LSB Industries Q3 2007 Earnings Call Transcript

Nov. 5.07 | About: LSB Industries, (LXU)

LSB Industries, Inc. (NYSE: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

Operator

Good day everyone and welcome tothe LSB Industries' Third Quarter 2007 Conference Call. At this time, I wouldlike to inform you that this conference is being recorded and that allparticipants are currently in a listen-only mode. I will now turn theconference over to Carol Oden. Please, go ahead, Ms. Oden.

Carol Oden

Thank you. Good morning and welcometo the LSB Industries Inc. Conference Call. Today, LSB's managementparticipants are Jack Golsen, Chairman and Chief Executive Officer; BarryGolsen, President; and Tony Shelby, Chief Financial Officer. This conferencecall is being broadcast live over the Internet and is also being recorded. Anarchive of the webcast will be available shortly after the call on our website atwww.lsb-okc.com and will be accessible for one month.

After comments by management, aquestion-and-answer session will be held. Instructions for asking questionswill be provided at that time.

Information reported on this callspeaks only as of today, November 5, 2007 and therefore, you are advised thattime-sensitive information may no longer be accurate as of the time of anyreplay. We will not make any projections as to the future results as torevenues, income or earnings per share of the company during this conferencecall. However, comments today may contain certain forward-looking statements,including but not limited to the strategy of our Climate Control to develop andintroduce products that use EarthPure non-ozone-depleting refrigerants. That wedo expect to increase our market share because of growing demand for ourClimate Control products; increased output at ClimateMaster, historicalshipping as the Climate Control backlog returning, developing product lineswithin our Climate Control, exposure of our Climate Control to the downturn ina single family residential market is not great, impact of certain legislationon the Climate Control geothermal market.

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

The term EBITDA as used in thispresentation is net income plus interest expense, depreciation, amortization,income taxes and certain non-cash charges unless otherwise described. EBITDA isnot a measurement of financial performance under GAAP and should not beconsidered as an alternative to GAAP measurements.

All statements other thanstatements of historical facts are forward-looking as more fully discussed inour 2006 10-K, as amended by our recent Amendment Number 1 to our 10-K and our10-Q for the quarter ended September 30, 2007 under Special Notes RegardingForward-Looking Statements. A more comprehensive listing of risk factors, whichcould cause results to vary from any forward-looking statements made duringthis conference call, is also included in our 2006 10-K, as amended by ourrecent Amendment Number 1 to our 10-K and our 10-Q for the quarter endedSeptember 30, 2007 under Special Notes Regarding Forward-Looking Statements. Wewill post on our website a reconciliation to GAAP of any EBITDA numbersdiscussed during this conference call.

Now, I will turn the conferencecall 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 withme today are Barry Golsen, LSB's President and Tony Shelby, our CFO. After weupdate you about the company, we will be available to answer your questionsabout the business.

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

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

Consolidated sales year-to-datewere $451.7 million up 22.6% over last years $368.2 million. Net income tocommon shares this year was over six times at $18.1 million from the $3 millionin 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 earningswere $1.67 compared to $0.65 in 2006.

Overall, our core businesses have been very strong thisyear. So far, neither the Climate Control business nor the Chemical businesshas been affected by the slowing US economy, which we all see taking place.Although each day more experience of forecasting in economic slowdown, we arenot forecasting the future in our business, which has been on a very steeprising trajectory. But we expect to see the near term growth curve flattening.

As we have said many times in the past, our decisions aremade for the long-term and for the long haul. We believe that we are in theright spot because of our energy savings and green products and the country'squest for energy independence. Products of both of our businesses are anecessity for the future of our country, and we expect the segments of thespecific markets that we are in to continue to grow.

Our market share of key products has continued to increaseand we continue to dominate in niche markets that we serve. Our facilities arein place to handle substantial volume increases in the future, if theymaterialize. On the subject of facilities, please keep in mind that our majorplant turnaround will occur in the fourth quarter this year. Under the newaccounting rule, cost of the turnaround will be expensed as incurred.

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

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

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

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

Tony Shelby

Thank you, Jack. Today we issued an earnings release andfiled the 10-Q for the third quarter of 2007. Both of these documents eitherare or will be available on our website. Before we get on to the numbers, Imight comment that this is somewhat of an unusual quarter in that theconsolidated results of operations include three separate income items thatrequire explanations.

