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Executives

Joe Ewing – VP, IR

Mike Bennett – President and CEO

Dan Greenwell – SVP and CFO

Analysts

Alain Rodriguez [ph]

Charles Rentschler – Wall Street Access

Jeff Feinberg – JLF Asset Management

Terence Ortslan – TSO Associates

David Rosen [ph]

Steve Byrne – Merrill Lynch

Michael Christodolou – Inwood Capital

Steven Yang [ph]

Brian Yu – Citigroup

Mi Ji Kong [ph]

Paul D’Amico [ph]

John Tobin [ph]

 

Terra Nitrogen Inc (TNH) Q2 2008 Earnings Call Transcript July 24, 2008 3:00 PM ET

 

Operator

 

Good day, ladies and gentlemen, and welcome to the second quarter 2008 Terra Industries earning conference call. My name is Jasmine and I will be the operator for today. At this time, all attendees will be on a listen-only mode. We will conduct a question and answer session towards the end of the conference. (Operator instructions) I would now like to turn the presentation over to your host for today’s call, Mr. Joe Ewing, Vice President of Investor Relations. You may proceed, sir.

Joe Ewing

 

Okay, thank you very much, Jasmine, and I would like to welcome everyone to Terra’s second quarter results conference call. This morning, we issued a news release announcing that for the 2008 second quarter, Terra achieved a record net income of $202 million or $1.94 per diluted share.

At the end of the news release which we issued is our Safe Harbor statement. It describes the limitations of forward-looking statements and any other items that are not historical facts included in the news release. Please note that those same limitations apply to any forward-looking statements we may make during this call.

With me today are Mike Bennett, Terra’s President and CEO, and Dan Greenwell, Senior Vice President and CFO.

Regarding recent and upcoming investor relations activities, since our last earnings call, we've held our annual meeting and our yearly investor reception in New York and we have also taken the Terra story on the road in a 3-day five-city tour, investor tour in the western and southern U.S. and we’ve also participated in three equity conferences.

Coming up we have the Credit Suisse Conference in New York in September and also an investor tour in several mid-western cities in late September and early October.

We also continue to host visitor tours to Sioux City to meet with our management and to tour our Port Neal manufacturing facility. If anyone there listening today is interested in making such a trip, we’d be happy to have you come and if you’d like to do so, please call Kim Mathers or me to help make those arrangements.

I’ll now turn the call over to Mike Bennett so he can give us his perspective on the second the quarter and also the outlook for Terra and the industry in upcoming months. Mike?

Mike Bennett

Thank you, Joe. Good afternoon everyone. Thanks for joining us today. We’re excited by Terra’s performance in the second quarter as well as the continued positive environment for our business.

During the second quarter, all of Terra’s sales segments, agricultural, industrial, environmental and each geographic segment, North America, Trinidad, and the UK, realized very strong operating and financial performances.

In North America, our geographic positions, product mix flexibility and our experience served us very well in a season delayed by a considerable moisture and tool [ph] conditions in much of the corn-belt.

Application activities stretched into early July and due to the prolonged season. As we mentioned in our April conference call, customer field commitments commenced in earnest during the month of April and continued throughout the quarter. Our forward gas position as of June 30 reflects the strong platform with sales commitments and secured margin that we have for the balance of the year.

Once again, we think our people that a great job of operating our plants and managing customer deliveries in this season.

As we look forward to the balance of the year and into next year, the economic environment for our business appears very strong. Global-grade inventories remain tight as does the projected supply-demand balance for nitrogen products. These facts are represented by continued off-season demand by our customers and continued strength in global nitrogen market prices.

Natural gas prices remain high but they have abated somewhat in the recent weeks. This trends overall underscore our positive outlook for the business.

Our planned restart of our Donaldsonville ammonia plant is progressing well. We’re currently undertaking those start-up activities and we do expect to be producing ammonia there before the end of July. We are also making progress with our Woodward, Oklahoma UAN expansion and continue to expect a 2010 start-up of that facility.

Terra is in its strongest financial condition ever. And we continue to actively evaluate different opportunities with which we can use cash to add earnings accretion for our shareholders.

At this point, I’ll turn the call over to Dan Greenwell for his remarks on the quarter and our financial position. Dan?

Dan Greenwell

Thank you, Mike, and good afternoon to everyone. Mike has highlighted our very strong second quarter results and robust environment for nitrogen products. I’d first like to round out our discussion of the top line with a few comments about product selling prices and natural gas cost. Then I’ll follow with additional comments about our operating result and joint venture operations in Trinidad and the United Kingdom and our plan to restart of the Donaldsonville ammonia plant.

We’ll also provide further discussion on our effective tax rate and future tax planning opportunities to lower the effective rates. I’ll then discuss our stock buyback program and Terra’s liquidity.

Net income available in common share holders was $202 million or $1.94 per share compared to last year’s $69 million or $0.66 per share. This is a record level of quarterly earnings for Terra shareholders.

Revenues increased by $150 million in the second quarter of 2008 as compared to last year. The 2007 revenues included our United Kingdom operations which generated a $120 million of second quarter revenues with an operating income of $19.8 million.

