UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-K

 

 

 

Terra Industries Inc.

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

Securities registered pursuant to section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of accelerated filed and large accelerated filer in Rule 12b-2 of the Act). Large Accelerated Filer x Accelerated Filer o Non-accelerated Filer o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x

 

The aggregate market value of the voting and non-voting common shares held by non-affiliates computed by reference to the price at which the common shares were last sold, or the average bid and asked price of such common shares, as of the last business day of the registrant’s most recently completed second fiscal quarter was $4,460,503,747.35.

 

The number of Common Shares, without par value, outstanding as of February 27, 2009 was 99,700,706.

 

Documents Incorporated by Reference

 

Certain portions of the proxy statement for the 2009 Annual Meeting of Stockholders of Terra Industries Inc. are incorporated by reference into Part III hereof. The proxy statement for the 2009 Annual Meeting of Stockholders will be filed with the Securities and Exchange Commission, pursuant to Regulation 14A, not later than 120 days after the end of the 2008 fiscal year, or, if we do not file the proxy statement within such 120-day period, we will amend this Annual Report on Form 10-K to include the information required under Part III hereof not later than the end of such 120-day period.

Forward-Looking Information is Subject to Risk and Uncertainty

 

Certain statements in this report may constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. These statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. Actual outcomes and results may differ materially from what is expressed or forecasted in these forward-looking statements. As a result, these statements speak only as of the date they were made and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

 

Words such as “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” and similar expressions are used to identify these forward-looking statements. These include, among others, statements relating to:

 

 

Additional information as to these factors can be found in the section entitled “Business,” “Legal Proceedings,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the Notes to our consolidated financial statements included as part of this report.

 

Table of Contents

 

 

Terra Industries Inc. together with its subsidiaries (Terra, we, our, or us) is a leading North American producer and marketer of nitrogen products, serving agricultural and industrial markets. In addition to manufacturing facilities at Port Neal, Iowa; Courtright, Ontario, Canada; Yazoo City, Mississippi; Donaldsonville, Louisiana and Woodward, Oklahoma, we own a 75.3% interest in Terra Nitrogen Company, L.P. (TNCLP), which, through its subsidiary, Terra Nitrogen, Limited Partnership, operates our manufacturing facility at Verdigris, Oklahoma. We are the sole general partner and the majority limited partner of TNCLP. In addition, we own a 50% interest in Point Lisas Nitrogen Limited (Point Lisas), an ammonia production joint venture in the Republic of Trinidad and Tobago. We also own a 50% interest in GrowHow UK Limited (GrowHow), a nitrogen products production joint venture with facilities located in the United Kingdom.

 

We are one of the largest North American producers of anhydrous ammonia (or ammonia), the basic building block of nitrogen fertilizers. We convert a significant portion of the ammonia we produce into urea ammonium nitrate solutions (UAN), ammonium nitrate (AN) and urea. Each of these products is easier for distributors and farmers to transport, store and apply to crops than ammonia. We also convert ammonia to nitric acid and dinitrogen tetroxide for use in industrial applications.

 

2008 Overview

 

In 2008, we delivered the best annual financial results in our long history, as the excellent global nitrogen market conditions from 2007 continued through the first three quarters of 2008. The broad-based economic decline impacted the nitrogen market during the fourth quarter of 2008, causing nitrogen product demand to decline, reducing product sales prices and curtailing product shipment. Although the unprecedented global economic challenges of the fourth quarter were a sharp contrast to the positive operating environment of the first three quarters, we still delivered impressive financial results for the fourth quarter 2008. To extrapolate on key initiatives and transactions that occurred during 2008, we have included a discussion of significant items below.

 

Woodward Expansion

 

We announced in May 2008 plans to expand the upgrading capacity at our Woodward, Oklahoma nitrogen manufacturing facility at an expected cost of approximately $180 million with a completion date targeted for the end of 2010. As a result of this project, UAN capacity at the facility should increase from 300,000 tons to 825,000 tons. The expansion project fits well with Terra’s strategy of focusing on higher value upgraded products.

 

Terra Environmental Technologies

 

Terra Environmental Technologies Inc. (TET), an indirect wholly owned subsidiary of Terra, continued implementation of its plan to service the vehicle diesel exhaust fluid (DEF) market. DEF is a 32.5% urea liquor solution used in diesel engine selective catalytic reduction (SCR) aftertreatment systems. The urea based SCR technology has been adopted by most of the light to heavy duty vehicle and engine manufacturers to comply with the 2010 emission standards as defined by the 1990 Amendments to the Clean Air Act. By doing so, TET expanded on its presence in the stationary market reducing nitrogen oxide (NOx) emissions from such facilities as power generating plants. TET announced in December execution of a Distribution Agreement with Brenntag, North America, Inc. (Brenntag) for the distribution of TET’s TerraCair^® DEF product.

Joint Venture Operations

 

Our joint venture operations in North America and the United Kingdom delivered strong financial results in 2008. We recorded $95.6 million in equity earnings and received $88.7 million in cash consideration payments from GrowHow. We also recorded $56.2 million in equity earnings and received $72.8 million in cash distributions from our North American joint ventures in 2008.

 

Dividends and Stock Repurchases

 

In May 2008, we instituted a quarterly dividend of $.10 per common share. This decision reflects our desire to enhance shareholder value and our conviction that Terra’s long-term prospects are strong. We also extended and expanded our share repurchase program. The prior share repurchase program was scheduled to expire on June 30, 2008, and allowed for the repurchase of up to 10% (or approximately 9.5 million shares) of Terra’s outstanding common stock. The new program adopted by our Board of Directors in May 2008 allows for the repurchase of an additional 10 million shares and carries over the balance of 2.8 million unpurchased shares from the prior program, for a total authorization of approximately 12.8 million shares, representing 14% of Terra’s outstanding shares. The program authorized in May 2008 extends to June 30, 2010. In 2008, Terra repurchased a total of 5.4 million shares at a total cost of $157.5 million.

 

Pension Stability

 

During the first quarter of 2008, we decided to reallocate pension assets into a high-quality, long duration bond investment mix. With the economic downturn in the fourth quarter, this prudent decision has provided stability to our pension plans without significant cash contribution requirements. Our qualified defined benefit plans are fully funded at the end of 2008 and have assets of $285.3 million. Additionally, none of our pension assets are invested in illiquid asset classes.

 

Sale of Beaumont Facilities

 

On December 31, 2008, we closed on the sale of our Beaumont, Texas facility to Eastman Chemical Company (Eastman) pursuant to an agreement executed in 2007. For additional information regarding the sale of our Beaumont facility, see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 2, Discontinued Operations, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Business Strategy

 

We are a leading North American producer and marketer of wholesale nitrogen products, serving agricultural and industrial markets.

 

The principal customers for our North American nitrogen products are national agricultural retail chains, farm cooperatives, independent dealers and industrial customers. Agricultural customers generally use nitrogen products as fertilizer for crops. Industrial customers use nitrogen products to manufacture chemicals, plastics and other products such as acrylonitrile, polyurethanes, fibers, explosives and adhesives; to reduce NOx and other emissions from power plants; and in water treatment processes. Our facility in Yazoo City, Mississippi produces industrial grade ammonium nitrate (IGAN) prills (a form of dry pellet) and ammonium nitrate solution that are utilized as explosives in the mining industry as well as a raw material in the production of catalyst materials. We have a long term supply contract with one of our customers to provide IGAN products for a majority of the Yazoo City capacity.

Agricultural and industrial customers accounted for approximately 71% and 29% of our 2008 North American nitrogen product revenues respectively.

 

Financial information about our principal industry segment and geographic areas is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Note 22, Industry Segment Data, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Nitrogen Business

 

Overview

 

The principal forms of globally traded nitrogen fertilizer are ammonia and urea. AN is also traded in global markets. UAN is used principally in North America and Western Europe, and has only recently been traded in other international markets. UAN’s high water content and need for transportation in tankers can cause transportation costs per unit of nitrogen to be higher than for other forms of internationally traded nitrogen products.

 

The locations of our North American production facilities provide us a competitive advantage in serving agricultural customers in the Corn Belt and other major agricultural areas in the United States and Canada. The GrowHow facilities are able to competitively serve the entire British agricultural market. The Point Lisas ammonia production facility in Trinidad and Tobago serves U.S. and international nitrogen markets, benefiting from access to low-cost natural gas supplies.

 

Ammonia, AN, urea and UAN are the principal nitrogen products we produce and sell in North America. GrowHow produces and sells primarily ammonia, AN and fertilizer compounds in the U.K. The Point Lisas production facility in Trinidad provides ammonia for sale into both the U.S. and international nitrogen markets. Other products we manufacture include nitric acid, dinitrogen tetroxide and carbon dioxide. These products, along with a portion of our ammonia, AN and urea production, are used in non-agricultural applications.

 

Our Terra Environmental Technologies business provides products and services to customers using nitrogen products (primarily ammonia, aqua ammonia and liquid and dry urea) to reduce NOx emissions from various stationary sources, such as power plants, and other environmental processes such as water treatment plants, and also in the emerging DEF market.

 

Although the different nitrogen fertilizer products are interchangeable to some extent, each has its own characteristics which make one product or another preferable to the end-user. Our plants are designed to provide the fertilizer products preferred by end-users in the regions which they serve. These preferences vary according to the crop planted, soil and weather conditions, regional farming practices, relative prices, and the cost and availability of storage, handling and application equipment. Our nitrogen products and 2008 production are described in greater detail below.

 

Anhydrous Ammonia

 

We are the leading U.S. producer of ammonia. Ammonia is the simplest form of nitrogen fertilizer and the feedstock for the production of other nitrogen fertilizers, including urea, AN and UAN. Ammonia is also a vital raw material for many industrial applications. Ammonia is produced when natural gas reacts with steam and air at high temperatures and pressures in the presence of catalysts. Ammonia has a nitrogen content of 82% by weight and is generally the least expensive form of fertilizer on a per-pound-of-contained-nitrogen basis. Although generally the cheapest source of nitrogen available to

agricultural customers, ammonia can be less desirable to end-users than urea, AN and UAN because of its need for specialized application equipment and its limited application flexibility.

 

In 2008, we produced approximately 3,171,000 tons of ammonia at our North American facilities. We are obligated by contract with Point Lisas to purchase one-half of the ammonia produced by Point Lisas through 2018 based on market indexed prices. In 2008, we purchased approximately 390,000 tons pursuant to our contract with Point Lisas. We sold a total of 1,669,000 tons of ammonia worldwide in 2008 and consumed approximately 2,016,000 tons of ammonia as a raw material to manufacture our other nitrogen products.

 

Urea Ammonium Nitrate Solutions (UAN)

 

UAN is a liquid fertilizer and, unlike ammonia, is odorless and does not require refrigeration or pressurization for transportation or storage. UAN is produced by combining liquid urea, liquid ammonium nitrate and water. The nitrogen content of UAN ranges from 28% to 32% by weight. (Unless we state otherwise, all references to UAN assume a 32% nitrogen content.) Because of its high water content, UAN is relatively expensive to transport, making it largely a regionally distributed product.

 

UAN can be applied to crops directly or mixed with crop protection products, permitting the application of several materials simultaneously, reducing energy and labor costs and accelerating field preparation for planting. UAN may be applied from ordinary tanks and trucks and sprayed or injected into the soil, or applied through irrigation systems. In addition, UAN may be applied throughout the growing season, providing significant application flexibility. Due to its stability, UAN (like AN) may be used for no-till row crops where fertilizer is spread on the surface of the soil.

 

We are the largest producer of UAN in North America. We produced approximately 3,703,000 tons of UAN at our North American facilities in 2008 and sold approximately 3,918,300 tons of UAN in 2008, primarily to U.S. fertilizer dealers and distributors.

 

Ammonium Nitrate (AN)

 

We are the largest manufacturer and marketer of agricultural-grade AN fertilizer in the U.S. and produce AN through GrowHow in the U.K. AN is produced by combining nitric acid and ammonia into a liquid form which is then converted to a solid, largely for fertilizer applications. The nitrogen content of AN is 34% by weight. AN is less subject to volatilization (evaporation) losses than other nitrogen products.