Chemical's operating income and EBITDA include twosettlement gains totaling $4.8 million and the consolidated [earnings] includesa significant credit related to the net operating loss tax credit. These threeitems I just referred to will be explained more fully during this financialreview and there will be more extensive explanation in 10-Q, which we encourageyou to read.

The financial results for the quarter ended September 30,2007, third quarter results in other words. Our two core businesses both had agood third quarter. Sales were $147.6 million, an increase of 19% over thethird quarter of last year. Climate Control sales were up 24%, Chemical saleswere 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 lastyear. After allocation of corporate costs, the consolidated operating incomefor the third quarter of 2007 was $19.1 million compared to $6.8 million inlast year's third quarter.

EBITDA. Climate Control's EBITDA increased by $2.9 millionto $10.5 million and Chemical increased by $9.2 million to $13.8 million. Theconsolidated EBITDA for the third quarter of '07 was $23.3 million. This was anincrease of $13.2 million compared to the 2006 third quarter. As indicatedabove, the operating income and EBITDA for the third quarter includes the twosettlement gains totaling $4.8 million.

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

In the net income as -- I don't know, I mentioned regardingthe net operating loss carry-forward. The third quarter 2007 includes aprovision 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 $3.2million due to the expected utilization of remaining net operating loss carry-forward.

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

With respect to the settlement gains that we mentionedearlier, as indicated, Chemical's operating income EBITDA included twosettlements 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 wasoutlined previously in our previous filings. There was a settlement of $1.5million of the business interruption claim. The settlement with Dynegy isrelated litigation for alleged price manipulation of natural gas marketaffecting 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 insurancerecovery in our business interruption claims for damages to the gas pipelinefeeding the Cherokee facility. The damages were caused by the HurricaneKatrina, resulting in curtailment and interruption in the delivery of naturalgas to Cherokee. This recovery of $1.5 million was recorded as a credit toChemical's cost of sales. Both of these settlements and the income taxaccounting is explained in more detail in the 10-Q.

Now, with respect to the year-to-date numbers at September30, 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 $21.2million 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 $42.3million 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 wepreviously disclosed, we have changed our method of accounting to major plantmaintenance activities in our Chemical business, which we'll refer to in thisconference call as "plant turnarounds." We have planned certain ofthose plant turnarounds in fourth quarter of '07, when the seasonal culturaldemand is normally at the lowest level. And we are slight that we will incurapproximately $2.4 million in the fourth quarter for turnaround cost, which wewill be experienced for and as incurred. The addition to tax cost for theturnarounds will be cost of an (inaudible) overhead, while the plants were downfrom the turnaround. This is a normal occurrence when we are doing the turnaround.

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

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

The $50 million senior secured loan due 2009 bears interestof 11%, and is secured by first lien on the majority of the chemical plantassets in Arkansas and Alabama, certain equipment of the climate controlbusiness, the stock of ThermaClime and certain ThermaClime subsidiaries and asecond lien on the assets securing the working capital revolver loan.

We have negotiated a new five-year $50 million term loanwith a major USA money share bank with funding not to occur until certainconditions are satisfied, which we anticipate will occur on/or before Thursdayof this week. If the loan is closed as schedule, the proceeds will be used toprepay the senior secured loan due 2009. The new loan will be secured by onlythe chemical plants in Arkansas and Alabama with accrueinterest 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 $10.4million and includes the following components. The net cash provided byoperations was $18.5 million. We used $1.4 million for investing, $1.3 millionto redeem the Series 2 preferred stock, $2.9 million to pay dividends onpreferred stocks, to bring everything correct and $2.6 million for netreductions, long-term debt and other items. So, a net increase of $10.4million.

In summary, regarding our financialstatements, our stockholders' equity has increased to $87 million from $44million at year end 2006. There's no outstanding borrowings on the $50 millionworking capital revolver loan and cash on hand was $41 million. Our totallong-term debt trailing 12-months EBITDA, these are all numbers at September30. Our long-term debt trailing 12-months EBITDA was approximately 1.8 timeswith a series of exchanges, conversions and redemptions of Series 2 preferredstock and all accrued and unpaid dividends should be eliminated. There are 20.6million common shares outstanding and approximately 4.9 million additionalcommon shares issuable upon the conversion and/or exercise of all dilutivesecurities options launched.

Earnings per share reflectedsignificant increase quarter versus quarter and year versus year. Theimprovement in our balance sheet and capital structure will continue to be amanagement strategy.

That concludes the financialoverview of our results of operation and financial position. Barry will nowreview the Climate Control business.