Excluding the impact of prior year's United Kingdom sales, second quarter North American revenues increased by $272 million, approximately $255 million of this increase resulted from price improvement.

As we have seen over the past several quarters, average UAN net back sale prices continued to increase as result of strong market conditions. In addition, ammonia sales prices continued to demonstrate price strength.

Included in operating income was $5.7 million related to the sale of recovered ruthenium catalyst material that Terra no longer uses in its operations.

You may have noted that we have a $7.3 million of net income associated with discontinued operations. The discontinued operations consist of our Beaumont, Texas methanol operations.

The second quarter income is principally related to revenues realized under the Beaumont facility's methanol production contract which are payable when methanol margins achieved specified levels and can amount to as much as $12 million per year.

During the 2008 second quarter, conditions were present that allowed Terra to recognize these revenues at the maximum $12 million level. Under the Beaumont contract, there is an annual cap of $12 million on profit sharing revenue, so we’ll not see further profit sharing revenue in 2008.

In 2007, these revenues were recognized in the third quarter. The Beaumont facility is under contract to be sold with an expected closing to occur on or before January 2009. We are carrying the Beaumont assets on our books at estimated realizable value upon sale.

Natural gas cost increased by approximately $1.74 per MMBtu or $49 million during the second quarter of 2008 as compared to the prior year. We continue to purchase gas as we take orders for products that we’ll ship in the future.

The year-over-year decrease to second quarter selling and general and administrative expenses totaled $1 million. The second quarter of 2007 included approximately $3 million of cost associated with the United Kingdom when it was consolidated in our results.

We recognized approximately $12 million of net benefit during the second quarter of 2008 that stems from incentive compensation for a general partnership interest in Terra Nitrogen limited partnership. This is reflected in the minority interest line on our income statement. Our United Kingdom joint venture operations performed a very well during the second quarter. Sales, prices, and volume increases in the UK more than offset higher gas costs which continued to be volatile. During the second quarter, the joint venture sold assets related to the carbon dioxide business and Terra's share of the pretax gain was $8.5 million. This gain is included in the equity earnings from the joint venture. There were no significant integration or synergy charges in the second quarter for the joint venture. The joint venture anticipates additional synergy cost of approximately $9 million in the second half of 2008.

As Mike mentioned, we are in process of startup activities for Donaldsonville ammonia facility. The aggregate cost of the startup activities will approximate $18 million, approximately one-third of the amount consist of catalyst cost. The total cost was approximately $5 million higher than we originally anticipated as we elected to replace optional components to enhance operation reliability and efficiency. Production from this facility will replace product that has previously been purchased in international markets after prevailing prices.

Terra's effective tax rate after minority interest in UK equity earnings was 35.3% for the second quarter. Terra was a federal and state cash tax payer in the second quarter of 2008. We have developed multiple tax strategies to lower the effective tax rate and the amount of cash taxes paid. We anticipate certain of these tax planning strategies will be in place before the end of 2008 and estimate our 2008 effective annual rate between 32% and 34%. During the second quarter, we bought back approximately 189,000 shares of our common stock as an average price of $40 per share (inaudible) for the repurchase during the quarter was $7.5 million. Under our share repurchase program, we have approximately 12.6 million shares authorized for buyback at the end of June of 2008. Our cash balances, which included $92 million in customer prepayments, totaled $752 million. This cash is invested in high-quality money funds.

We also received $20 million from our Trinidad and other North American joint venture operations during the second quarter. We spent approximately $29 million for normal maintenance capital and turnarounds during the second quarter of 2008. We estimate our annual 2008 sustaining capital expenditures and turnaround cost will total $60 million to $65 million. In addition, we estimate capital expenditures of approximately $40 million to $50 million associated for capital expansion at the Woodward facility.

The 2008 total annual capital expenditures and turnaround cost will approximate between $100 million to $115 million. Terra declared a $0.02 per share common dividend payable on September 12 to shareholders of record as of August 25, 2008. At this time, I'd like to turn the call back to Mike Bennett.

Mike Bennett

 

All right. Thank you, Dan. That concludes our prepared remarks this afternoon. At this time I would like to turn the call back over to Jasmine, so that she can instruct listeners on how to pose questions to us. Jasmine?

 

Question-and-Answer Session

 

Operator

 

(Operator instructions) Your first question comes from Alain Rodriguez [ph]. You may proceed.

Alain Rodriguez

Thank you very much. Good afternoon guys.

Mike Bennett

 

Good afternoon.

Dan Greenwell

 

Good afternoon.

Alain Rodriguez

Mike, quick question for you and this is regarding China. Come December, what do you think they will likely to do in terms of the 135% tariffs that they have out there? Like, is there an incentive for them to keep it or remove it?