 

Due to its stability, AN is often the product of choice for pastures and no-till crops where fertilizer is spread upon the surface and is subject to evaporation losses.

 

During 2008, we produced approximately 310,000 tons of merchant ammonium nitrate solution (ANS) and 486,000 tons of agricultural grade AN (Amtrate^tm). We produced 190,000 tons IGAN, at our Yazoo City, Mississippi facility during 2008. During 2008, we sold approximately 489,800 tons of Amtrate^tm, 191,700 tons of IGAN, and 308,800 tons of ANS.

 

Urea

 

Urea is produced by converting ammonia and carbon dioxide into liquid urea, which can be further processed into a solid, granular form. Urea is used for fertilizer and animal feed, in industrial applications as a raw material to produce resins, and environmentally as a reagent to reduce NOx emissions. Granular urea has a nitrogen content of 46% by weight, the highest level of any solid

nitrogen product. We produce both a granulated form of urea, for the industrial market, and urea liquor (liquid) for animal feed supplements and industrial applications.

 

In 2008, we produced and sold approximately 250,000 tons of merchant urea and urea liquor; all of it at North American plants.

 

Nitric Acid

 

Nitric acid is made by oxidizing ammonia with air. The product is used as a raw material for other nitrogen products and by industrial customers to produce such products as nylon fibers, polyurethane foams and specialty fibers. In 2008, we produced approximately 2,110,000 tons of nitric acid. Approximately 35,000 of these tons were sold to industrial users and the remainder was used as a raw material for the production of our other nitrogen products.

 

Dinitrogen Tetroxide

 

Dinitrogen tetroxide is the propellant oxidizer used in various satellite, rocket and missile propulsion systems. It is also used by industrial customers in the manufacturing of pharmaceuticals. Dinitrogen tetroxide is produced by cooling and condensing a slipstream of process gas from a nitric acid plant containing various oxides of nitrogen. The recovered product is filtered and its composition adjusted to meet final product specifications. We manufactured approximately 262,300 pounds of the product in 2008.

 

Marketing

 

Nitrogen is both a global and local commodity: global because it is produced and traded in almost all regions of the world and local because fertilizer customers display preferences for nitrogen in one of its four basic forms based upon local conditions. Because transportation is a significant component of a customer’s total product cost, a key to our competitiveness in the nitrogen business is proximity to the end user, which allows us to have the lowest delivered cost for the customer’s product of choice. In addition, we must continuously provide a reliable source of the preferred nitrogen product.

 

The principal customers for our manufactured and imported nitrogen products fall into two broad categories—agricultural fertilizer customers and industrial customers. The agriculture customers consist of independent dealers, national retail chains, and cooperatives. These agricultural customers, in turn, sell product to dealers, farmers and other users. Industrial customers use nitrogen products as a feedstock for a variety of chemical processes, in the manufacture of pulp, paper, and fibers and to control NOx emissions from power plants and vehicle diesel engines. Our agricultural and most of our industrial customers are located primarily in the Gulf States, Midwestern plains and southern regions of the U.S. where our facilities are located. It is our objective to ship as much of our North American production as possible directly from our manufacturing facilities to our customers.

 

Distribution

 

Our Donaldsonville, Louisiana terminal has ready access to rail, truck and ammonia pipeline transportation and provides us with economical access to ocean-going vessel and barge transportation for imports of nitrogen products. The terminal includes two ammonia storage tanks, each with a capacity of 30,000 tons, and can receive ocean-going vessels carrying 50,000 tons or more of ammonia. During 2008, the terminal received and shipped approximately 700,000 and 786,000 tons of ammonia, respectively. During 2008, we received and shipped 409,000 and 375,000 tons of UAN, respectively.

 

To maintain our distribution capabilities, we lease terminal assets in Blytheville, Arkansas consisting of storage and supporting infrastructure for 40,000 tons of ammonia, 9,500 tons of UAN and 40,000 tons

of urea. We have entered into a long-term agreement to exclusively lease certain of these terminal assets.

 

We own a 50% interest in the Houston Ammonia Terminal, located on the Houston Ship Channel near Pasadena, Texas. This terminal has two 15,000 ton ammonia storage tanks which provide ammonia to industrial customers in the area via a pipeline system capable of shipping approximately 1,000 tons per day. The terminal can also receive ocean-going vessels.

 

Transportation

 

We use several modes of transportation to distribute products to customers, including rail cars, common carrier trucks, barges and common carrier pipelines. Railcars are the major mode of transportation at our North American manufacturing facilities. At December 31, 2008, we had 3,048 railcars under lease. We own ten nitric acid railcars. In addition, we operate a common carrier that specializes in transporting all forms of nitrogen. We have three (3) barge tows for UAN and three (3) barge tows for ammonia under long-term charter. We use two separate pipeline transportation agreements to move ammonia to the Corn Belt from our facilities. The Magellan ammonia pipeline services Verdigris and Port Neal and the NuStar ammonia pipeline services Donaldsonville.

 

Nitrogen Industry Overview

 

The three major nutrients required for plant growth are phosphorous, mined as phosphate rock; potassium, mined as potash; and nitrogen, produced from natural gas. Phosphorus plays a key role in the photosynthesis process. Potassium is an important regulator of plants’ physiological functions. Nitrogen is an essential element for most organic compounds in plants because it promotes protein formation. Nitrogen is also a major component of chlorophyll, which helps promote green healthy growth and high crop yields. There are no known substitutes for nitrogen fertilizers in the cultivation of high-yield crops. These three nutrients occur naturally in the soil to a certain extent, but must be replaced because crops remove them from the soil. Nitrogen, to a greater extent than phosphate and potash, must be reapplied each year in areas of intense agricultural usage because of nitrogen absorption by crops and its tendency to escape from the soil by evaporation or leaching. Consequently, demand for nitrogen fertilizer tends to be more consistent on a year-by-year, per-acre-planted basis than is demand for phosphate or potash fertilizer.

 

The major nitrogen consuming crops in North America are corn and wheat and in the United Kingdom, wheat. Certain crops, such as soybeans and other legumes, can better absorb atmospheric nitrogen and do not require nitrogen fertilizers.

 

Demand

 

Global demand for fertilizers generally grows at predictable rates that tend to correspond to growth in grain production. Global fertilizer demand is driven in the long-term primarily by population growth, increases in disposable income and associated improvements in diet. Short-term demand depends on world economic growth rates and factors creating temporary imbalances in supply and demand. These factors include weather patterns, the level of world grain stocks relative to consumption, agricultural commodity prices, energy prices, crop mix, fertilizer application rates, farm income and temporary disruptions in fertilizer trade from government intervention, such as changes in the buying patterns of China or India. Grain consumption has historically grown at approximately 1.2% per year. According to the International Fertilizer Industry Association, over the last 45 years global fertilizer demand has grown 3.7% annually and global nitrogen fertilizer demand has grown at a faster rate of 4.8% annually. During that period, North American nitrogen fertilizer demand has grown 3.3% annually.

Supply

 

Over the past seven years, global ammonia capacity has remained relatively flat, growing at an average of approximately 2% per year. This result was attributable principally to the combination of new project capacity being offset by permanent plant closings in the U.S. and in Europe. As global operating rates and prices have risen, so have plans for new capacity.

 

This anticipated new global capacity will come primarily from advantaged natural gas regions of the world, such as the Middle East and Africa. This expansion of capacity could be limited, however, by high capital and construction costs, lower nitrogen prices and increasing natural gas prices. Russia has increased domestic gas prices as well as prices paid by their export customers. This has increased production costs for new and existing plants in the former Soviet Union and Europe.

 

Imports account for a significant portion of U.S. nitrogen product supply. Producers from the former Soviet Union, Canada, the Middle East, Trinidad and Venezuela are major exporters to the U.S. These export producers are often competitive in regions close to the point of entry for imports, primarily the Gulf coast and east coast of North America. Due to higher freight costs and limited distribution infrastructure, importers are less competitive in serving the main corn-growing regions of the U.S., which are more distant from these ports. According to Fertecon, a leading fertilizer industry publication, world ammonia imports grew from 17.0 million tons in 2000 to 20.9 million tons by 2007 due to the exceptional increase in gas prices in the U.S. and Europe during this period and the consequent closure of U.S. capacity.

 

Outlook

 

As of October 2008, Fertecon forecasts that global nitrogen fertilizer demand is expected to rise by around 2% per year from 2005 to 2015, increasing by 25 million tons or close to 25% over the period. In North America, nitrogen fertilizer consumption is expected to increase in the period from 2005 to 2015 from 14 million tons to 16 million tons, a 15% increase.

 

The continued growth in demand for nitrogen products has helped stabilize global ammonia capacity utilization rates, which averaged 83.5% between 2006 and 2007. According to Fertecon, global ammonia utilization rates are forecasted to remain in the low-80’s through 2015. North American ammonia utilization rates are forecast to remain stable at 89% through 2015.

 

To help meet the growing global demand for fertilizers, especially in high growth areas like China and India, new ammonia capacity is expected to come on stream globally in the next nine years. According to Fertecon, global ammonia capacity is forecast to increase by 23.4 million tons by 2015, a total increase of 17%. This projected capacity increase excludes Chinese plants as any new volumes in China are not expected to reach global markets. There are a number of new capacity projects expected or underway in gas advantaged regions; however, increased construction costs and changes in market dynamics have delayed a number of such projects.

 

World trade in ammonia is expected to increase by 1.8 million tons or 8% in the period to 2015, according to Fertecon, representing more modest growth than seen from 2000 to 2005. Fertecon projects that higher gas costs for Russian and Ukrainian exporters and the lower relative gas price outlook for the U.S. would appear to support continued operating rates at the remaining U.S. ammonia capacity, limiting the near-term growth in ammonia imports.

 

Global grain inventories are currently at levels significantly below the ten-year average, and corn prices, which have been volatile in recent months, stand at $3.40 per bushel as of February 20, 2009

versus $4.98 per bushel one year prior. Both of these factors influence the outlook for demand for our products.

 

The emergence of ethanol as an alternative energy source has the potential to drive incremental fertilizer demand. Corn, the primary feedstock for U.S. ethanol production, represents approximately 40% of fertilizer demand in North America. New ethanol capacity is increasing demand for corn and, according to Fertecon, is expected to contribute to a forecasted 21 million hectare increase in planted corn area in the world by 2030. The amount of corn used in the U.S. for ethanol production has more than doubled in the last five years. In 2007-2008, approximately 3.0 billion bushels of corn were used for ethanol production. According to the USDA, a 22% increase is forecast for the current 2008-2009 crop year, bringing the total bushels used for ethanol to 3.7 billion. This number is projected to rise to almost 4.0 billion bushels by 2009-2010, equivalent to approximately 30% of the U.S. corn crop.

 

The 1990 Amendments to the Clean Air Act increasingly require companies that combust fossil fuels to reduce their emissions. Reduction of oxides of both nitrogen and sulfur are accomplished with Selective Catalytic Reduction (SCR) and wet scrubbing technologies. Environmental control devices using ammonia or ammonia based compounds, across a broad range of applications from coal based generation to diesel engines, are very effective in meeting emissions targets. Further, TET is establishing an infrastructure to serve the diesel engine transportation market. We believe these new and emerging markets may increase North American demand for ammonia by up to 1.0 million tons by 2010.

 

Seasonality and Volatility

 

The fertilizer business is highly seasonal, based upon the planting, growing and harvesting cycles. Nitrogen fertilizer inventories must be accumulated to permit uninterrupted customer deliveries, and require significant storage capacity. This seasonality generally results in higher fertilizer prices during peak consumption periods, with prices normally reaching their highest point in the spring, decreasing in the summer, and increasing again in the late fall/early winter period as depleted inventories are restored.

 

Nitrogen fertilizer prices can also be volatile as a result of a number of other factors. The most important of these factors are:

 

 

Governmental policies may directly or indirectly influence the number of acres planted, the level of grain inventories, the mix of crops planted and crop prices, as well as environmental demands.

