Edgar Filing: TERRA INDUSTRIES INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2005

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number: 1-8520

TERRA INDUSTRIES INC.

(Exact name of registrant as specified in its charter)

Maryland

52-1145429

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

Terra Centre

P.O. Box 6000

600 Fourth Street

Sioux City, Iowa

51102-6000

(Address of principal executive offices)

(Zip Code)

Registrant’s telephone number, including area code: (712) 277-1340

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 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 ¨

As of June 30, 2005, the following shares of the registrant’s stock were outstanding:


Common Shares, without par value		93,010,269 shares

TABLE OF CONTENTS


Part I – FINANCIAL INFORMATION

	Item 1.	Financial Statements
		Consolidated Balance Sheets	3
		Consolidated Statements of Operations	4
		Consolidated Statements of Cash Flows	5
		Consolidated Statements of Changes in Common Shareholders’ Equity	6
		Notes to Consolidated Financial Statements	7

	Item 2.	Management Discussion and Analysis of Financial Condition and Results of Operations	26

	Item 3.	Quantitative and Qualitative Disclosures About Market Risk	33

	Item 4.	Controls and Procedures	33

Part II – OTHER INFORMATION

	Item 1.	Legal Proceedings	34

	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	34

	Item 3.	Defaults Upon Senior Securities	34

	Item 4.	Submission of Matters to a Vote of Security Holders	34

	Item 5.	Other Information	34

	Item 6.	Exhibits	35

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TERRA INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)


	June 30, 2005			December 31, 2004			June 30, 2004
Assets
Cash and cash equivalents	$	92,451		$	233,798		$	110,944
Accounts receivable, less allowance for doubtful accounts of $207, $262 and $586		161,600			150,271			129,414
Inventories		150,461			148,808			90,015
Other current assets		31,195			58,106			36,739

Total current assets		435,707			590,983			367,112

Property, plant and equipment, net		779,951			797,978			677,268
Equity method investments		187,897			215,939			—
Deferred plant turnaround costs		30,491			33,897			22,114
Intangible assets		10,525			24,884			—
Other assets		11,506			21,827			25,331

Total assets	$	1,456,077		$	1,685,508		$	1,091,825

Liabilities
Debt due within one year	$	113		$	167		$	157
Accounts payable		87,360			119,571			76,940
Accrued expenses and other current liabilities		65,514			220,195			72,797

Total current liabilities		152,987			339,933			149,894

Long-term debt and capital lease obligations		331,308			435,238			402,123
Deferred income taxes		74,036			58,224			31,436
Pension liabilities		119,555			119,570			63,453
Other liabilities		45,568			47,872			52,782
Minority interest		98,059			92,197			93,255

Total liabilities and minority interest		821,513			1,093,034			792,943

Preferred Stock - liquidation value of $136,718 and $137,269 at June 30, 2005 and December 31, 2004		132,519			133,069			—

Common Shareholders’ Equity
Capital stock Common Shares, authorized 133,500 shares 93,010; 92,944 and 77,684 outstandiing		144,580			144,531			129,094
Paid-in capital		693,875			681,639			555,684
Accumulated other comprehensive loss		(49,767	)		(55,994	)		(47,221	)
Unearned compensation		(2,023	)		(2,568	)		—
Accumulated deficit		(284,620	)		(308,203	)		(338,675	)

Total common shareholders’ equity		502,045			459,405			298,882

Total liabilities and minority interest, preferred stock and common shareholders’ equity		$1,456,077		$	1,685,508		$	1,091,825

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per-share amounts)

(unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2005			2004			2005			2004
Revenues
Net sales	$	487,415		$	416,264		$	935,338		$	776,725
Other income, net		2,578			504			4,667			1,072

Total revenues		489,993			416,768			940,005			777,797

Costs and Expenses
Cost of sales		408,587			370,578			822,330			694,225
Selling, general and administrative expense		16,046			9,295			26,499			16,604
Recovery of product claim costs		—			(2,389	)		—			(17,903	)
Equity in earnings of unconsolidated affiliates		(4,401	)		—			(9,407	)		—