Mike Bennett

 

Well, you know that’s a great question and I wish I had some unusual insight into that. Obviously, I think the tariff was inactive because more urea likely slipped out of air in 2007 than they would have liked and certainly I still believe that the main thrust of the nitrogen industry and the basis for it in China is to make sure that they have agricultural self-sufficiency. I think what happens after December will depend on a lot of things. Certainly, what type of crop production year they have this year, and also I think a lot of how they ultimately ration or balance their energy resources. We hear a lot of anecdotal reports about the coal being very tight in China and some curtailments on various activities, industrial activities because of that. And so ultimately, I think that both of those factors will play into whatever decision they undertake but to be candid, I really don’t have any special insight at this point in time.

Alain Rodriguez

That was good enough. Another quick question on nitrogen prices. I mean, they have been moving up seems to going higher and higher. Are you seeing any greater appetite from your customers to buy forward and how do you balance that?

Mike Bennett

Well, certainly this year as we mentioned customers came forward much earlier than normal, primarily to secure supplies for off-season fill and some prepayment for fall ammonia application. There’s still appetite out there at this point in time; I wouldn’t say if it’s abnormally strong for this time of the year, I think that certainly the first round of buying for fill has largely taken place. Normally, folks take a bit of breather before they jump back in and we candidly wouldn’t expect another real kind of push on customer demand until we start getting closer to the fall application season which typically is in that September-October time frame and then once again, when prepayment dollars are secured for the end of the year from farmers, that’s when we would expect to see a lot of the demand for spring ‘09 prepay and that sort of thing.

Alain Rodriguez

Okay, thank you very much.

Operator

Your next question comes from the line of Charles Rentschler. You may proceed.

Charles Rentschler – Wall Street Access

Hi, everybody. Question about your best outlook on corn for next year. Mike, what do you think, what’s your wild, wild guess for how many corn acres were planted this year and what the yields would be and then what do you think the corn acreage planning would be for next year, for ’09?

Mike Bennett

Well – Charlie, as you know, that also happens to be a big subject I’m not a particular expert on, but certainly the USDA report of a little over 87 million acres was a tad higher than we thought might happen primarily because the weather, because certainly the price incentives were there for farmers to plant corn. Obviously we’ve lost somewhere in the range of probably 3 million of those acres due to flooding and various issues. And so at the end of the day whether it’s lined up could probably create a scenario where the yield this year certainly could be supportive of what the USDA has estimated, but when you kind of cut through all that and look at the ending balance numbers of USDA, it would suggest that corn inventories will drop further and that in my view, should be a continued good scenario for an increase in planted acres next year. The most common range of acreage early on that I have heard for next year ranges somewhere in the 92 to as high as 95 million acre range. Ultimately, I think corn prices stack up post harvest and where the soybean prices are at ultimately will determine where the number falls in. Even with some of the money coming out of the commodity markets here over the last couple of weeks and with December corn back under $6 now, there’s still a very strong financial incentive and good financial return to growers to produce corn and I don’t see much out there that will probably change the economic equation significantly primarily due to supply and demand fundamentals.

Charles Rentschler – Wall Street Access

Okay and as a follow-up, of course Donaldsonville is being brought back on stream, and Woodward is being upgraded I guess to produce more UAN, but can we look forward to some more upgrade-type projects, maybe you could give us a bit of an update on the aqueous urea solution demand from the 2010 SCR truck engines.

Mike Bennett

Yes, well, as we’ve talked in the past, Charlie, we certainly think that the market for urea liquor solution for the SCR and diesel engines holds great potential. We expect that market to really begin to materialize as I indicated in 2010. And in the early years of that market, we think that with the Woodward project especially that we have got the flexibility to meet the market share objectives that we have as a company. As we go further out, it’s pretty clear to us that we are going to have to add additional upgraded capacity to meet the growing needs of that market. And as we indicated, I think in the last call, we’ve evaluated several other similar projects to the Woodward project at some of our other facilities where we have access to ammonia and the CO2 available and we’re still evaluating those to try to make the best decisions we can but, in all likelihood Charlie, in order to meet the demands of that market as we get out, maybe five years or so from now, we’re clearly going to have to pick some more urea liquor capacity within the system.

Charles Rentschler – Wall Street Access

 

Thank you.

Operator

 

You’re next question comes from the line of Jeff Feinberg. You may proceed.

Jeff Feinberg – JLF Asset Management

 

Thanks very much. This is Jeff Feinberg with JLF Asset Management. Congratulations guys.

Mike Bennett

 

Thank you.

Jeff Feinberg – JLF Asset Management

 

Just a quick question for Mike. Listening to the commentary about the strength in pricing, can we think about the profitability increasing from the June level into the September level?

Mike Bennett

 

Well, I think that the one of the things that we emphasized in the commentary was the fact that, especially where UAM is concerned, that custom-order activity begun early and so I don’t think at lease for the current quarter people should be thinking of the business in terms of a snap shot of today’s spot prices versus today’s spot gas but rather looking back at the what the situation was relative to product pricing and natural gas pricing back really in the first half of the second quarter. I think that will shape particularly the third quarter. And typically in our business, our results realize what I call a lag both in the market pricing and to a degree in what’s happening in natural gas markets because of those forward positions. So, typically, when we see a spot situation on pricing in gas, perhaps like we had today, normally, you expect to see those trends materialize more clearly in the business the further out you go. And so, more likely, those trends will start to materialize more toward the end of the year and they will certainly in the current quarter.