Raw Materials

 

The principal raw material used to produce manufactured nitrogen products is natural gas.

 

 

 

Natural gas costs in 2008 accounted for approximately 50% of our total costs and expenses. Significant increases in natural gas costs that are not hedged or recovered through increased prices to customers would have an adverse impact on our business, financial condition and results. We believe there will be a sufficient supply of natural gas for the foreseeable future and we will, as opportunities present themselves, enter into firm transportation contracts to minimize the risk of interruption or curtailment of natural gas supplies during the peak-demand season. We use a combination of spot and term purchases of varied duration from a variety of suppliers to obtain natural gas supply.

 

We use derivative instruments to hedge a portion of our natural gas purchases. Our policy is designed to hedge exposure to natural gas price fluctuations for production required for estimated forward product sales commitments. We hedge natural gas prices through the use of supply contracts, financial derivatives and other instruments.

 

The settlement dates of forward-pricing contracts coincide with gas purchase dates as well as shipment periods on forward committed sales. Forward-pricing contracts are based on a specified price referenced to spot market prices or appropriate New York Mercantile Exchange (NYMEX) futures contract prices.

 

Point Lisas has a contract through 2018 to purchase natural gas from the National Gas Company of Trinidad and Tobago. The joint venture’s cost of natural gas has historically been significantly lower than U.S. natural gas costs, which historically has resulted in the joint venture being substantially more profitable than comparable North American ammonia only facilities.

 

Competition

 

The markets in which we operate are highly competitive. Competition in agricultural input markets takes place largely on the basis of price, supply reliability, delivery time and quality of service. Feedstock availability to production facilities and the cost and efficiency of production, transportation and storage facilities are also important competitive factors.

Government intervention in international trade can distort the competitive environment. The relative cost and availability of natural gas are also important competitive factors. Significant determinants of the competitive position of our plants are the natural gas acquisition and transportation contracts negotiated with our major suppliers as well as proximity to natural gas sources and/or end-users.

 

Our domestic competitors in the nitrogen fertilizer markets are primarily other independent fertilizer companies. Nitrogen fertilizers imported into the U.S. compete with domestically produced nitrogen fertilizers, including those we produce. Imports of nitrogen products represent approximately 56% of nitrogen used in North America. Some foreign competitors in countries with inexpensive sources of natural gas (whether as a result of government regulation or otherwise) can produce nitrogen fertilizers at a low cost. A substantial amount of new ammonia capacity is expected to be added abroad in the foreseeable future in countries with favored natural gas costs.

 

Credit

 

Our credit terms are generally 15-30 days, but may be extended for longer periods during certain sales seasons, consistent with industry practices.

 

Environmental and Other Regulatory Matters

 

Our U.S. operations are subject to various federal, state and local environmental, health and safety laws and regulations, including laws relating to air quality, hazardous or solid wastes and water quality. Our operations in Canada are subject to various federal and provincial regulations regarding such matters, including the Canadian Environmental Protection Act administered by Environment Canada, and the Ontario Environmental Protection Act administered by the Ontario Ministry of the Environment. All of our facilities require operating permits that are subject to review by governmental agencies. We are also involved in the manufacturing, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by federal, state, provincial or other regulatory agencies. We take precautions to reduce the likelihood of accidents involving these materials. If such materials have been or are disposed of at sites that are targeted for investigation and/or remediation by federal or state regulatory agencies, we may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) or analogous laws for all or part of the costs of such investigation and remediation, and damages to natural resources.

 

The State of Arizona designated Inspiration Consolidated Copper Company (ICCCo), one of our subsidiaries that disposed of its assets in a 1988 asset sale agreement (1988 Asset Sale Agreement) and no longer operates a business, as one of several potentially responsible parties (PRP) under the state Superfund law at the Pinal Creek Drainage Basin Site (Pinal Site) in Globe/Miami, Arizona. The Pinal Site generally consists of two separate properties, each a copper mining and production facility, one of which had been owned by ICCCo. The PRP designation was based upon ICCCo’s prior ownership and operation of one of the Pinal Site properties. Under state and federal Superfund laws, all PRPs may be jointly and severally liable for the costs of investigation and/or remediation of an environmentally impaired site regardless of fault or the legality of original disposals. The Pinal Site is the subject of ongoing investigation and cleanup to address groundwater releases of acidic metal-bearing solutions from past copper mining and production facilities. The remedial actions are governed by a 1997 consent decree (1997 Consent Decree) between the Arizona Department of Environmental Quality and the two current owners/operators of the copper mining and production facilities (one of whom is the successor to ICCCo’s buyer), both of whom the State also designated as PRPs, and ICCCo (collectively, the Group).

The two current owners/operators of the copper mining and production facilities have been jointly financing and performing the investigation and remediation work since the late 1980’s. ICCCo has been and will be indemnified by its buyer and the buyer’s successor for its share of the common costs under the terms of the 1988 Asset Sale Agreement and a subsequent April 2005 settlement agreement. The April 2005 settlement agreement further confirmed and documented that the buyer’s successor will indemnify ICCCo for its share of all past and future costs arising out of the 1997 Consent Decree, judicially determined claims against ICCCo arising out of the cost recovery suit discussed below, and ICCCo’s share of common counsel legal fees in conjunction with all these matters, as well as other matters described in the 1988 Asset Sale Agreement.

 

In 1991, the Group filed a cost recovery action against other former owners and operators of the two properties constituting the Pinal Site. A substantial portion of this litigation has been settled and resolved. The one principal unresolved issue is the allocation of liability between the two current owners/operators of the two copper mining and production facilities. As noted above, ICCCo is no longer actively involved in the cost recovery litigation since it is fully indemnified by the buyer’s successor under the terms of the April 2005 settlement agreement. More than a decade ago, residents in an area of the Pinal Site brought a class action lawsuit against the Group seeking property damages and medical monitoring for potential personal injuries allegedly related to the acidic, metal-bearing groundwater. The class action lawsuit was settled in September 2000, although plaintiffs reserved the right to assert personal injury claims individually. Pursuant to the terms of certain environmental indemnity provisions of the 1988 Asset Sale Agreement, ICCCo paid 50% of the September 2000 settlement agreement costs allocated to the former ICCCo copper mining and production facility. After consideration of such factors as the number of PRPs and the levels of financial responsibility, including the ongoing litigation and contractual indemnities, we believe our liability with respect to these matters will not be material.

 

We retained a small number (less than 10%) of our retail locations after the sale of our distribution business in 1999. Some of these locations are now, or are expected in the future to be, the subject of environmental clean-up activities for which we have retained liability. We do not believe that those environmental costs and liabilities will have a material effect on our results of operations, financial position or net cash flows. As of December 31, 2008, there were four remaining retail locations with which we were engaged in some level of environmental clean-up activities and/or monitoring. The total net cost associated with the former retail locations in 2009 and beyond (including environmental expenditures and proceeds from voluntary clean-up reimbursements and sale of properties) is not expected to exceed $0.5 million.

 

With respect to the Verdigris, Oklahoma facility, Freeport-McMoRan Resource Partners, Limited Partnership (a former owner and operator of the facility) retains liability for certain environmental matters. We retained certain liability for the pre-closing environmental condition of the Billingham and Severnside, England facilities in conjunction with the establishment of GrowHow joint venture in 2007. After ceasing production at the Severnside England facility on January 31, 2008, we commenced dismantling the facility and remediation of the site. Pursuant to the agreement with Kemira GrowHow Oyj (Kemira), our GrowHow partner, we are responsible for any remediation costs required to prepare the Severnside site for disposal. We anticipate remediation costs to be approximately $5.0 million to $10.0 million. We have an option to purchase the Severnside land for a nominal amount at any time prior to sale. If we elect not to exercise this option, we are still entitled to receive the sales proceeds. We anticipate that the proceeds related to the sale of the Severnside land would exceed the total cost of reclamation of the site.

We may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors, at certain facilities, such as our nitric acid facilities, to comply with applicable environmental requirements. Our capital expenditures related to environmental control in 2008, 2007 and 2006 were approximately $5.3 million, $2.5 million and $1.2 million, respectively. Projected environmental capital expenditures are $19.2 million for 2009, $7.7 million for 2010 and $3.9 million for 2011.

 

We endeavor to comply in all material respects with applicable environmental, health and safety regulations and we have incurred substantial costs in connection with this compliance. Because these laws and regulations are expected to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. We do not expect our compliance with these laws and regulations to have a material adverse effect on our results of operations, financial position or net cash flows. However, there can be no guarantee that new regulations will not result in material costs.

 

We believe that our policies and procedures now in effect are in compliance with applicable environmental laws and with the permits relating to the facilities in all material respects. However, in the normal course of our business, we are exposed to risks relating to possible releases of hazardous substances into the environment. Such releases could cause substantial damages or injuries. Although environmental expenditures have not been material during the past year, it is impossible to predict or quantify the impact of future environmental liabilities associated with releases of hazardous substances from our facilities. Such liabilities could have a material adverse impact on our results of operations, financial position or net cash flows.

 

Employees

 

We had 938 full-time employees at December 31, 2008.

 

Available Information

 

Terra was incorporated in Maryland in 1978 and is subject to the reporting requirements of the Securities Exchange Act of 1934 (the Exchange Act) and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). Copies of these reports, proxy statements and other information can be obtained from the SEC through the following site:

 

Office of Public Reference

100 F Street, NE

Room 1580

Washington, D.C. 20549-0102

 

Phone: (800) SEC-0330

Fax: (202) 777-1027

E-mail: publicinfo@sec.gov

 

The SEC maintains a Web site that contains reports, proxy statements and other information regarding issuers that file electronically with the SEC. These materials may be obtained electronically by accessing the SEC’s Web site at http://www.sec.gov.

 

We make available, free of charge on our Web site, our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable

after we electronically file these documents with, or furnish them to, the SEC. These documents are posted on our Web site at www.terraindustries.com.

 

We also make available, free of charge on our Web site, the charters of the Audit Committee, the Compensation Committee, and the Nominating and Corporate Governance Committee, as well as the Corporate Governance Guidelines of our Board of Directors (the Board) and our Code of Ethics and Standards of Business Conduct (including any amendment to, or waiver from, a provision of our Code of Ethics and Standards of Business Conduct) adopted by our Board. These documents are posted on our Web site at www.terraindustries.com.

 

Copies of any of these documents will also be made available, free of charge, upon written request to:

 

Terra Industries Inc.

Attention: Investor Relations

600 Fourth Street

P.O. Box 6000

Sioux City, Iowa 51102-6000

Phone: (712) 277-1340

 

In addition to the other information contained in this Form 10-K, the following risk factors should be considered carefully in evaluating our business. Our business, financial condition, or results of operations could be materially adversely affected by any of these risks. Please note that additional risks not presently known to us or that our management currently deems immaterial may also impair our business and operations.

 

A substantial portion of Terra’s operating expense is related to the cost of natural gas, and an increase in such cost that is either unexpected or not accompanied by increases in selling prices of products could result in reduced profit margins and lower product production.

 

The principal raw material used to produce nitrogen products is natural gas. Natural gas costs in 2008 comprised about 50% of total costs and expenses. A significant increase in the price of natural gas (which can be driven by, among other things, supply disruptions, governmental or regulatory actions, cold weather and oil price spikes) that is not hedged or recovered through an increase in the price of related nitrogen products could result in reduced profit margins and lower product production. We have previously idled one or more of our plants in response to high natural gas prices and may do so again in the future. A significant portion of our competitors’ global nitrogen production occurs at facilities with access to fixed-priced and/or product related natural gas supplies, similar to our gas supply contract in Trinidad. The natural gas costs for these competitors’ facilities have been and likely will continue to be substantially lower than our costs.

 

Declines in the prices of our products may reduce profit margins.