Barry Golsen

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

We are the US market leader in our coreproducts, which are geothermal heat pumps, water source heat pumps and hydronicfan coils. We also manufacture and market small air handlers, large custom airhandling units, modular water chillers, coaxial heat exchangers and tube andfin heat exchangers.

In addition, we complete large scalegeothermal installations throughout the United States. We have an installedbase of millions of units and our products are used in many different types ofbuildings for new construction, renovation and replacement. Historically, ourbusiness has not been dependent on the health or weakness of any singleconstruction sector.

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

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

The improvement in profitabilitywas primarily the result of higher sales volumes, principally in our heat pumpand fan coil businesses. This mirrored increases in 2006 and the first half of2007. Additionally, sales price increases we implemented earlier took effect inthe third quarter resulting in a gross margin of 29.7%, up from 29.2% in lastyear's third quarter and up slightly from the second quarter gross profit of29.4%.

Year-to-date this September, ourUS market share for heat pump products and fan coils was approximately 43% and41%, respectively, up from 38% for heat pumps and 40% for fan coil in the sameperiod last year.

During the third quarter of 2007,bookings of product orders reached an all-time quarterly record of $65.8million this was up 8% over the same period last year. We closed the quarterwith 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 downbacklog while growing sales and new bookings is a good thing and as some ofyour know our backlogs had increased substantially during 2006 to levels thatwe consider to be too high. As our lead-times have pushed out beyond what weconsider to be optimum for a good customer service. We've worked hard to reduceour factory lead-times and they have improved substantially.

Prior 2006, our Climate Controlbusiness had been slightly seasonal shipping more in the second and thirdquarters than the first and fourth quarters, corresponding to the seasonalityof the construction industry that we served.

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

With regard to manufacturingcapacity, we've substantially completed an expansion in plant-widereconfiguration at ClimateMaster and a reconfiguration of the assembly area atInternational Environmental. We also continue to make good progress toward ourgoal of doubling our total air coil production volume and bringing all heat pumpcoil production in-house.

In previous calls, we discussedthat material price increases during 2006 were in many cases more than thoseincurred during 2004 and 2005. Although, we implemented across the board salesprice increases last year, due to the large backlogs we were carrying, the fullimpact of these price increases was delayed. While we're trying to recoup allof the material cost increases, we are operating in a very price-competitiveenvironment and the majority of our business is subject to a competitive bidprocess.

During the last conference call, I reported that we had seensome softening in the price of copper and steel, but that raw material priceswere continuing to fluctuate. At this time, raw material costs have stabilizedsomewhat, albeit at a high level. Based on current information, we expectoverall 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 monitormaterial costs very closely.

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

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

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

ClimateMaster continues to develop and introduce watersource heat pump and geothermal products, which use EarthPure non-ozonedepleting refrigerants. This is a continuation of our strategy to provide themost comprehensive leading-edge environmentally responsible product line in theHVAC industry.

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

Also during the third quarter, International introduced itsnew [U-MOD] fan coil product line. This is a product very similar to the mod orvertical high-rise products International has been so successful with inmarkets 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 airgrills and water piping, all factory installed, only a need to install theseitems on the job site and reducing contractors total installed cost. U-MODs arealso designed to minimize factory lead times and to facilitate fieldconfiguration as required.

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

As you know the vast majority of our Climate Controlbusiness sales are to commercial and institutional construction and renovation.In 2006, commercial and institutional sales accounted for approximately 80% oftotal Climate Control business sales, and over 90% of these sales, or 73% ofour 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 ofconstruction sectors that we focus on since most of our sales are to thosesectors.

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

McGraw-Hill is forecasting that building contract activityfor these combined segments will decrease by 3% in 2008 and increase 4%, 7% and5% respectively in 2009, '10 and '11. For all practical purposes, the updatednumbers do not represent a meaningful change. The commercial and institutionalconstructions sectors, which are important to LSB, are forecast to remainstrong for the foreseeable future.

Turning to single-familyresidential, we're all aware of the sharp decline that has occurred in themarket at large. According to McGraw-Hill there was a 14% decline in 2006 from2005 and a 25% decline forecast for 2007.

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

Focusing more specifically on theHVAC industry, total unitary equipment shipments of air conditioners and airsource heat pumps as reported by the air conditioning and refrigerationinstitute 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 Augustshipments were actually 19% lower this year than August of 2006.

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

Year-to-date through September,our residential business was approximately 5% higher than the same period in2006. Whereas, we have managed to outpace the residential HVAC market for thepast seven quarters, the depth of the current market slump had impacted ourrate of growth.