Jeff Feinberg – JLF Asset Management

 

I didn’t follow up on the gas, I’m sorry, can you just the make the point on gas and – ?

Mike Bennett

 

When we make those customer commitments and secure those sales, we also secure our forward natural gas past positions through derivatives.

Jeff Feinberg – JLF Asset Management

 

Yes.

Mike Bennett

 

So that we lock our margins down. So obviously, when we are reselling material in April for third quarter delivery, we didn’t leave ourselves open to natural gas volatility and so obviously the gas price secured against those sales maybe different from what you see in the spot market today.

Jeff Feinberg – JLF Asset Management

 

I see. Okay. Obviously, it will still be a very healthy result and the like. Okay.

Mike Bennett

 

Thanks for your question.

Jeff Feinberg – JLF Asset Management

 

Thank you.

Operator

 

Your next question comes from the line of Terence Ortslan. You may proceed.

Terence Ortslan – TSO Associates

 

Thanks. Terry Ortslan. The market obviously quite prolific, I just want to identify some risks here that you see as a dark clouds ahead and maybe the import market – if you see any changes in the imports of the nitrogen coming in?

Mike Bennett

 

Yes. Well, first of all, it’s always – sometimes it’s hard to see the dark clouds and go away – go there almost over the top of it but realistically right now, regardless of some of the volatility in the pricing of various commodities from day to day and week to week, fundamentally we still have a very tight supply-demand balance for grain and ultimately grain demand will continue to increase and that certainly is the fundamental challenge and I think the basis for the cycle that we are in. The other side of the equation really wants you to look at nitrogen pricing which is largely driven by the strong demand during production earlier [ph] fits that cost and certainly the recent trends at least at North America had been indicative of the decent level of supply and likely a less rapid rate of growth in terms of natural gas demand in part because of general economy and so from that standpoint, while certainly not a perfect world, I think that those two fundamental factors at least at this point certainly are supported.

As we look into 2009, and certainly if one expects a larger planted acreage of corn similar to what Charlie and I discussed earlier, it will require more nitrogen supply for the domestic market as we look forward to now all the way to next June and as a result, we believe that imports will have to increase. At this point, our crystal ball which isn’t always the clearest, tells us that import levels probably will need to be at least not afar with import levels from the prior year and that even at that level of imports, if we do have that kind of planted corn acreage, we will likely draw inventory down in the supply chain not dissimilar to what we saw happened early in the spring of 2007 and so at this point in time we think of market needs a very healthy rate of imports, the US market up until recently has actually been trading at a bit of a discount due to some of the trends in global market and so we probably have not had a real strong incentive for imports to come in over the past few months but price is ultimately here, will have to be reflected with global markets in order to attract enough imports to ensure that we got the right supply balance.

Terence Ortslan – TSO Associates

 

Where do you foresee the increased imports will be able to arrive from, not from the Black Sea, that’s quite (inaudible).

Mike Bennett

 

Primarily, when you look at that import fertilizers in the U.S., the major import from a fertilizer perspective has to be urea and much of that urea is not really Black Sea material, it is Middle East or Trinidad, Venezuela and so forth, primarily granular. Certainly, we think ammonia imports should stay pretty steady; probably we need to see a slight increase this year in urea imports and probably continued fairly strong UAN imports which primarily have been coming from the Black Sea.

Terence Ortslan – TSO Associates

 

One additional question about the share repurchase program, will you wait and see for the termination of the program that you have or will you be renewing your program between now and then?

Mike Bennett

 

Well actually, we just vamped the size of the program up and we extended the term of that program to give us additional flexibility and I think right now we have basically about $12 million shares authorized by the board as part of that program and we extended the end-date of that program to basically mid-2010 and so essentially we got a $12.6 million share authorization and we basically got two years right now to utilize with that authorization.

Terence Ortslan – TSO Associates

 

Okay, thank you for the detailed answer.

Mike Bennett

 

You are welcome.

Operator

 

Your next question comes from David Rosen [ph]. You may proceed.

David Rosen

 

A couple of questions. First, on your tax rate, it sounded like it was 37.5%, you said it was expected for the full year and now it is going down to 32%. Does that mean that the two back half quarters you are going to have mid-20% tax rate?

Mike Bennett

 

There should be some tax credits that we anticipate getting in the second half of the year, principally related to some 80B23 [ph] adjustments. We look to do some restructuring in the second half of the year, so we would expect lower effective rates in the third and fourth quarter, but we would expect the annualized rate for the year to be between 32% to 34% is I believe what I said in my prepared comments.

David Rosen

 

Okay. Progress in Donaldsonville, for this quarter, did you take a charge?

Mike Bennett

 

No, we did not. We actually received a bit of a benefit, some those of catalyst sales as we were renewing the Donaldsonville facility. We reclaimed some catalysts from Donaldsonville. So, no, we did not take a charge. We actually recorded a bit of a benefit from catalyst sales out of Donaldsonville.