		420,232			377,484			839,422			692,926

Income from operations		69,761			39,284			100,583			84,871

Interest income		1,667			612			3,421			989
Interest expense		(14,130	)		(13,440	)		(29,983	)		(26,941	)
Loss on early retirement of debt		(16,389	)		—			(27,193	)		—
Change in fair value of warrant liability		3,960			—			8,860			—

Income before income taxes and minority interest		44,869			26,456			55,688			58,919
Income tax provision		(15,975	)		(5,025	)		(18,160	)		(16,325	)
Minority interest		(7,192	)		(3,566	)		(11,395	)		(6,499	)

Net income		21,702			17,865			26,133			36,095
Preferred share dividends		(1,275	)		—			(2,550	)		—

Net Income Available to Common Shareholders	$	20,427		$	17,865		$	23,583		$	36,095

Basic and diluted income per share:
Basic	$	0.22		$	0.24		$	0.26		$	0.48
Diluted		0.20			0.23			0.24			0.46

Basic and diluted weighted average shares outstanding:
Basic		91,439			75,898			91,415			75,769
Diluted		107,123			77,879			106,780			77,663

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)


	Six Months Ended June 30,
	2004			2005
Operating Activities
Net income	$	26,133		$	36,095
Adjustments to reconcile net income to net cash flows from operating activities:
Noncash loss on early retirement of debt		22,543			—
Change in fair value of warrant liability		(8,860	)		—
Recovery of product claim costs		—			(12,874	)
Depreciation and amortization		60,131			50,484
Deferred income taxes		22,833			16,526
Minority interest in earnings		11,395			6,499
Equity earnings of unconsolidated affiliates		(9,407	)		—
Amortization of unearned compensation		691			—
Term loan discount accretion		1,774			—
Changes in current assets and liabilities:
Accounts receivable		(14,750	)		4,126
Inventories		(4,068	)		506
Accounts payable and accrued expenses		(165,657	)		(3,069	)
Other assets and liabilities, net		48,010			(68,177	)

Net cash flows from operating activities		(9,232	)		30,116

Investing Activities
Purchase of property, plant and equipment		(10,213	)		(3,425	)
Plant turnaround expenditures		(7,375	)		(819	)
Distributions received from unconsolidated affiliates		23,625			—

Net cash flows from investing activities		6,037			(4,244	)

Financing Activities
Payments under borrowings arrangements		(125,084	)		(79	)
Preferred share dividends paid		(3,400	)		—
Proceeds from exercise of stock options		114			269
Distributions to minority interests		(5,535	)		(2,306	)

Net cash flows from financing activities		(133,905	)		(2,116	)

Effect of exchange rate changes on cash		(4,247	)		(146	)

Increase (decrease) to cash and cash equivalents		(141,347	)		23,610
Cash and cash equivalents at beginning of period		233,798			87,334

Cash and cash equivalents at end of period	$	92,451		$	110,944

Supplemental cash flow information:
Interest paid	$	24,302		$	25,550
Income tax refunds received		11,049			—
Income taxes paid		398			339

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2005 AND 2004

(in thousands)

(unaudited)


	Common Stock		Paid-In Capital			Accumulated Other Comprehensive Loss			Unearned Compensation			Accumulated Deficit			Total			Comprehensive Income (Loss)
Balance at January 1, 2005	$	144,531	$	681,639		$	(55,994	)	$	(2,568	)	$	(308,203	)	$	459,405
Comprehensive income (loss):
Net income		—		—			—			—			26,133			26,133		$	26,133
Foreign currency translation adjustment		—		—			(19,215	)		—			—			(19,215	)		(19,215	)
Change in fair value of derivatives, net of taxes of $2,882		—		—			25,442			—			—			25,442			25,442

Comprehensive income																		$	32,360

Preferred share dividends		—		—			—			—			(2,550	)		(2,550	)
Reclassification of warrant liability		—		12,240			—			—			—			12,240
Exercise of stock options		42		62			—			—			—			104
Restricted stock		7		(66	)		—			(146	)		—			(205	)
Amortizaton of unearned compensation		—		—			—			691			—			691