As you know, geothermal heatpumps are a green form of renewable energy that reduces energy consumption andgreenhouse gas emissions. And by the way, I'm focusing on that because all ofour single-family residential sales are geothermal heat pumps. So, may be Irepeat that, geothermal heat pumps are a green form of renewable energy thatreduce energy consumption in greenhouse gas emissions. We believe that themarket drivers for our residential geothermal products are somewhat differentthan the market at large. High energy prices, environmental issues, energysecurity concerns drive the demand for geothermal systems. The overall size ofthe residential market approximately 6 million units per year even in itsreduced state after the reductions that I mentioned before, also representshuge upside potential for geothermal products.

And this is a point that I wouldlike to focus on. I would like to emphasize that it's important to note thatLSB's overall exposure to a downturn in single-family residential market is notgreat. In 2006, only 6% of LSB's total sales were to this market. Year-to-datethrough September 2007, single-family residential sales were only 5% of LSB'stotal revenue.

One final comment aboutgeothermal, while we are on the subject. Recently Canada, enacted legislationwhich when implemented will provide a federal grant of $3,500 for theinstallation of geothermal heat pumps in existing homes, this has been matchedby several Canadian provinces including Ontario, the largest, bringing thetotal incentive package up to $7,000. Due to the development of implementationprocedures 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 areseveral thesis of legislation pending in the United States, which could alsobenefit geothermal sales if enacted. Some of these have by-products assponsorship and support, whereas our results today and our business model goingforward do not rely on governmental incentive. If the current pending legislationis enacted, it could impact the growth of the geothermal market positively,however, to what extent is speculative.

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

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

Tony Shelby

Okay. Thanks Barry. Our Chemicalbusiness produces market with chemical products of industrial mines and then agriculturalmarkets and holds a leading position in the manufacturing and marketing ofnatural gases.

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

The agricultural products aresold at the market price in effective time of the sale. And this agriculturalbusiness is seasonal and cyclical and is currently a strong up-cycle driven bylow growing inventories and increased crop production required in nitrogenfertilizers.

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

Cherokee consumes natural gas asa raw material feedstock. El Dorado and Baytown both consume anhydrousammonia which is delivered by our pipeline.

Summary of the financial resultsfor the third quarter; overall, our Chemical business performed extremely wellin the third quarter of 2007. As indicated in the financial review, theoperating 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 thirdquarter. Sales prices were up significantly for agricultural fertilizer andslightly up for mining products and industrial assets. Gross profit margins andoperating income including the settlement gains were significantly higher as aresult of stronger fertilizer demand, resulting in higher sales prices relativeto the raw material cost and continued improvement in plant reduction rates.

Agricultural products account formost of the improvement in operating profit over the third quarter of 2006, dueto the strong performance and outlook for the farming economy. Assay has beenhighly publicized, global grain stocks including foreign wheat at low levelsand are driving the demand for fertilizer products.

Due to abnormally high amounts ofrainfall in '07 in mid-South coupled with drought conditions in Southeast, salesvolumes were well below our estimates than the potential for fertilizervolumes. However, higher prices and better margins allowed for significantlyimproved results when compared to last year.

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

The strong demand for allproducts resulted in production efficiencies associated with higher operatinglevels of the plant.

The Baytown facility continue to generateconsistent positive results and turning in another good quarter. Cherokee'soperating income for the third quarter of 2007 benefited from the twosettlement gains and from the strong demand and expanding margins for ureaammonium nitrate, published UAM prices in the market area were approximately65% higher in the third quarter of 2007, than in the third quarter of 2006.

Cherokee's natural gas feedstockswere relatively stable, experiencing very little volatility throughout the 2007third quarter. Spot natural gas prices, excluding transportation, during thethird quarter of 2007 averaged about $6.18, or approximately same as the thirdquarter 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 thesemarkets changed daily.

El Dorado, Arkansasbenefited from strong agricultural product demand, continued efficient plantperformance and favorable sales prices relative to the cost of anhydrousammonia, all of these resulting in improved margins.

El Doradopurchases were approximately $220,000 tons per year of ammonia, and [formulaprice] tied to the published Tampamarket price.

Anhydrous ammonia publishedprocess at Tampaaveraged approximately $300 per metric ton in the third quarter, compared toapproximately $286 in the third quarter of 2006. Published selling prices fromfertilizer grade ammonium nitrate in our market were approximately 28% higherin the third quarter of 2007, than in the third quarter of 2006.