David Rosen

 

Okay. The UK joint venture, is there any reason to think that the economics from that business are not sustainable?

Mike Bennett

 

Well, as we mentioned, the UK gas cost as we’ve seen over the last several years, and we started moving into winter months in the UK, that gas cost is extremely volatile and there’s not a strong forward market for gas in the UK. And as we also mentioned, we expect some synergy costs in the second half of 2008 of approximately $9 million. So I caution UK operations with volatile gas and then of course, the synergy charges and cost that we expect to occur in the second half as well.

David Rosen

 

Earlier another question was asked on the third quarter and your response was basically the fourth quarter, so it seems as though – where we stand today based on kind of what the green market is suggesting pricing should be and where natural gas is, I mean, Q4 should be reasonably robust, do you have an issue with that statement?

Mike Bennett

 

Well, it all depends on the definition of the additives I guess, but I think realistically as we go forward, certainly if the pricing trends that we see today in the marketplace continue that hasn't moved forward further in time, we are likely to see on average a better realized pricing simply because today’s stock price is obviously higher than those that we saw in the first half. And certainly, if the gas market stays anywhere close to current levels, they’re the best levels that we’ve seen really since the first quarter. And so as we start taking additional gas positions, which would primarily be aimed toward Q4 and on into the first half of ’09, we definitely could see some benefit from that.

David Rosen

 

Got you. There is always this question about supply response. In your estimation, where you stand today, how long will it take for someone to Greenfield their facility to meet different demands?

Mike Bennett

 

Our – kind of our conventional thinking today is that from planning to production, you’re probably at looking into something close to four years.

David Rosen

 

So basically if someone were to come out today and decide to build a plant, it wouldn't come online till some time in mid 2012.

Mike Bennett

 

I think realistically that would be probably being a fair estimate.

David Rosen

 

Okay. There were some sell side analysts that have come out and speculated that there will be a supply response in 2009.

Mike Bennett

 

Well, there are projects but they are apparently under construction and certainly there will be a additional capacity brought on stream this year, not as much on the basis of what we know from outside consultants in ‘09 and some additional capacity in 2010 and 2011 that currently is under construction. But as we show people in our investor presentation, when you at the rate of growth in nitrogen demand that certainly we’ve seen over the past few years and is projected over the next three or four, at this point in time, it doesn’t appear that the cumulative amount of new capacity is likely to be significantly different than the cumulative growth and demand over that time period. Yes, I think like anything, when times are good and there’s good money to be made, people reinvest in industries and we would expect that but it is not the kind of thing that you can turn around on a dime.

David Rosen

 

Final question, again on the Donaldsonville terminal, you guys – not the terminal but the Donaldsonville plant, that will actually appear in Q4. Can you give us any order of magnitude, what the opportunity that presents as opposed to buying products internationally?

Mike Bennett

 

Well, I can give you just a straight mathematical example and you can determine your own opportunity. When we purchased ammonia internationally, quite frankly the margins on that are too sticky. I mean if you had much more than $10 a ton, you've probably done well. If you take a snapshot of today and you assume $10 natural gas, a plant like that would have cash cost somewhere in the range of $370 per short ton. Ammonia today at the Gulf Coast, I am not sure what it’s quoted at, but let us say for the sake of argument, it is $600 dollars for a short ton, that would imply that the snapshot opportunity today would be $230 a ton. And so, there is a significant difference between purchasing ammonia and producing it when you have that type of spread between selling price and some raw material costs.

David Rosen

 

And if I do that delta, that would get – on 400,000 tons, that would be about $92 million. And again, if I use your tax rate that you provided which I guess would be on a run rate basis 32%, that would add about $0.60 of earnings respectively.

Mike Bennett

 

Based on that snapshot, I would say that’s a rough estimate on the impact and again that is annualized, right.

David Rosen

 

Correct, about $0.15. Okay. Again, great quarter and we are looking forward to similar type of results in the future.

Mike Bennett

 

Thank you.

Operator

 

Your next question comes from Steve Byrne, you may proceed

Steve Byrne – Merrill Lynch

 

In your ammonium nitrate business, how much of that is sold into agricultural markets versus the industrial and explosives market?

Mike Bennett

 

Steve, roughly when you look at ammonium nitrate, our Ag ammonium nitrate business is roughly 50% of our output there (inaudible) and the balance is – goes primarily to the industrial markets.

Steve Byrne – Merrill Lynch

 

In the spot price, it has moved from roughly $400 a ton to $500 a ton in the last two weeks, can you talk about those end markets as to whether – what is the incremental driver that has caused that spot price to pop like that and are your industrial contracts tied to some trailing price or how does that work? When would you see – when would that kind of a price increase flow through into your industrial contracts?

Mike Bennett

 

Well, first of all, all of our industrial contracts vary. Now, the ORC [ph] agreement which consumes at least a good share of our industrial ammonium nitrate is more or less a tolling agreement, Steve, which is based primarily on natural gas costs and we entered into that agreement obviously in 2005 when people didn’t think (inaudible) much worth much. And so, on that business, we do not see the kind of fly up in margins that we will probably see on the Ag side.