Balance at June 30, 2005	$	144,580	$	693,875		$	(49,767	)	$	(2,023	)	$	(284,620	)	$	502,045


	Common Stock		Paid-In Capital			Accumulated Other Comprehensive Loss			Unearned Compensation			Accumulated Deficit			Total			Comprehensive Income (Loss)
Balance at January 1, 2004	$	128,968	$	555,529		$	(44,596	)	$	—		$	(374,770	)	$	265,131
Comprehensive income:
Net income		—		—			—			—			36,095			36,095		$	36,095
Foreign currency translation adjustment		—		—			1,271			—			—			1,271			1,271
Change in fair value of derivatives, net of taxes of $3,210		—		—			(3,896	)		—			—			(3,896	)		(3,896	)

Comprehensive income																		$	33,470

Exercise of stock options		123		146			—			—			—			269
Restricted stock		3		9			—			—			—			12

Balance at June 30, 2004	$	129,094	$	555,684		$	(47,221	)	$	—		$	(338,675	)	$	298,882

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1.	Financial Statement Presentation

Basis of Presentation

The accompanying unaudited consolidated financial statements and condensed notes thereto contain all adjustments necessary, in the opinion of management, to summarize fairly the financial position of Terra Industries Inc. and all majority-owned subsidiaries (“Terra”, “the company” and “it”) and the results of operations for the periods presented. Because of the seasonal nature of Terra’s operations and effects of weather-related conditions in several of its marketing areas, results of any interim reporting period should not be considered as indicative of results for a full year. These statements should be read in conjunction with the company’s 2004 Annual Report on Form 10-K to Shareholders.

Revenue Recognition

Revenue is recognized when title and risk of loss passes to the customer. Revenue is recognized as the net amount to be received after deducting estimated amounts for discounts and trade allowances. Revenues include amounts paid by customers for shipping and handling.

Cost of Sales and Hedging Transactions

Realized gains and losses from hedging activities and premiums paid for option contracts are deferred and recognized in the month in which the hedged transactions closed. Swaps, options and other derivative instruments that do not qualify for hedge accounting treatment are marked to fair value each accounting period. Costs associated with settlement of natural gas purchase contracts and costs for shipping and handling are included in cost of sales. Cash flows related to natural gas hedging are reported as cash flows from operating activities.

Stock-Based Compensation

Terra accounts for its employee stock-based compensation plans in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and the related interpretations, which utilize the intrinsic value method. The company has adopted the disclosure-only provisions of SFAS No. 123, “Accounting for Stock Based Compensation”. The pro forma impact on basic income and diluted income per share of accounting for stock-based compensation using the fair value method required by SFAS No. 123 follows:


	Three Months Ended June 30						Six Months Ended June 30
(in thousands, except per-share amounts)	2005			2004			2005			2004
Net income available to common shareholders	$	20,427		$	17,865		$	23,583		$	36,095
Add: Stock based employee compensation expense included in reported net income, net of related tax effects		352			290			691			428
Deduct: Stock based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(352	)		(290	)		(691	)		(428	)

Pro forma net income available to common shareholders	$	20,427		$	17,865			23,583		$	36,095

Income per share:
Basic – as reported	$	0.22		$	0.24		$	0.26		$	0.48

Basic – pro forma		0.22			0.24			0.26			0.48

Diluted – as reported	$	0.20		$	0.23		$	0.24		$	0.46

Diluted – pro forma		0.20			0.23			0.24			0.46

Impairment of Long-Lived Assets

Terra reviews its long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If the sum of the expected future cash flows expected to result from the use of the asset (undiscounted and without interest charges) is less than the carrying amount of the asset, an impairment loss is recognized based on the difference between the carrying amount and the fair value of the asset.

Natural Gas Futures, Swaps, Options and Basis Swaps

The estimated fair value of each class of derivatives is based on published referenced prices and quoted market prices from brokers.