 

Prices for nitrogen products are influenced by the global supply and demand conditions for ammonia and other nitrogen-based products. Long-term demand is affected by population growth and rising living standards that determine food consumption. Short-term demand is affected by world economic conditions and international trade decisions. Supply is affected by increasing worldwide capacity and the increasing availability of nitrogen product exports from major producing regions such as the former Soviet Union, Canada, the Middle East, Trinidad and Venezuela. New global ammonia capacity is expected abroad in the foreseeable future. If this anticipated growth in new capacity exceeds the growth in demand, the price at which we sell our nitrogen products may decline, resulting in reduced profit margins, lower production of products and potential plant closures. Supply in the U.S. and Europe is also affected by trade regulatory measures, which restrict import supply into those markets. Changes in those measures would likely adversely impact available supply and pricing.

 

Our products are subject to price volatility resulting from periodic imbalances of supply and demand, which may cause the results of operations to fluctuate.

 

Historically, the prices for our products have reflected frequent changes in supply and demand conditions. Changes in supply result from capacity additions or reductions and from changes in inventory levels. Demand for products is dependent on demand for crop nutrients by the global agricultural industry and on the level of industrial production. Periods of high demand, high capacity utilization and increasing operating margins tend to result in new plant investment and increased production until supply exceeds demand, followed by periods of declining prices and declining capacity utilization until the cycle is repeated. In addition, markets for our products are affected by general economic conditions. As a result of periodic imbalances of supply and demand, product prices have been volatile, with frequent and significant price changes. During periods of oversupply, the price at

which we sell our products may be depressed and this could have a material adverse effect on our business, financial condition and results of operations.

 

Our products are global commodities and we face intense competition from other producers.

 

Our products are global commodities and can be subject to intense price competition from both domestic and foreign sources. Customers, including end-users, dealers and other crop-nutrient producers and distributors, base their purchasing decisions principally on the delivered price and availability of the product. We compete with a number of U.S. producers and producers in other countries, including state-owned and government-subsidized entities. The U.S. and the European Commission each have implemented trade regulatory measures which are designed to address this type of unfair trade. Changes in these measures could have an adverse impact on our sales and profitability of the particular products involved. Some of our principal competitors have greater total resources and are less dependent on earnings from nitrogen fertilizer sales. In addition, a portion of global production benefits from natural gas contracts that have been, and could continue to be, substantially lower priced than our natural gas. Our inability to compete successfully could result in the loss of customers, which could adversely affect sales and profitability.

 

Our business is subject to risks related to weather conditions.

 

Adverse weather conditions may have a significant effect on demand for the Company’s nitrogen products. Weather conditions that delay or intermittently disrupt field work during the planting and growing season may cause agricultural customers to use less or different forms of nitrogen fertilizer, which may adversely affect demand for the product that we sell. Weather conditions following harvest may delay or eliminate opportunities to apply fertilizer in the fall. Weather can also have an adverse effect on crop yields, which lowers the income of growers and could impair their ability to pay our customers.

 

Weather and/or weather forecasts can dramatically affect the price of natural gas, our main raw material. Colder than normal winters as well as warmer than normal summers increase the natural gas demand for residential use. Also, hurricanes affecting the gulf coastal states can severely impact the supply of natural gas and cause prices to rise sharply.

 

Our risk measurement and hedging activities might not prevent losses.

 

We manage commodity price risk for our businesses as a whole. Although we implemented risk measurement systems that use various methodologies to quantify the risk, these systems might not always be followed or might not always work as planned. Further, such risk measurement systems do not in themselves manage risk, and adverse changes involving volatility, adverse correlation of commodity prices and the liquidity of markets might still adversely affect earnings and cash flows, as well as the balance sheet under applicable accounting rules, even if risks have been identified. The ability to manage exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by limitations imposed by our bank agreement covenants.

 

In an effort to manage financial exposure related to commodity price and market fluctuations, we have entered into contracts to hedge certain risks associated with our business, its assets and operations. In these hedging activities, we have used fixed-price, forward, physical purchase and sales contracts, futures, financial swaps and option contracts traded in the over-the-counter markets or on exchanges. Nevertheless, no single hedging arrangement can adequately address all risks present in a given contract or industry. Therefore, unhedged risks will always continue to exist. We may not be able to

successfully manage all credit risk and as such, future cash flows could be impacted by counterparty default.

 

We are substantially dependent on our manufacturing facilities, and any operational disruption could result in a reduction of sales volumes and could cause us to incur substantial expenditures.

 

Our manufacturing operations may be subject to significant interruption if one or more of our facilities were to experience a major accident, equipment failure or were damaged by severe weather or other natural disaster. In addition, our operations are subject to hazards inherent in chemical manufacturing. Some of those hazards may cause personal injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. For example, an explosion at our Port Neal, Iowa facility in 1994 required us to rebuild nearly the entire facility, and a June 1, 2006 explosion shut down the ammonia production plant in Billingham, England until repairs were completed in August 2006. In addition, approximately four weeks of unplanned outages at our Point Lisas Nitrogen facility during the 2006 third quarter to repair failing heat exchangers were only partly successful and the plant operated at about 80% of capacity until replacement exchangers were installed during a scheduled turnaround in early 2007. Also, a mechanical outage at the Courtright, Ontario facility in April 2001 required us to shut down that facility for approximately two months. We currently maintain property insurance, including business interruption insurance, but we may not have sufficient coverage, or may be unable in the future to obtain sufficient coverage at reasonable costs.

 

We may be adversely affected by environmental laws or regulations to which we may be subject.

 

Our U.S., Canadian and U.K. operations and properties are subject to various federal, state and local environmental, safety and health laws and regulations, including laws relating to air quality, hazardous and solid materials and wastes, water quality, investigation and remediation of contamination, transportation and worker health and safety. We could incur substantial costs, including capital expenditures for equipment upgrades, fines and penalties and third-party claims for damages, as a result of compliance with, violations of or liabilities under environmental laws and regulations. We are also involved in the manufacturing, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by federal, state, provincial or other regulatory agencies. If such materials have been or are disposed of or released at sites that require investigation and/or remediation, Terra may be responsible under CERCLA, or analogous laws for all or part of the costs of such investigation and/or remediation, and for damages to natural resources. Under some of these laws, responsible parties may be held jointly and severally liable for such costs, regardless of fault or the legality of the original disposal or release.

 

We have liability as a “potentially responsible party” at certain sites under certain environmental remediation laws, and have also been subject to related claims by private parties alleging property damage and possible personal injury arising from contamination relating to active as well as discontinued operations. We may be subject to additional liability or additional claims in the future. Some of these matters may require expenditure of significant amounts for investigation and/or cleanup or other costs.

 

We may be required to install additional pollution control equipment at certain facilities in order to maintain compliance with applicable environmental requirements.

 

Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at ongoing operations. We may be required to install additional air and water quality control equipment, such as low emission burners, scrubbers,

ammonia sensors and continuous emission monitors, at certain of our facilities in order to comply with applicable environmental requirements. Such investments would reduce income from future operations. Present and future environmental laws and regulations applicable to operations, more vigorous enforcement policies and discovery of unknown conditions may require substantial expenditures and may have a material adverse effect on results of operations, financial position or net cash flows.

 

Government regulation and agricultural policy may reduce the demand for our products.

 

Existing and future government regulations and laws may reduce the demand for our products. Existing and future agricultural and/or environmental laws and regulations may impact the amounts and locations of fertilizer application and may lead to decreases in the quantity of nitrogen fertilizer applied to crops. Changes in U.S. energy policies may affect the demand for our nitrogen products. Any such decrease in the demand for fertilizer products could result in lower unit sales and lower selling prices for nitrogen fertilizer products. U.S. and E.U. governmental policies affecting the number of acres planted, the level of grain inventories, the mix of crops planted and crop prices could also affect the demand and selling prices of our products. In addition, we manufacture and sell ammonium nitrate (AN) in the U.S., and in the U.K. through our GrowHow joint venture. Ammonium nitrate can be used as an explosive and was used in the Oklahoma City bombing in April 1995. It is possible that either the U.S. or U.K. governments could impose limitations on the use, sale or distribution of AN, thereby limiting our ability to manufacture or sell this product.

 

We are subject to risks associated with international operations.

 

Our international business operations are subject to numerous risks and uncertainties, including difficulties and costs associated with complying with a wide variety of complex laws, treaties and regulations; unexpected changes in regulatory environments; currency fluctuations; tax rates that may exceed those in the U.S.; earnings that may be subject to withholding requirements; and the imposition of tariffs, exchange controls or other restrictions. During 2008, we derived approximately 19% of our net sales from outside of the U.S. Terra’s business operations include a 50% interest in an ammonia production joint venture in the Republic of Trinidad and Tobago and a 50% interest in a U.K. joint venture for the production of ammonia, and a 50% interest in an ammonia shipping joint venture that provides transportation of ammonia from the Trinidad facility to the U.S. and other world markets.

 

Our business may be adversely impacted by our leverage, which may require the use of a substantial portion of excess cash flow to service debt and may limit our access to additional capital.

 

Our debt could have important consequences on our business. For example, it could (i) increase our vulnerability to adverse economic and industry conditions by limiting flexibility in reacting to changes in the business industry, (ii) reduce our cash flow available to fund working capital, capital expenditures and other general corporate purposes, (iii) place us at a competitive disadvantage compared to competitors that have less leverage and (iv) limit our ability to borrow additional funds and increase the cost of funds that we can borrow. We may not be able to reduce financial leverage when we choose to do so, and may not be able to raise capital to fund growth opportunities.

 

We may be unable to refinance our debt upon a change of control.

 

In the event that we experience a “change of control” (as defined in our bond indenture and the instruments governing our Series A Cumulative Convertible Perpetual Preferred Shares (Series A Preferred Shares)), we may need to refinance large amounts of debt. If a change of control occurs, we must offer to buy back the notes under our indenture governing the 7% senior notes due 2017 and the Series A Preferred Shares for a price equal to 101% of the notes’ principal amount or 100% of the

liquidation value of the Series A Preferred Shares, as applicable, plus any interest or dividends which have accrued and remain unpaid as of the repurchase date. There can be no assurance that there will be sufficient funds available for any repurchases that could be required by a change of control.

 

Additionally, under our revolving credit facilities, a change of control will occur if, among other such things, an individual or group acquires more than 35% of the outstanding voting shares of Terra. Such a change of control would constitute an event of default under the credit facilities. If such change of control was to occur, we may not have the ability to replace our current revolving credit facility on terms equal to or more favorable than current terms.

 

CF’s exchange offer to purchase all of our outstanding common stock may be disruptive to our business and threatens to adversely affect the Company’s operations and results.

 

On February 23, 2009, CF Industries Holdings, Inc. commenced an exchange offer to purchase all of our outstanding common stock (the CF Offer). The CF Offer expires on May 15, 2009. The uncertainty regarding the outcome of the CF Offer may disrupt our business which could result in an adverse effect on our operating results.

 

Responding to the CF Offer has been, and may continue to be, a distraction for our management and employees and has required and may continue to require us to incur significant costs. Management and employee distraction related to the CF Offer also may adversely impact our ability to optimally conduct our business and pursue our strategic objectives.

 

None.

 

Terra’s North American manufacturing facilities and its joint venture manufacturing facilities, in which Terra owns a 50% interest, are designed to operate continuously, except for planned shutdowns (usually biennial) for maintenance and efficiency improvements. Capacity utilization (gross tons produced divided by capacity tons at expected operating rates and on-stream factors) of the nitrogen products manufacturing facilities was approximately 100%, 98% and 83% in 2008, 2007 and 2006, respectively.

 

Terra owns all of its manufacturing facilities, unless otherwise indicated below.

 

Our facilities have the following production capacities:

 

North America

 

 

Donaldsonville, Louisiana. The Donaldsonville facility is located on approximately 766 acres fronting the Mississippi River and, in 2004, included two ammonia plants, a urea plant and two melamine crystal production plants. During 2006 all of these plants, except for one ammonia plant, were

decommissioned and sold for parts or scrap. The remaining ammonia plant which had been idled was restarted in the third quarter of 2008. The facility contains a deep-water port facility on the Mississippi River, allowing for barge transportation and making Donaldsonville one of the northernmost points on the river capable of receiving economical ocean-going vessels.