On the Ag business, I think the driver behind ammonium nitrate price increases really has been the global push in urea prices. Those ammonium nitrate values ultimately stem from what is happening in the Black Sea. Certainly, when you look at Europe with higher expected production cost, and Europe being the other significant market, in fact, probably a more significant market for Ag ammonium nitrate demand, certainly, I think that those are influencing drivers. So for us, as we go forward through the second half, assuming those drivers remain in place, we will see much better pricing on the Ag side of AN, but won’t see nearly anything of that magnitude on the industrial piece.

Steve Byrne – Merrill Lynch

 

Can you talk about the outlook for – the regulatory climate for handling and transporting AN, are you – has your outlook improved recently on that?

Mike Bennett

 

Well, I don’t know that it’s improved, Steve. We think some great measures were put in place to help insure that that material doesn’t get into the wrong hands. Material now is fairly heavily regulated relative to keeping track of basically who is receiving and merchandising the material. And of course, we’ve got much better measures in place these days to really track and identify shipments. So, I think a lot of very sound yet common sense measures were put in place to really mitigate the odds of something untoward happening in that regard. Those things have been put to place. It’s actually been there now for some time. Absent some other type of issue or incident, I really don’t expect much additional regulation or change in that regard but certainly it’s had a big impact on the industry on I think some of the shipping patterns in the material and certainly it’s had an impact on the, I think, the ease of import as well.

Steve Byrne – Merrill Lynch

 

So that market has probably tightened in recent years then?

Mike Bennett

 

Well, maybe to some degree because also we’ve had some competitors get out of that market and certainly that’s helped the balance. But at the end of the day, ammonium nitrate more and more is what I call almost a specialty fertilizer. It is a great product agronomically for a number of crops especially in the South and the Southeast. You don’t really see it is used much anymore on corn or of the mainstream crops but the real value is basically delivering that nitrate in conditions where you have a lot of moisture and humidity and lighter soil types like we see in the South and Southeast.

Steve Byrne – Merrill Lynch

 

Okay and just last one. Dan, you see that 32% to 34% tax rate in 2009?

Dan Greenwell

Probably in the 34 range for 2009.

Steve Byrne – Merrill Lynch

 

Okay. Thank you.

Operator

 

Your next question comes from Michael Christodolou. You may proceed.

Michael Christodolou – Inwood Capital

 

Hi, gentlemen. A couple of questions on inventory. Mike, I think during the West spring in April and May, you made some commentary that there’s a number of your dealers were unable to take physical delivery of their prepayment volumes just because their growers in turn couldn’t access the field and then it seemed to get better and then there was the course of flooding in Iowa and Indiana in June and a couple of questions, did any prepaid volumes originally just made it for first halfway of shipment not yet shipped?

Mike Bennett

 

Well, I would say that any of that that didn’t get shipped are relatively minor in the scheme of things, Mike. Basically, at the end of the day, this season just continue to pace out and pace out. Anecdotally, when you look at really our inventories today, we’re not really in a much significant position than I think were a year ago at this time. I think for the most part, our customers are in pretty good shape and really here in July as we’ve indicated, the bill activity on products like UAN and topping up ammonia has really been moving at a pace that we would normally expect.

Michael Christodolou – Inwood Capital

 

And your inventory is right there flat on a dollar basis and I guess even if that’s valued at cost, right?

Mike Bennett

 

It cost us a little more to put that inventory away this time.

Michael Christodolou – Inwood Capital

 

So the volumes are actually down probably that you are preparing at the end of June 30 versus a year ago?

Mike Bennett

 

Yes, but one thing you got to remember is that a year ago, we also were still consolidating the UK.

Michael Christodolou – Inwood Capital

 

Right.

Mike Bennett

 

So, overall, we certainly don’t think our volumes and inventory are terrible at all, but in summary, they may be a little higher than last year which was kind of a (inaudible) year but when you’re back to the UK the dollar value in North America is fairly higher this year.

Michael Christodolou – Inwood Capital

 

What are you doing from the field for wheat planting here in the fall?

Mike Bennett

 

Well, at his point in time it is still early in the game. But basically, in a lot of our geography, wheat farmers did pretty well this year. Usually, the scenario that we don’t see a wide advance purchasing on for fertilizer before, and the planning market for that is quite primarily ammonia for the three plants and the UAN market for that crop really doesn’t come until top grass usually in the first of the calendar year. So, at this point in time, some of the things we’ve seen suggest that wheat acreage may be flat to slightly down next year but any decrease may likely be due to the continued strong opportunity for growers in corn and soy beans.

Michael Christodolou – Inwood Capital

 

My last question, did I hear you say you thought maybe 3 million acres of corn were lost, and I am curious if I heard that correctly? And also, did you see any attempt to – in the last months for side-dressing for growers trying to just salvage some of the acreage?

