Rick one thing I might mention to you is that in the past we had disclosed that we have interest rates caps and with the turbulence in the credit markets later down and our interest rates caps, which we previously marked up to market we marked down to market in the third quarter. And that's a -- so that would be an interest expense. So the interest rate which is a fixed number is -- we probably pay this what we pay but you have to market up to market down the market as rates go up and down. So that would -- there was a mark down to market that we have collected the interest rate in the third quarter.

Rick Nelson - J Giordano Securities

Okay.

Tony Shelby

But very good question.

Rick Nelson - J Giordano Securities

Okay. Barry, I had a question and it's a follow on to Dan's comments on the Canadian incentive program. You mentioned that the new legislation calls for about $3500 in new incentives, which might make a total of $7000. Without devoting obviously what your margins might be and so forth, what would the cost of a conversion be for an existing home?

Barry Golsen

Well, as you know, it's really hard to generalize. I mean, there are so many facts and circumstances that we relate every real individual. Every job's different.

Rick Nelson - J Giordano Securities

Yes.

Barry Golsen

Depending on the age of the house, the conditions that are there, what part of the system has to be replaced, what kind of conditions there are for putting loops in the ground, so I mean, it's, I can't really answer that in general on that.

Rick Nelson - J Giordano Securities

But it does sound like a fairly hefty incentive.

Barry Golsen

Yeah. It's up to $7,000.

Rick Nelson - J Giordano Securities

Well. Okay.

Barry Golsen

We expect -- we would expect to see an impact from that, but as I mentioned, they are still in the process of, like government's work. First they pass a law, then they have to figure how they are going to implement the law, and there is a bureaucracy, they have to get in gear to actually execute the implementation and that's where they are at right now. So we haven't really seen any impact from that yet.

Rick Nelson - J Giordano Securities

Do you fellows you see anything afoot in our country as far as incentive programs?

Barry Golsen

Well, right now, I mentioned that there is quite a bit of legislation that's pending in Congress right now. And it is kind of a laundry list of things that are going on and if you would like, I can, it's pretty lengthy to discuss, it would take up really too much time for this conference call, but there are some byproducts in support for several different bills that are out there and if some or all of those are passed, it could have a positive impact. But also, as I said, we are not counting on that in terms of our business model, [is it a curse], it is a plus, and we will welcome it and we think it will be beneficial for the country to incentivize people to use this kind of technology for obvious reasons, but if it doesn't happen, we are not counting on it for our business model.

Rick Nelson - J Giordano Securities

Okay. Those are all the questions I have for now. Thanks a lot.

Jack Golsen

Thanks, Rick.

Operator

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

Jack Golsen

Thank you for participating everybody. See you next quarter.

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.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!