 

Port Neal, Iowa. The Port Neal facility is located on approximately 120 acres 12 miles south of Sioux City, Iowa on the Missouri River. The facility consists of an ammonia plant, two urea plants, two nitric acid plants and a UAN plant.

 

Verdigris, Oklahoma. The Verdigris facility is located on 650 acres northeast of Tulsa, Oklahoma, near the Verdigris River. It is the second largest UAN production facility in North America. The facility comprises two ammonia plants, two nitric acid plants, two UAN plants and a port terminal. Terra owns the plants and leases the port terminal from the Tulsa-Rogers County Port Authority.

 

Woodward, Oklahoma. The Woodward facility is located on approximately 450 acres in rural northwest Oklahoma and consists of an integrated ammonia/methanol plant, a nitric acid plant, a urea plant and a UAN plant.

 

Yazoo City, Mississippi. The Yazoo City facility is located on approximately 2,240 acres in Yazoo County, Mississippi with approximately 60 acres of such land subject to a long-term lease with Yazoo County. The facility includes one ammonia plant, four nitric acid plants, an AN plant, two urea plants, a UAN plant and a dinitrogen tetroxide production and storage facility.

 

Courtright, Ontario, Canada. The Courtright facility is located on 700 acres south of Sarnia, Ontario near the St. Clair River. The facility consists of one ammonia plant, a UAN plant, a nitric acid plant and one urea plant.

 

Joint Ventures

 

 

 

Billingham, U.K. The Billingham facility, located in the Teesside chemical area, is geographically split among three separate areas: the main site contains an ammonia plant, three nitric acid plants and a carbon dioxide plant; the Portrack site approximately two miles away contains an AN fertilizer plant; and the north Tees site approximately five miles away has ammonia storage which GrowHow operates under a 99-year lease with a third-party and import/export facility that GrowHow uses under license from the Crown and under an agreement with a third-party operator. The Billingham facility is owned by GrowHow.

Ince, U.K. The Ince facility is located in northwestern England and is owned by GrowHow. The facility consists of one ammonia plant, three nitric acid plants, an AN plant and three fertilizer compound plants.

 

Point Lisas, Trinidad. The Point Lisas Nitrogen facility in the Republic of Trinidad and Tobago is owned by a 50/50 joint venture with KNC Trinidad Limited. This facility has the capacity to produce annually 720,000 tons of ammonia from natural gas supplied under contract with the National Gas Company of Trinidad and Tobago.

 

 

From time to time, we are involved in claims, disputes, administrative proceedings and litigation, arising in the ordinary course of business. We do not believe that the matters in which we are currently involved, either individually or in the aggregate, will have a material adverse effect on our business, results of operations, financial position or net cash flows.

 

No matters were submitted to a vote of our security holders during the fourth quarter of 2008.

 

The following sets forth the name, age and offices of each present executive officer of Terra, the period during which each executive officer has served as such and each executive officer’s business experience during the past five years:

 

 

Except for any employment described above with TNGP (or its predecessor), the General Partner of TNCLP, which is an indirect subsidiary of Terra, no occupation carried on by any executive officer of Terra during the past five years as described above was carried on with any corporation or organization that is a parent, subsidiary or other affiliate of Terra. There are no family relationships among the executive officers and directors of Terra or arrangements or understandings between any executive officer and any other person pursuant to which any executive officer was selected as such. Officers of Terra are elected annually to serve until their respective successors are elected and qualified.

 

 

Terra’s common shares are traded on the New York Stock Exchange (NYSE) under the symbol “TRA”. Set forth below are the high and low sales prices of Terra’s common shares during each quarter specified as reported on the NYSE.

 

 

As of February 27, 2009 there were approximately 5,683 record holders of Terra’s common stock.

 

On May 6, 2008 Terra’s Board of Directors declared a dividend of $0.10 per share for every share of the Company’s common stock outstanding on May 19, 2008, payable on June 3, 2008. Subsequent dividends of $0.10 per share for each share of the Company’s common stock were declared on July 16, 2008 for shares of the Company’s common stock outstanding on August 25, 2008, payable on September 12, 2008, and declared on October 15, 2008 for shares of the Company’s common stock outstanding on November 24, 2008, payable on December 12, 2008, and declared on February 10, 2009, for shares of the Company’s common stock outstanding on March 18, 2009, payable on April 7, 2009. No dividends were declared or paid during 2007. Future dividends are necessarily dependent upon future earnings, capital requirements, general financial condition, general business conditions, approval from our Board of Directors and other factors.

Performance Graph

 

A comparative performance graph is to be included with our annual report to security holders that accompanies or precedes a proxy or information statement relating to an annual meeting of security holders at which directors are to be elected. A line-graph presentation is required, comparing cumulative, indexed, five-year stockholder returns on specified, hypothetical investments. These investments must include the S&P 500 Stock Index and either a nationally recognized industry standard or an index of peer companies selected by Terra.

 

 

The “Annual Return Percentage” table below illustrates the annual returns realized in each of the years from 2004 through 2008 on hypothetical investments in Terra, the S&P 500 Stock Index and Terra’s industry peer group.

 

 

The “Indexed Annual Returns” table assumes three investments of $100 at the close of the last trading day in 2003, and follows these investments through the subsequent five years. The three investments are in Terra common shares, the S&P 500 Stock Index, and Terra’s industry peer group.

 

Terra has for some years chosen to use a self-selected industry peer group. In the graph and table above, companies in Terra’s self-selected industry peer group manufacture commodity chemicals (including chemicals other than nitrogen products and methanol) and have market caps similar to Terra’s. The current peer group consists of the following companies: Agrium, Inc., Celanese AG, CF Industries Holdings, Inc., Cytec Industries, Inc., Georgia Gulf Corporation, Huntsman Chemical, Methanex Corporation, Millennium Chemicals Inc., Mosaic, NOVA Chemicals Corp., Potash Corporation of Saskatchewan Inc., TNCLP, and Yara International ASA.

 

Company Purchases of Equity Securities

 

On May 6, 2008, the Board of Directors authorized us to repurchase a maximum of 12,841,717 shares of our outstanding common stock. The stock buyback program has been and will be conducted on the open market, in private transactions or otherwise at such times prior to June 30, 2010, and at such prices as determined appropriate by us. During 2008, we repurchased 5,393,055 common shares at an average per share price of $29.20. The remaining number of common shares that we are authorized to repurchase is 7,448,662 at December 31, 2008.

 

The calculation of the average price paid per share does not include the effect for any fees, commissions or other costs associated with the repurchase of such shares.

 

The following table provides information about share repurchases by us during 2008.

 

 

The calculation of the average price paid per share does not include the effect for any fees, commissions or other costs associated with the repurchase of such shares.

 

On August 20, 2008, our Board of Directors authorized us to make cash payments to holders of our 4.25% Series A Cumulative Convertible Perpetual Preferred Shares (Series A Preferred Shares), a total of which 120,000 shares were then outstanding, in order to induce such holders of Series A Preferred Shares to convert such Series A Preferred Shares to common stock of the Company. As a result of such action, a total of 118,400 Series A Preferred Shares were converted into 11,887,550 shares of the Company’s common stock at a cash premium of $5.3 million.

 

The following table presents our selected financial data. The table should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K. Certain prior-year amounts have been reclassified to conform to the current-year presentation. In 2008, we declared our Beaumont methanol plant as discontinued operations. All fiscal years present reflect the classification of Beaumont’s financial results as discontinued operations.

 

 

 

 

Overview

 

As you read this management’s discussion and analysis of financial condition and results of operations, you should refer to our Consolidated Financial Statements and related Notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Introduction

 

In this discussion and analysis, we explain our business in the following areas:

 

 

Business Strategy

 

We are a leading North American producer and marketer of nitrogen products made from natural gas. Terra is the largest producer of ammonia in the United States and the second largest producer in North America. We also operate production assets in Trinidad and Tobago, and the United Kingdom, through joint venture agreements. Our six North American and two international production locations, along with a robust distribution capability, provide us with the ability to effectively serve key agricultural, industrial and environmental markets. Terra has an extensive history of operating as a public entity and managing complex corporate structures including master limited partnerships, joint ventures and corporate alliances. In fact, since the 1980’s, Terra has successfully integrated numerous large-scale value-enhancing acquisitions that have contributed to our track record of strong cash flows over the business cycle.

 

Regarding the business cycle, the nitrogen products industry in which Terra operates has periods of oversupply during industry downturns that lead to capacity shutdowns or curtailments at the least cost-effective plants. These shutdowns may be followed by supply shortages that result in higher selling prices and higher industry-wide production rates during any subsequent industry upturns. Higher selling prices can encourage capacity additions that ultimately lead to an oversupply of product, and the cycle repeats.

 

Successful companies in cyclical businesses, like nitrogen products, pursue conservative capital management and investments strategies. This enables them to weather industry downturns and continue to effectively serve their target markets cost-effectively throughout the business cycle.

 

Our business strategy seeks to pursue profitable growth in the core, nitrogen-based agricultural products business as a scale operator in North America. We also seek to leverage our current business and manufacturing strength outside the core business in closely-adjacent market segments that help to

assure long-term cash flow growth and tend to reduce volatility in earnings. Elements of this strategy include:

 

 

Recent Business Environment

 

The following factors are the key drivers of our profitability: nitrogen products selling prices, as determined primarily by the global nitrogen demand/supply balance; and natural gas costs, particularly in North American markets.

 

Demand

 

Nitrogen products demand is driven by a growing global population, its desire for a higher-protein diet and to a lesser degree, by the rise of corn-consuming biofuels in North America. Current market conditions highlighted by very strong commodity grain prices are making yields realized at harvest—rather than dollars spent on inputs per acre of crop—the grower’s primary concern. Since nitrogen products can sometimes substitute for one another, a grower in these circumstances appreciates the greater application flexibility of upgraded products since it gives him a larger window of opportunity to get nitrogen on his crops and encourages a higher yield. While upgraded products contain less nitrogen by weight, they are generally easier to ship, store and apply than ammonia. In today’s market environment, upgraded products, and UAN in particular, are realizing significant premiums over ammonia as a nitrogen source. This should remain the case for as long as commodity grain prices hold strong.

 

Supply

 

Imports are a major factor in the nitrogen products supply picture, as they account for over half of the total North American nitrogen supply, with the levels varying among the various products. Products containing the highest percentage of nitrogen by weight are the most economical to ship, thus make up the greatest share of those imports. Most producers exporting nitrogen products into North America can afford to do so because they are manufacturing product with cheaper gas than that which is available to North American producers. European and Commonwealth of Independent States (CIS) producers have their own variable gas cost dynamics and we do not expect these producers will be able to consistently export nitrogen products at lower costs than North American producers.

 

Natural Gas Costs

 

North American natural gas markets have been volatile for a number of years. From 2000 to 2005, European and CIS countries had lower natural gas costs than North America. During the industry

downturn of those years, North American producers—having the highest cost basis—were the marginal producers, and many North American producers shut down capacity or went out of business altogether. North American volatility returned in 2008, with natural gas prices rising significantly in the first and second quarters while declining dramatically in the third and fourth quarters. Based on projected net increases in natural gas supply for most of 2009, we expect moderate North American natural gas prices, enabling us to remain competitive with global producers. We also believe our geographic plant positions in Oklahoma and Iowa provide us with a favorable delivered gas cost basis as compared to our Gulf Coast competitors.

 

The following is the average NYMEX forward natural gas price for the succeeding twelve month period noted for the respective dates:

 

 

As shown in the table above, the forward natural gas price for the succeeding twelve month periods have been volatile in 2008. The first half of 2008 experienced a 69% increase in the forward natural gas price from $7.81 per million British thermal units (MMBtu) at December 31, 2007 to $13.22 per MMBtu at June 30, 2008. The second half of 2008 experienced a 54% decline in the forward natural gas price from $13.22 per MMBtu at June 30, 2008 to $6.09 per MMBtu on December 2008.