Mike Bennett

 

Well, I guess first of all, some of the numbers that we heard that states were reporting like the state of Iowa, the state of Illinois and the state of Missouri, when you aggregate what some of those estimates were, somewhere in that ballpark of acreage probably isn’t totally unrealistic in terms of those crops. And most of that damage occurred late enough where really replanting probably wasn’t a viable option (inaudible) especially when you’re looking at corn with such a short window on the growing season. And so, clearly at worst, the loss will certainly offset anything that we picked up in upside acreage initially. And yes, we’ve seen very good demand for nitrogen all the way through this season and we had a pretty good over the top and side dress season out here especially in the western corn-belt, and a lot of that has been driven by just delays imposed by the weather.

Michael Christodolou – Inwood Capital

 

Thanks for the insight. Keep up the great work.

Mike Bennett

 

Thank you.

Operator

 

Your next question comes from the line of Steven Yang [ph]. You may proceed.

Steven Yang

 

Hi. Can you hear me?

Mike Bennett

 

Yes.

Steven Yang

 

Quick question. In terms of the operation utilization – plant utilization rate and the plant operation cost, you seem to increase in electricity costs and how has that impacted your plant cost?

Mike Bennett

 

Well, first of all, obviously far and away the biggest cost of production for us is the cost of natural gas. Like anyone else, I think we’re subject to what I call normal inflationary increases and things like wages and power costs. For the most part, in our facilities, we purchase power under term contracts with the utility providers. And so while certainly in some areas over time we’ve seen changes in electricity costs, I wouldn’t call those dramatic, relatively minor and certainly have not had a major impact on our variable cost of production.

Steven Yang

 

Are there anything outside of electricity costs other than natural gas?

Mike Bennett

 

Really, when you look at our business, natural gas dominates production costs and the second biggest cost we have in the company is primarily freight. Freight and distribution expenses to move our product and – as everyone has been around knows certainly freight costs have been moving upward and certainly that’s been an issue for our customers as well as the increased cost in material.

Steven Yang

 

And then capacity utilizations, is this same as last year?

Mike Bennett

 

Our capacity utilization has been high. I don’t have the numbers right in front of me but basically our facilities have done well up in this year and I would guess that we are going to be up in the 97% plus range.

Steven Yang

 

Okay. Thank you.

Operator

 

Your next question comes from the line of Brian Yu. You may proceed.

Brian Yu – Citigroup

 

Great, thanks. Quick question here in terms of pre-buy. Can you tell if this is dealers tactically buying for the fall to refill their bins or are they buying these to fill commensurate orders from the farmers?

Mike Bennett

 

Well, there’s probably a little of both for those, Brian, but I think primarily, at this stage of the game it would be largely driven by retailers wanting to fill that storage knowing that they’re going to move that material in the coming spring. You know in some cases even earlier this past year, there were some particularly people who have integrated into grain, running some programs where they were selling some imports to farmers in addition to running forward grain sales programs for them to help hedge their costs. But I would guess most of the material that, at least on UAN that's been sold this far has probably not been sold yet at the farm level. Whereas on ammonia prepayment, my guess is that a higher percentage of that has probably had some cash commitment on the part of the farmer associated with it.

Brian Yu – Citigroup

 

Mike, just anecdotally have been hearing about retailers having some working capital issues because of the high cost of fertilizers, have you had to change any of your prepayment terms?

Mike Bennett

 

Well, not thus far. I mean, Brian, typically on the short-term step that we’re going to be shipping here over the next quarter, at this time of year, normally, that material isn’t associated with a prepayment program and as you ship – as you take orders per shipment further out you associate more prepayment with that just to kind of secure the position of that sale and obviously the integrity of your cost edge against it. But typically, like 100% prepaid programs most commonly are associated with the prepayments that we make to customers sales that we make in like the December and January that will accompany the spring movement of that material, and typically that’s when they receive most money from farmers for advanced payment on inputs.

Brian Yu – Citigroup

 

Okay. And one last one, I'm switching topics a bit, any major turnarounds planned in your operations for the back half?

Mike Bennett

 

Well, actually only one. It's kind of an unusual year in that we only have one turnaround planned that’s at Port Neal, and that will occur I think in the first half of August. But this year, we do not have a very good turnaround planned. We went slightly over a two-year cycle there. So, only one planned and that will be Port Neal in August.

Brian Yu – Citigroup

 

And how long will that be accounted for?

Mike Bennett

 

I believe that’s going to be roughly a two- to three-week turnaround.

Brian Yu – Citigroup

 

Great. Thanks and great quarter.

Mike Bennett

 

Thank you, Brian.

Operator

 

Your next question comes from the line of Mi Ji Kong [ph]. You may proceed.

Mi Ji Kong

Hi. Given the run-up in product prices, wondering if you could talk a little bit about what’s driving this increase. Where’s the marginal producer pricing his product now? And related to that, as things turn or when they turn sometime in the future, given our natural gas cost now almost at a discount to where Western European prices are being set, like how has that changed the earnings power of your business?