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

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

Our Chemical business willcontinue to focus on growing our non-seasonal industry customer base with anemphasis on customers, except the risk inherent with raw material cost, whilemaintaining a strong presence in the agricultural segment. In the meantime, wehave the ability to allocate significantly move our capacity to fertilizerswhen market gives us the kind of margins that we're now seeing. Our strategyemphasizes cost reduction and continues operations of plants at full rate,thereby allowing the fixed cost each year in the production.

That concludes our preparedremarks. I will turn the call over to Jack now to begin the Q&A segment ofthe call.

Jack Golsen

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

Question-and-Answer Session

Operator

(Operator Instructions). Yourfirst 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; justto start quickly on the Chemicals business, you mentioned turnarounds, do wetake that as plural or more than one of your plans setting turnarounds in thefourth quarter or am I misreading.

Tony Shelby

Dan, as indicated the plant siteshas multiple plant at each locations, for instance, you have four nitric acidplants at El Dorado, Arkansas as well as prilling plant and soforth. And so, yet you have multipleturnarounds but those are scheduled so that they don't occur in the samequarter.

Jack Golsen

Let me indicate, the heavyturnarounds take place in the fourth quarter of this year. That one has alwaysbeen that way because sometime the extent of the turnaround depends on thecondition of the facility.

Dan Mannes - Avondale Partners

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

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

Jack Golsen

Yes, I can say to that. We havejust 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 aresuccessful the turnaround has been. But preliminary it looks like that's goingto be a successful turnaround and we will be able to get production up higherthan it was prior to the turnaround. What was the other part of your question?

Dan Mannes - Avondale Partners

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

Jack Golsen

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

Tony Shelby

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

Jack Golsen

Yeah.

Tony Shelby

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

Dan Mannes - Avondale Partners

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

Barry Golsen

No, we actually, when we reportsales we actually consider Canadato be domestic.

Dan Mannes - Avondale Partners

Okay. Can you give any historicalidea of the relative size of the Canadian market relative to the US andhow do you…

Barry Golsen

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

Dan Mannes - Avondale Partners

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

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

Tony Shelby

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

Dan Mannes - Avondale Partners

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

Tony Shelby

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

And so, typically andhistorically, what we've been able to do is when one sector is down we focusedon other sectors. And that's what we've plan to do. Going forward, there is noguarantee that this sector will be totally counter cyclical but we've attemptedto 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 onefinal question, as I look at the backlog, it seems like you have done a prettygood job of bringing that down. Can you talk it all about the make-up of thebacklog? That’s a new, different product or is that another area of your focus?

Tony Shelby

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

Dan Mannes - Avondale Partners

Okay. Well, thanks for the colorand good quarter guys.

Jack Golsen

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

Dan Mannes - Avondale Partners

I'll do my best.

Jack Golsen

Okay. Thanks.

Operator

(Operator Instructions). Yournext 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 tosend 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, Ijust 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 seemsa little bit high given the amount of debt you have on the books. Were thereextra charges in there? Was it a natural higher average debt level during thequarter? Or is this the sort of number we can accept for the fact that you arerefinancing $50 million, is there anything unusual about that?

Tony Shelby

No there is nothing unusual.

Rick Nelson - JGiordano Securities

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

Tony Shelby

Oh, Rick one thing I might mention to you is that in thepast we had disclosed that we have interest rates caps and with the turbulencein the credit markets later down and our interest rates caps, which wepreviously 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 ratewhich is a fixed number is -- we probably pay this what we pay but you have tomarket 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 thethird quarter.

Rick Nelson - JGiordano Securities

Okay.

Tony Shelby

But very good question.

Rick Nelson - JGiordano Securities

Okay. Barry, I had a question and it's a follow on to Dan'scomments on the Canadian incentive program. You mentioned that the newlegislation calls for about $3500 in new incentives, which might make a totalof $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 - JGiordano Securities

Yes.

Barry Golsen

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

Rick Nelson - JGiordano Securities

But it does sound like a fairly hefty incentive.

Barry Golsen

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

Rick Nelson - JGiordano Securities

Well. Okay.

Barry Golsen

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

Rick Nelson - JGiordano Securities

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

Barry Golsen

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

Rick Nelson - JGiordano Securities

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

Jack Golsen

Thanks, Rick.

Operator

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

Jack Golsen

Thank you for participating everybody. See you next quarter.

Operator

Ladies and gentlemen, this concludes our conference fortoday. Thank you all for participating and have a nice day. All parties may nowdisconnect.

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