 

Strategy Effectiveness

 

By executing the business strategies discussed above through 2008, we were able to:

 

Results of Operations

 

Consolidated Results

 

We reported 2008 net income of $641.0 million on revenues of $2.9 billion compared with 2007 net income of $201.9 million on revenues of $2.3 billion. The increase in net income and revenue is due to higher sales prices. The 2007 net income includes a $38.8 million early retirement of debt charge and a $39.0 million impairment charge. Diluted income per share for 2008 was $6.20 compared with $1.90 for 2007.

 

The following table shows the results of operation for the three years ended December 31, 2008, 2007 and 2006 (certain percentages that are not considered to be meaningful are represented by “NM”):

 

The following table shows North American volumes and prices for the three years ended 2008, 2007 and 2006:

 

 

 

Results of Operations—2008 Compared with 2007

 

Our net sales for 2008 increased by 23% to $2.9 billion from $2.3 billion in 2007. The increase in net sales was primarily attributable to higher sales prices across all products resulting from strong nitrogen demand driven by high commodity grain prices. Specifically, 2008 ammonia, UAN and AN pricing were 64%, 48% and 38%, respectively, above 2007 price levels. Volumes for ammonia and UAN were down 5% and 4%, respectively, compared to 2007 due to light nitrogen demand in the fourth quarter, while AN volumes were unchanged. Net sales in 2007 included $319.1 million from U.K. operations which were contributed into the GrowHow UK Limited joint venture (GrowHow) during the 2007 third quarter and its 2008 results are classified as non-operating equity earnings.

 

Our gross margin was $863.2 million in 2008 compared to $527.5 in 2007 and increased as a percentage of sales to 29.9% from 22.5%. The gross margin percentage improvement for 2008 reflects price increases more than offsetting our increase in natural gas costs. For the year, natural gas unit costs, net of forward pricing gains and losses, increased by 32% from $7.08 per MMBtu in 2007 to $9.33 per MMBtu in 2008. We enter into forward sales commitments by utilizing forward pricing and prepayment programs with customers. We use derivative instruments to hedge a portion of our natural gas requirements. The use of these derivative instruments is designed to hedge exposure to natural gas price fluctuations for production required for forward sales estimates. As a result of forward price contracts, 2008 natural gas costs were $134.0 million higher than spot prices, as compared to 2007 natural gas costs which were $53.3 million higher than spot prices.

 

Primarily due to market price declines, we recorded an inventory valuation charge to cost of sales of $17.4 million for the fourth quarter 2008. For additional information regarding our accounting policy on inventory valuation, see Note 1, Summary of Significant Accounting Policies, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Due to a significant decline in fertilizer demand during late 2008, we decided to temporarily halt production at our Donaldsonville, Louisiana and Woodward, Oklahoma facilities. We recorded a charge of $16.5 million to cost of sales representing the fair value carried in accumulated other comprehensive income (loss) of related derivative contracts because these contracts no longer qualify under hedge accounting. In addition, we recorded a $16.0 million charge to cost of sales representing a portion of fair value carried in accumulated other comprehensive income for those contracts that we determined would not result in production costs that would support reasonably profitable operations.

 

Discontinued Operations

 

We have reported our Beaumont, Texas methanol operations as discontinued operations for the years ending December 31, 2008 and 2007. The Beaumont operations were included in our methanol segment in prior years. In connection with reporting discontinued operations, we have determined that our methanol segment no longer meets the requirements of a reporting segment.

 

During the third quarter of 2007 we recorded an asset impairment charge of $39.0 million related to the Beaumont asset. We also recorded revenue of $12.0 million pursuant to a contractual agreement with the Methanex Corporation for each of the years ending December 31, 2008 and 2007.

 

Selling, General and Administrative Costs

 

Selling, general and administrative costs decreased $21.2 million primarily due to lower share-based compensation expense and U.K. operations included within 2007 results, offset by increases in salary and wages due to headcount increases in 2008 and professional services.

Equity Earnings of Unconsolidated Affiliates—North America

 

We recorded income of $56.2 million from our North American equity investments in 2008 as compared to $16.2 million in 2007. In addition, we also received cash distributions of $72.8 million from our North American equity investments in 2008 as compared to $29.5 in 2007. Our North American joint ventures benefited from strong market demand in 2008 which drove pricing increases.

 

Equity Earnings of Unconsolidated Affiliates—GrowHow

 

We recorded income of $95.6 million from GrowHow in 2008 as compared to a loss of $2.7 million in 2007. We received a contribution settlement payment and a balancing consideration payment from GrowHow of $27.4 million and $61.3 million, respectively, in 2008. Our U.K. operations were contributed into GrowHow on September 14, 2007, therefore 2007 results only include the period from formation through December 31, 2007. The joint venture benefited from strong market demand in 2008 which drove pricing increases. Additionally, the continued relative strength of the British pound provided favorable foreign exchange translation.

 

Minority Interest

 

Minority interest represents third-party interests in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2008 and 2007 amounts are directly related to TNCLP earnings and losses. During 2008, the cumulative shortfall of the Minimum Quarterly Distribution was satisfied which entitled us to increased income allocations as provided for in the TNCLP Partnership Agreement. The 2008 minority interest balance reflects the impact of these adjusted income allocations. Our increased income allocation attributed to our General Partner interest was $36.6 million in the year ended December 31, 2008. Minority interest expense was $67.7 million in 2008 and $50.3 million in 2007.

 

Income Taxes

 

Our income tax expense in 2008 and 2007 was $239.9 million and $127.3 million, respectively. The 2008 effective rate was 27.5%, compared to 36.6% in 2007. Our effective tax rate reflects tax benefits derived from operations outside the U.S. which are generally taxed at rates lower than the U.S. federal statutory rate of 35%.

 

The tax provision rate for 2008 includes a benefit of approximately $33.3 million related to a fourth quarter 2008 intercompany restructuring of our foreign operations into a global holding company structure. Terra’s effective tax rate also reflects tax credits primarily related to the Woodward, Oklahoma UAN upgrade project. The 2008 benefit recorded from current tax credit usage is approximately $19.5 million. Also during 2008, Terra completed its evaluation of the domestic manufacturer’s deduction provision of the American Jobs Creation Act of 2004 and recorded a benefit of approximately $13.3 million as a result of qualifying production activity income derived in the U.S.

 

For a full reconciliation of our effective tax rate to the U.S. federal and state statutory rates and further explanation of our provision for income taxes, see Note 20, Income Taxes, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Results of Operations—2007 Compared with 2006

 

Our net sales increased by $523.2 million to $2.3 billion for 2007 compared to $1.8 billion for 2006. The increase was primarily due to increased nitrogen prices and increased sales quantities for ammonia,

UAN and AN. Demand for nitrogen products increased due to higher production of key commodities, including corn and wheat, in response to higher prices.

 

Our gross margin increased by $409.0 million to $527.5 million for 2007, compared to $118.5 million for 2006. The increase in gross margin was primarily due to a $285.3 million increase in sales prices, a $75.3 million increase in sales volumes and lower natural gas unit costs.

 

Natural gas unit costs, net of forward pricing gains and losses, were $7.08 per MMBtu during 2007, compared to $7.03 per MMBtu during 2006. We enter into forward sales commitments by utilizing forward pricing and prepayment programs with customers. We use derivative instruments to hedge a portion of our natural gas requirements. The use of these derivative instruments is designed to hedge exposure to natural gas price fluctuations for production required for forward sales estimates. As a result of forward price contracts, 2007 natural gas costs for the nitrogen products segment were $53.3 million higher than spot prices, as compared to 2006 natural gas costs which were $50.3 million higher than spot prices.

 

Selling, General and Administrative Costs

 

Selling, general and administrative costs increased $23.6 million primarily due to higher share-based compensation expense due to the increases in our financial performance and stock price during 2007.

 

Equity Earnings of Unconsolidated Affiliates—North America

 

We recorded income of $16.2 million from our North American equity investments in 2007 as compared to $17.0 million in 2006. In addition, we also received cash distributions of $29.5 million from our North American equity investments in 2008 as compared to $35.9 million in 2007.

 

Equity Earnings of Unconsolidated Affiliates—GrowHow

 

We recorded a loss of $2.7 million from GrowHow during 2007. We did not receive any cash consideration from GrowHow in 2007. The equity earnings are classified as non-operating and excluded from income from operation as the investees’ operations do not provide additional capacity nor are the joint venture’s operations integrated with our North American supply chain. Included in the loss is approximately $13.0 million related to severance and other charges from the announced closure of the Severnside production facility and administrative operations.

 

Interest Income

 

Our interest income increased by $10.8 million in 2007 as compared to 2006. The increase is due to higher levels of cash throughout 2007.

 

Interest Expense and Loss on Early Retirement of Debt

 

Our interest expense decreased $18.9 million in 2007 to $29.1 million as compared to $48.0 million in 2006. The decrease in interest expense is due to the debt refinancing that we completed in February 2007. As a result of the debt refinancing, we recorded a $38.8 million charge for the early retirement of our bonds due in 2008 and 2010.

 

Income Taxes

 

Our income tax expense in 2007 and 2006 was $127.3 million and $9.6 million, respectively. The 2007 effective tax rate was 36.6%, compared to 76.1% in 2006. The 2006 effective tax rate differed from the statutory rate due primarily to the effect of currency fluctuations and disallowed interest expense on intercompany loans to non-U.S. subsidiaries.

Liquidity and Capital Resources

 

Summary

 

Our primary uses of cash and cash equivalents were to fund our working capital requirements, make payments for plant turnarounds and capital expenditures, repurchase our common stock under the share repurchase program, make distributions to minority interests, and fund a common stock dividend. The principal sources of funds were cash flows from operations and funds received from GrowHow, our 50% owned joint venture, and proceeds from the sale of the Beaumont, Texas facility. Cash and cash equivalent balances at December 31, 2008 were $966.7 million. During 2008, cash and cash equivalents increased $268.5 million.

 

Our cash equivalents included $755.5 million invested in money market mutual funds, all of which participate in the U.S. Treasury Money Markey Fund Guarantee Program, which was extended to April 30, 2009. There are no withdrawal restrictions on any of these funds. The remaining cash equivalents were invested in obligations of highly-rated financial institutions with an average weighted maturity of approximately 11 days.

 

Cash Flows

 

The following table summarizes our cash flows from operating, investing and financing activities for each of the past three fiscal years ($ in millions):

 

 

Operating Activities

 

Our cash flows from operating activities were $483.1 million during 2008. The $483.1 million is comprised of $743.9 million from operations offset by $260.8 million from changes in our working capital accounts. The $743.9 million includes $641.0 million of net income, adjusted for non-cash expenses. The significant non-cash expenses that we incurred include $78.9 million of depreciation of property, plant and equipment and amortization of deferred plant turnaround costs; $67.7 million of minority interest; and $39.8 million of loss on derivatives; offset by $95.6 million of equity earnings from GrowHow and $15.2 million of deferred income taxes.

 

Included in the December 31, 2008 cash and cash equivalents balance of $966.7 million is $111.6 million of customer prepayments for the selling price and delivery costs of products that we expect to ship during the first half of 2009, as compared to the December 31, 2007 cash and cash equivalents balance of $698.2 which included $299.4 million in customer prepayments.

 

Investing Activities

 

Our cash flows from investing activities were $51.6 million during 2008. The primary sources of cash were related to the balancing consideration payment and contribution settlement from GrowHow of $61.3 million and $27.4 million, respectively. We also received $41.9 million from discontinued operations for the completed sale of the Beaumont, Texas facility to Eastman Chemical Company on

December 31, 2008. The primary uses were related to $79.2 million of property, plant and equipment purchases for our operations and $10.1 million for turnaround activities.

 

Financing Activities

 

Our financing activities used cash of $262.2 million during 2008. The primary uses were $157.5 million to repurchase our common stock under our stock repurchase plan; $69.6 million of distributions to the minority interest holders of TNCLP; and $28.3 million for dividends paid to the holders of common stock.