Mike Bennett

 

Well, I’ll answer the first question and then speculate on the second. Right now, to be honest, I don’t think that the robust nitrogen markets are really so much driven by or the marginal producer can operate. I think that we’ve in a large part right now despite the main balance globally is so tight that there’s going to be a coupling of that effect. Today, when we are looking at the global urea markets in the range of $800, basically, any plant that’s out there, as far as I know, from a cost structure standpoint, can operate at some pretty good cash margins. Certainly, the – I think the – what we’ve seen happen in crude oil that’s impacted the price structure of natural gas in Western Europe. Changes – fundamental changes in the pricing of Russian gas to Eastern and Central European producers clearly has made a significant difference and in my view is a step change relative to regional competitive positioning. And certainly today, certainly as a domestic North American producer where all of our products is sold. When one looks at those fundamental changes in some of these regions and also couples with that the significant increases in freight cost that we’ve seen over this timeframe it’s created a pretty significant competitive buffer for domestic producers and I think largely left the North American industry in a much stronger competitive position globally than it was certainly earlier in this decade.

Mi Ji Kong

Got it, thank you. Great quarter guys. Thanks.

Mike Bennett

Thank you.

Operator

 

(Operator instructions) Your next question comes from Paul D’Amico [ph]. You may proceed.

Paul D’Amico

Hi, good afternoon guys. Mike, just something you’d mentioned earlier and then you touched on in the most recent question. In terms of the demand forecast versus the supply that you either subscribe to thinking as coming on or that you’ve seen other people say. Where would you put that rate now over the next say two to three years, where would you see the supply response and the demand in line with that? And what product would you be talking about, in particular when you talk about nitrogen?

Mike Bennett

Well, first of all, I guess the consultant data that we had indicates that it’s probably not unreasonable to expect about a 3% annual growth rate in consumption of urea which globally is really the major form of nitrogen that’s traded and applied in many of the growth markets such as India and Asia. And so when one looks at urea capacity, the planned startups and for plants under construction. Basically this year and next year, it looks like new capacity actually will fall a bit short of that 3% growth rate but could very well catch up someday in 2010/2011 to kind of get back about in line with that 3% annual growth rate over the time period. And so the supply and the demand won’t be staged in absolutely evenly and it looks like we could have a bit of a GAAP relative to demand increases relative in the supply response in ’09 and then some of that GAAP being closed as we get out in 2010 and 2011.

Paul D’Amico

Just to be clear that supply response that you’re referring to, that’s excluding China?

Mike Bennett

That is excluding China, yes.

Paul D’Amico

Thank you.

Operator

Your next question comes from the line of John Tobin [ph].

John Tobin

Your 7% notes are rated B1, BB by the rating agencies which frankly seems out of sink with your very, very strong credit profile at the moment, have you got any plans to talk to the rating agencies to address your ratings or is that just not a priority for you.

Mike Bennett

No, as a matter of fact Standard & Poor’s updated their rating earlier this spring, so we have talked with them and we’ve talked with others as well. Moody's is probably scheduled to do something here in the short term, but no we talk to them on a regular basis and I think part of their rating model or profile is relative size of issuer and we fall in the categories of that. So we do touch base with them on a regular basis. They’re familiar with our operations and they run an independent shop, so we’ll go with their schedule on updating the ratings.

John Tobin

Okay, fair enough and I have a follow up question. Again, your financial performance has been very strong and your credit profile is exceptional. Your cash is twice your debt balance outstanding. Your stock price performance has probably been a disappointment for you, as well as for your investors, what – big picture, what are you guys thinking about doing, is there something being talked about, mergers, acquisitions, something to change that?

Mike Bennett

Well, obviously we’d love to change that and certainly as I’ve touched on the – just very briefly in my remarks, one of – certainly my priorities here and priority for our board is to look at the all the different options that were available to us to utilize our strong financial position to create a more accretive earnings platform for shareholders and that can take a lot of different forms. Certainly, we’ve talked a little bit about the share buybacks today. We’ve talked about new projects that will add upgrading capacity which in turn will add additional earnings capability for the company, and we’ve always been very open about the fact that we continued to desire to make a creative acquisitions in our space, and we’re always looking and thinking about ways that we think are smart that can improve the profile of the company both in scale and I think, the performance over the cycle for shareholders. So, that is the priority for us. It’s on our mind – I think there are a lot of reasons why sometimes – currently a pure-play nitrogen company doesn’t get exactly the same type of, I guess, value that is subscribed these days to phosphate companies or certainly potash operations, but we think nitrogen is a good business. We think it can be a good investment for our shareholders and we’re committed to finding ways to make that more evident.

John Tobin

 

Very good. Thank you.

Operator

 

And we have no further questions at this time.

Mike Bennett

 

All right. Well, again we’d like to thank you all for your interest in Terra. We appreciate your participation today. And again, if any of you would like to come visit us or have follow-up questions, please contact Joe Ewing or Kim Mathers and we’d be delighted to host you or to field those questions. Have a great day. We look forward to speaking with you at the end of the third quarter.

Operator

 

Thank you for attending today’s conference. This concludes your presentation. You may now disconnect. Good day.

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Source: Terra Nitrogen Inc Q2 2008 Earnings Call Transcript
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