 

Long-term Debt and Revolving Credit Facilities

 

During 2007, we completed a debt refinancing whereby we issued $330 million of 7% unsecured senior notes due 2017. These proceeds were used to redeem $200.0 million of 127/8% senior secured notes and $131.3 million of 111/2% second priority senior secured notes due 2010.

 

In connection with the debt refinancing, we extended the term of our revolving credit facilities (facilities) through 2012. Borrowing availability under the facilities is generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible inventory, less outstanding letters of credit. These facilities include $50 million solely dedicated for the use of TNCLP, one of our consolidated subsidiaries.

 

At December 31, 2008, there were no outstanding revolving credit borrowings and there were $6.6 million in outstanding letters of credit, resulting in remaining borrowing availability of approximately $193.4 million under the facilities. We are required to maintain a combined minimum unused borrowing availability of $30 million. The facilities also require that we adhere to certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. In addition, if our borrowing availability falls below a combined $60 million, we are required to have generated $60 million of operating cash flows, or earnings before interest, income taxes, depreciation, amortization and other non-cash items (as defined in the facilities) for the preceding four quarters. The facilities also require that there be no change of control related to Terra, such that no individual or group acquires more than 35% of the outstanding voting shares of Terra. Such change of control would constitute an event of default under the facilities.

 

Our ability to meet facilities covenants will depend on future operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to meet these covenants could result in additional costs and fees to amend the facilities or could result in termination of the facilities. Access to adequate bank facilities may be required to fund our need to build inventories during the second half of the year in order the ensure product availability during the peak sales season. We believe that our facilities are adequate for expected 2009 sales levels.

 

In addition, our ability to manage our exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by our ability to obtain sufficient credit terms. For additional information regarding commodity price risk, see Item 7A, Quantitative and Qualitative Disclosures about Market Risk.

 

Based on our December 31, 2008 financial position and the current market conditions for our finished products and for natural gas, we anticipate that we will be able to comply with our covenants through 2009.

Preferred Shares and Common Stock

 

We have 4.25% Cumulative Convertible Perpetual Series A Preferred Shares (Series A Preferred Shares) with a liquidation value of $1.6 million outstanding at December 31, 2008. The Series A Preferred Shares are not redeemable, but are convertible into common stock at a conversion price of $9.96 per common share at the option of the holder. These Series A Preferred Shares may, at our option, be automatically converted to common shares after December 20, 2009 if the closing price for common shares exceeds 140% of the conversion price for any twenty days within a consecutive thirty day period prior to such a conversion. Upon the occurrence of a fundamental change to our capital structure, including a change of control, merger, or sale of Terra, holders of the Series A Preferred Shares may require us to purchase any or all of their shares at a price equal to their liquidation value plus any accumulated, but unpaid, dividends. We also have the right, under certain conditions, to require holders of the Series A Preferred Shares to exchange their shares for convertible subordinated debentures with similar terms.

 

On August 20, 2008, our Board of Directors authorized us to make cash payments to holders of our Series A Preferred Shares, a total of which 120,000 shares were then outstanding, in order to induce such holders of Series A Preferred Shares to convert such Series A Preferred Shares to common stock of the Company. As a result of such action, a total of 118,400 Series A Preferred Shares were converted into 11,887,550 shares of the Company’s common stock during 2008 at a cash premium of $5.3 million.

 

During 2008, 2007 and 2006 we paid $3.9 million, $5.1 million and $5.1 million, respectively, for preferred share dividends. We paid $28.3 million in common share dividends in 2008. There were no common share dividends paid in 2007 or 2006.

 

Share Repurchases

 

In May 2008, the Board authorized the repurchase of 10 million shares and carries over the balance of 2.8 million unpurchased shares from the prior program, for a total authorization of approximately 12.8 million shares, representing approximately 14% of our then outstanding common stock, on the open market in private transactions or otherwise. During 2008, the repurchases under the stock buyback programs were:

 

 

Capital Expenditures

 

During 2008 and 2007, we funded plant and equipment purchases of $79.2 million and $31.7 million, respectively. Our 2008 capital expenditures were primarily for replacement or sustaining capital needs. The 2008 capital expenditures included $18.6 million related to the restart of the Donaldsonville, Louisiana facility. In April of 2008, we announced plans to expand the upgrading capacity at our

Woodward, Oklahoma nitrogen manufacturing facility. We expect the project to cost $180.0 million and to be completed by the end of 2010. During 2008, capital expenditures related to the expansion were $13.0 million.

 

We expect 2009 plant and equipment purchases to approximate $170-175 million consisting primarily of $65-70 million in expenditures for replacement of equipment or to improve operating results at our manufacturing facilities and approximately $105 million for the expansion of our Woodward, Oklahoma facility.

 

Plant turnaround costs represent cash used for the periodic scheduled major maintenance of our continuous process production facilities that is performed at each plant, generally every two years. We funded $10.1 million and $50.7 million of plant turnaround costs in 2008 and 2007, respectively. We estimate 2009 plant turnaround costs will approximate $20-25 million.

 

Off-Balance Sheet Transactions

 

We have leases for equipment, railcars and production, office and storage facilities. These leases are accounted for as operating leases. The assets and liabilities associated with the operating leases are not recorded on our balance sheet.

 

In conjunction with the formation of GrowHow, we commenced the closure of our Severnside, U.K. facility. Pursuant to the agreement with Kemira, we are responsible for any remediation costs required to prepare the Severnside site for disposal. We have an option to purchase the Severnside land for a nominal amount at any time prior to sale. If we elect not to exercise this option, we are still entitled to receive the sales proceeds. We anticipate that the proceeds related to the sale of the Severnside land would exceed the total cost of reclamation of the site.

 

Contractual Obligations

 

Contractual obligations and commitments to make future payments at December 31, 2008 were:

 

 

 

Pension Assets and Liabilities

 

We have three pension plans—an employees’ retirement plan (U.S. Employees’ Plan) and an excess benefit plan (U.S. Excess Plan) in the United States and a pension plan for employees of Terra International (Canada) Inc. (Canadian Employees’ Plan) in Canada. Our U.S. Employees’ Plan and Canada Employees’ Plan are fully funded with combined plan assets exceeding projected benefit obligations by $3.2 million. Our U.S. Excess Plan is unfunded and had a projected benefit obligation of $9.9 million at December 31, 2008. The pension projected benefit obligations were computed based on a 6.7% discount rate, which was based on yields for high-quality corporate bonds (Moody’s Investor Service “AA” rated or equivalent) with a maturity approximating the duration of our pension obligation. Future declines in comparable bond yields would increase our pension obligation and future increases in bond yields would decrease our pension obligation. Our pension obligation, net of plan assets, could increase or decrease depending on the extent that returns on pension plan assets is lower or higher than the discount rate.

 

Our cash contributions to pension plans were $2.6 million in 2008. Future contributions depend on our funding decisions, actual returns for plan assets, and legislative changes to pension funding requirements and/or plan amendments. See Note 17, Retirement Benefit Plans, of the Notes to our Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further information on our retirement benefits plans.

 

Environmental, Health and Safety

 

Expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $11.6 million in 2008. Because environmental health and safety regulations are expected to continue to change and generally to become more restrictive than current requirements, the cost of compliance likely will increase. We do not expect compliance with such regulations to have a material adverse effect on the results of operations, financial position or net cash flows.

 

We incurred $7.3 million of 2008 capital expenditures to ensure compliance with environmental, health and safety regulations. We may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors to continue to achieve compliance with the Clean Air Act and similar requirements. These equipment requirements typically apply to competitors as well. We estimate that the cost of complying with these existing requirements in 2009, 2010, 2011 and beyond will be approximately $30.8 million in the aggregate.

 

Minority Interest

 

Minority interest represents the third party interest in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. We own 75.3% of the outstanding units. TNCLP makes cash distributions to the General and Limited Partners based upon formulas defined in the Agreement of Limited Partnership. Available Cash for distribution is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. Cash distributions to the Limited Partner and General Partner vary depending on when the cumulative distributions exceed the Minimum Quarterly Distribution (MQD) target levels set forth in the Agreement of Limited Partnership.

During 2008, the cumulative shortfall of the MQD was satisfied which entitled the General Partner to increased income allocations as provided for in the Agreement of Limited Partnership. The increased income allocation attributed to our General Partner interest was $36.6 million for 2008.

 

During 2008, 2007 and 2006, TNCLP distributed $69.6 million, $35.2 million and $8.9 million, respectively, to the minority TNCLP common unitholders.

 

On February 10, 2009, TNCLP announced a $2.97 per unit distribution to be paid during the first quarter of 2009.

 

Application of Critical Accounting Policies and Estimates

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires management to make judgments, assumptions and estimates that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. Note 1, Summary of Significant Accounting Policies, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplemental Data, of this Annual Report on Form 10-K describes the significant accounting policies and methods used in preparing the Consolidated Financial Statements. Management considers the accounting policies described below to be our most critical accounting policies because they are impacted significantly by estimates that management makes. Management bases its estimates on historical experience or various assumptions that they believe to be reasonable under the circumstances, and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. Management has discussed the development and selection of our critical accounting estimates, and the disclosure regarding them, with the audit committee of our Board of Directors, and does so on a regular basis. Actual results may differ materially from these estimates.

 

Derivative and Financial Instruments

 

We enter into derivative financial instruments, including swaps, basis swaps and put and call options, to manage the effect of changes in natural gas costs and the prices of our nitrogen products. We evaluate each derivative transaction and make an election of whether to designate the derivative as a fair-value or cash flow hedge or not to elect hedge designation for the derivative. Upon election of hedge designation, and to the extent such hedge is determined to be effective, changes in fair value are either (a) offset by the change in fair value of the hedged asset or liability or (b) reported as a component of accumulated other comprehensive income (loss) in the period of change, and subsequently recognized in the determination of net income in the period that the offsetting hedged transaction occurs. For derivatives that are not designated as hedges, or to the extent a hedge-designated derivative is determined to be ineffective, changes in fair value are recognized in earnings in the period of change.

 

Until our derivatives settle, we test the derivatives for ineffectiveness. This includes assessing the correlation of NYMEX pricing, which is commonly used as an index in natural gas derivatives, to the natural gas pipelines’ pricing at our manufacturing facilities. This assessment requires management judgment to determine the statistically- and industry-appropriate analysis of prior operating relationships between the NYMEX prices and the natural gas pipelines’ prices at our facilities.

 

To the extent possible, we base our market value calculations on third party data. Due to multiple types of settlement methods available, not all settlement methods for future period trades are available from third party sources. In the event that a derivative is measured for fair value based on a settlement method that is not readily available, we estimate the fair value based on forward pricing information for similar types of settlement methods.

Revenue Recognition

 

Revenue is recognized when persuasive evidence of a transaction exists, delivery has occurred, the price is fixed or determinable, no obligations remain and collectability is probable. Revenue from sales is generally recognized upon shipment of product to the customer in accordance with the terms of the sales agreement. As part of the revenue recognition process, we determine whether collection of trade receivables are reasonably assured based on various factors, including evaluation of whether there has been deterioration in the credit quality of our customers that could result in the inability to collect the receivable balance. In situations where it is unclear whether we will be able to collect the receivable, revenue and related costs are deferred. Related costs are recognized when it has been determined that the collection of the receivable is unlikely.

 

Inventory Valuation

 

Inventories are stated at the lower of cost or market. Market is defined as current replacement cost, except that market should not exceed the net realizable value and should not be less than net realizable value reduced by an allowance for an approximately normal profit margin. The cost of inventories is determined by using the first-in, first-out method. We perform a monthly analysis of our inventory balances to determine if the carrying amount of inventories exceeds their net realizable value. Our determination of estimated net realizable value is based on customer orders, market trends and historical pricing. If the carrying amount exceeds the estimated net realizable value, the carrying amount is reduced to the estimated net realizable value. We estimate a reserve for obsolescence and excess of our materials and supplies inventory. Inventory is stated net of the reserve.

 

Pension Assets and Liabilities

 

Pension assets and liabilities are affected by the estimated market value of plan assets, estimates of the expected return on plan assets and discount rates. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense ultimately recognized. Our pension plans for U.S. and Canada employees are fully funded. We have a pension plan for certain employees that is unfunded. The December 31, 2008 pension obligation was computed based on an average 6.7% discount rate, which was based on yields for high-quality corporate bonds with a maturity approximating the duration of our pension liability. The long-term return on plan assets is determined based on historical portfolio results and management’s expectations of the future economic environment. Declines in comparable bond yields would decrease our net pension asset. Our net pension asset could increase or decrease depending on the extent to which returns on pension plan assets are lower or higher than the discount rate.

 

Deferred Income Taxes

 

Terra accounts for income taxes using the asset and liability method described in Statement of Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributed to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and tax credits and loss carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences and carry-forwards are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is established when necessary to reduce deferred tax assets to amounts expected to be realized.

Additionally, undistributed earnings of a subsidiary are accounted for as a temporary difference, except that undistributed earnings of Terra’s foreign subsidiaries and affiliated corporate joint ventures accounted for on the equity method are considered to be permanently reinvested, and accordingly, no provision for U.S. income taxes has been provided thereon. If we were to receive distributions from any of these foreign subsidiaries or affiliates or determine the undistributed earnings of these foreign subsidiaries or affiliates to not be permanently reinvested, we could be subject to U.S. tax liabilities which have not been provided for in the consolidated financial statements.

 

Significant judgment is required in determining the worldwide provision for income taxes and there are many transactions for which the ultimate tax outcome is uncertain. It is our policy to establish provisions for taxes that may become payable in future years as a result of an examination by tax authorities. We establish the provisions based upon management’s assessment of exposure associated with permanent tax differences, tax credits and other filing positions. The provisions are analyzed periodically and adjustments are made as events occur that warrant adjustments to those provisions.

 

Plant Turnaround Costs

 

Plant turnarounds are periodically performed to extend the useful life, increase output and/or efficiency and ensure the long-term reliability and safety of integrated plant machinery at our continuous process production facilities. The nature of a turnaround is such that it occurs on less than annual basis and requires a multi-week shutdown of plant operations. Specific procedures performed during the turnaround include the disassembly, inspection and replacement or overhaul of plant machinery (boilers, pressure vessels, piping, heat exchangers, etc.) and rotating equipment (compressors, pumps, turbines, etc.), equipment recalibration and internal equipment efficiency assessments.

 

Preceding a turnaround, plants experience decreased efficiency in resource conversion to finished products. Replacement or overhaul of equipment and items such as compressors, turbines, pumps, motors, valves, piping and other parts that have an estimated useful life of at least two years, the internal assessment of production equipment, replacement of aged catalysts, and new installation/recalibration of measurement and control devices result in increased production output and/or improved plant efficiency after the turnaround. Turnaround activities are betterments that meet at least one of the following criteria: 1) extend the equipment useful life, or 2) increase the output and/or efficiency of the equipment. As a result, we follow the deferral method of accounting for these turnaround costs and thus they are capitalized and amortized over the period benefited, which is generally the two-year period until the next turnaround. Turnaround activities may extend the useful life of the assets since the overhaul of heat exchangers, pressure vessels, compressors, turbines, pumps, motors, etc. allow the continued use beyond the original design. If criteria for betterment or useful life extension are not met, we expense the turnaround expenditures as repair and maintenance activities in the period performed.

 

Impairment of Long-Lived Assets

 

Management assesses the recoverability of long-lived assets when indicators of impairment exist. The assessment of the recoverability of long-lived assets reflects management’s assumptions and estimates. Factors that management must estimate when performing impairment tests include sales demand, production levels, prices and costs, inflation, discount rates, currency exchange rates and capital spending. Significant management judgment is involved in estimating these factors, and they include inherent uncertainties. All assumptions utilized in the impairment analysis are consistent with management’s internal planning.

During 2007, we entered into an option agreement to sell our Beaumont, Texas facility. In connection with this option agreement, we evaluated the Beaumont facility for impairment and determined that the assets were impaired. We recorded a $39 million impairment charge for these assets.

 

Recently Issued Accounting Standards

 

In December 2007, the Financial Accounting Standards Board (FASB) issued SFAS 141R, Business Combinations (SFAS 141R), which changes the way we account for business acquisitions. SFAS 141R requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction and establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed in a business combination. Certain provisions of this standard will, among other things, impact the determination of acquisition-date fair value of consideration paid in a business combination (including contingent consideration); exclude transaction costs from acquisition accounting; and change accounting practices for acquired contingencies, acquisition-related restructuring costs, in-process research and development, indemnification assets, and tax benefits. SFAS 141R is effective for business combinations and adjustments to an acquired entity’s deferred tax asset and liability balances occurring after December 31, 2008. We are currently evaluating the future impacts and disclosures of SFAS 141R.

 

In December 2007, the FASB issued SFAS 160, Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51 (SFAS 160). SFAS 160 improves the comparability and transparency of financial statements when reporting minority interest. Entities with a noncontrolling interest will be required to clearly identify and present the ownership interest in the consolidated statement of financial position within equity, but separate from the parent’s equity. The amount of consolidated net income attributable to the parent and to the noncontrolling interest will be identified and presented on the face of the consolidated statement of income. The statement offers further guidance on changes in ownership interest, deconsolidation, and required disclosures. The statement is effective for fiscal years and interim periods within those fiscal years beginning January 1, 2009. Upon adoption, we will recharacterize the minority interest as noncontrolling interests and reclassify as a component of equity.

 

In March 2008, the FASB issued SFAS 161, Disclosures about Derivative Instruments and Hedging Activities (SFAS 161). SFAS 161 is an amendment of SFAS 133, Accounting for Derivative Instruments and Hedging Activities (SFAS 133). To address concerns that the existing disclosure requirements of SFAS 133 do not provide adequate information, SFAS 161 requires enhanced disclosures about an entity’s derivative and hedging activities and thereby improves the transparency of financial reporting. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. We are currently evaluating the future impacts and disclosures of SFAS 161.

 

In June 2008, the FASB issued FASB Staff Position No. EITF 03-6-1, Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities (FSP EITF 03-6-1). The FASB decided that unvested share-based payout awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of EPS pursuant to the two-class method under SFAS 128, Earnings per Share. This guidance is effective for fiscal years beginning after December 15, 2008 and interim periods within those years and prior periods must be adjusted retrospectively. We are currently assessing the impact FSP EITF 03-6-1 will have on our financial statements.

 

In December 2008, the FASB issued FSP FAS 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets, which amends Statement 132(R) to require more detailed disclosures about

employers’ pension plan assets. New disclosures will include more information on investment strategies, major categories of plan assets, concentrations of risk within plan assets and valuation techniques used to measure the fair value of plan assets. This new standard requires new disclosures only, and will have no impact on our consolidated financial position, results of operations or cash flows. These new disclosures will be required for us beginning in our Form 10-K for the 2009 fiscal year.

 

 

Risk Management and Financial Instruments

 

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We manage risk using derivative financial instruments for changes in natural gas supply prices and changes in nitrogen prices. Derivative financial instruments have credit risk and market risk. See Note 5, Derivative Financial Instruments, of the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for additional information on the use of derivative financial instruments.

 

Our policy is to avoid unnecessary risk and to limit, to the extent practical, risks associated with operating activities. Our management may not engage in activities that expose us to speculative or non-operating risks and is expected to limit risks to acceptable levels. The use of derivative financial instruments is consistent with our overall business objectives. Derivatives are used to manage operating risk within the limits established by our Board of Directors, and in response to identified exposures, provided they qualify as hedge activities. As such, derivative financial instruments are used to manage exposure to interest rate fluctuations, to hedge specific assets and liabilities denominated in foreign currency, to hedge firm commitments and forecasted natural gas purchase transactions, to set a floor for nitrogen selling prices and to protect against foreign exchange rate movements between different currencies that impact revenue and earnings expressed in U.S. dollars.

 

The use of derivative financial instruments subjects us to some inherent risks associated with future contractual commitments, including market and operational risks, credit risk associated with counterparties, product location (basis) differentials and market liquidity. We continuously monitor the valuation of identified risks and adjust the portfolio based on current market conditions.

 

Foreign Currency Fluctuations

 

Our policy is to manage risk associated with foreign currency fluctuations by entering into forward exchange and option contracts covering specific currency obligations or net foreign currency operating requirements, as deemed necessary and appropriate in each individual circumstance. Such hedging is limited to the amounts and duration of the specific obligations being hedged and, in the case of operating requirements, no more than 75% of the forecasted requirements. The primary currencies to which we are exposed are the Canadian dollar and the British pound. At December 31, 2008, we had no open forward currency positions.

 

Natural Gas Prices—North American Operations

 

Natural gas is the principal raw material used to manufacture nitrogen and methanol. Natural gas prices are volatile and we mitigate some of this volatility through the use of derivative commodity instruments. Our current policy is to hedge natural gas provided that such arrangements would not

result in costs greater than expected selling prices for our finished products. Estimated North American natural gas requirements for 2009 are approximately 113 billion cubic feet (BCF). We have hedged 29% of our expected 2009 North American requirements and none of our requirements beyond December 31, 2009. The fair value of these instruments is estimated based, in part, on quoted market prices from brokers, realized gains or losses and our computations. These instruments and other natural gas positions fixed natural gas prices at $105.6 million (includes $65.3 million related to accumulated other comprehensive loss) more than published prices for December 31, 2008 forward markets. Market risk is estimated as the potential loss in fair value resulting from a hypothetical price change. Changes in the market value of these derivative instruments have a high correlation to changes in the spot price of natural gas. Based on our derivatives outstanding at December 31, 2008 and 2007, which included swaps, basis swaps and call options, a $1 per MMBtu increase in NYMEX would result in a $2.4 million and $12.6 million, respectively change or fluctuation in our natural gas cost.

 

Natural Gas Prices—Trinidad Operation

 

The natural gas requirements of Point Lisas Nitrogen Limited are supplied under contract until 2018 with the Natural Gas Company of Trinidad and Tobago. The cost of natural gas to the joint venture fluctuates based on changes in the market price of ammonia.

 

Nitrogen Prices

 

The prices for nitrogen products can be volatile and from time to time we mitigate some of this volatility through the use of derivative commodity instruments. We have not hedged any of our 2009 North American sales.

 

Interest Rate Fluctuations

 

The table below provides information about our financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. We had no interest rate financial derivatives outstanding at December 31, 2008.

 

Interest Rate Sensitivity

 

 

Our management is responsible for the preparation, integrity and objectivity of the accompanying consolidated financial statements and the related financial information. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and necessarily include certain amounts that are based on estimates and informed judgments. Our management also prepared the related financial information included in this Annual Report on Form 10-K and is responsible for its accuracy and consistency with the consolidated financial statements.

 

The accompanying consolidated financial statements have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, who conducted its audits in accordance with the standards of the Public Accounting Oversight Board. The independent registered public accounting firm’s responsibility is to express an opinion as to the fairness with which such financial statements present our financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

 

Report of Independent Registered Public Accounting Firm

 

To the Board of Directors and Stockholders of Terra Industries Inc.:

 

We have audited the accompanying consolidated balance sheets of Terra Industries Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2008. Our audits also included the financial statement schedule listed in the Index at Item 15. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements and the financial statement schedule based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Terra Industries Inc. and subsidiaries at December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2008, in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, present fairly, in all material respects, the information set forth therein.

 

As discussed in note 17 to the consolidated financial statements, in 2006 the Company adopted Statement of Financial Accounting Standard No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans, relating to the recognition and related disclosure provisions effective December 31, 2006.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on the criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2009, expressed an unqualified opinion on the Company’s internal control over financial reporting.

 

 

DELOITTE & TOUCHE LLP

Omaha, Nebraska

February 27, 2009

Consolidated Statements of Financial Position

 

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Operations

 

 

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Cash Flows