Use of Estimates in Preparation of the Financial Statements

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to the 2004 Consolidated Financial Statements and Notes to conform to the 2005 presentation.

2.	Equity Investments

Terra’s investments in companies that are accounted for on the equity method of accounting consists of the following: (1) 50% ownership interest in Point Lisas Nitrogen Limited, (“PLNL”) which operates an ammonia production plant in Trinidad (2) 50% interest in an ammonia storage joint venture located in Houston, Texas and (3) 50% interest in a joint venture in Oklahoma CO₂ at Terra’s nitrogen plant. These investments were $187.9 million at June 30, 2005. Terra includes the net earnings of these investments as an element of operating income since the investee’s operations provide additional capacity to Terra.

The combined results of operations and financial position of Terra’s equity method investments are summarized below:


	Three Months Ended June 30				Six Months Ended June 30
(in thousands)	2005		2004		2005		2004
Condensed income statement information:
Net sales	$	36,933	$	1,450	$	79,736	$	2,583

Net income	$	11,226	$	507	$	29,769	$	858

Terra’s equity earnings of
unconsolidated affiliates	$	4,401	$	—	$	9,407	$	—

Condensed balance sheet information:
Current assets	$	56,467	$	1,649	$	56,467	$	1,649
Long-lived assets		245,257		3,117		245,257		3,117

Total assets	$	301,724	$	4,766	$	301,724	$	4,766

Current liabilities	$	22,417	$	1,045	$	22,417	$	1,045
Long-term liabilities		300		753		300		753
Equity		279,007		2,968		279,007		2,986

Total liabilities and equity	$	301,724	$	4,766	$	301,724	$	4,766

The carrying value of these investments at June 30, 2005 was $48.4 million more than Terra’s share of the affiliates’ book value. The excess is attributable primarily to affiliate fixed asset values and is being amortized over a period of approximately 15 years.

Terra has transactions in the normal course of business with PLNL whereby Terra is obliged to purchase 50 percent of the ammonia produced by PLNL at current market prices. During the three and six month periods ending June 30, 2005, Terra purchased approximately $12.9 million and $33.4 million of ammonia, respectively, from PLNL. On April 15, 2005, PLNL made a cash distribution to its shareholders, of which Terra’s portion was $22.5 million.

3.	Income Per Share

Basic income per share data is based on the weighted-average number of Common Shares outstanding during the period. Diluted income per share data is based on the weighted-average number of Common Shares outstanding and the effect of all dilutive potential common shares including stock options, restricted shares and convertible preferred shares.

The following table provides a reconciliation between basic and diluted income per share for the three and six month periods ended June 30, 2005 and 2004:


	Three Months Ended June 30					Six Months Ended June 30
(in thousands, except per-share amounts)	2005			2004		2005			2004
Basic income per share computation:
Income from continuing operations	$	21,702		$	17,865	$	26,133		$	36,095
Less: Preferred share dividends		(1,275	)		—		(2,550	)		—

Income available to common shareholders	$	20,427		$	17,865	$	23,583		$	36,095

Weighted average shares outstanding		91,439			75,898		91,415			75,769

Basic income per common share	$	0.22		$	0.24	$	0.26		$	0.48

Diluted income per share computation:
Income available to common shareholders	$	20,427		$	17,865	$	23,583		$	36,095
Add: Preferred share dividends		1,275			—		2,550			—

Income available to common shareholders and assumed conversions	$	21,702		$	17,865	$	26,133		$	36,095

Weighted average shares outstanding		91,439			75,898		91,415			75,769
Add incremental shared from assumed conversions:
Preferred shares		14,140			—		14,162			—
Restricted stock		670			1,777		659			1,777
Common stock warrants		687			—		345			—
Common stock options		187			204		199			117

Dilutive potential common shares		107,123			77,879		106,780			77,663

Diluted income per common share	$	0.20		$	0.23	$	0.24		$	0.46

Common stock options totaling 0.1 million shares for the three and six month periods ended June 30, 2005 and 2004 were excluded from the computation of diluted income per share because the exercise prices of these options exceeded the average market price of Terra’s stock for the respective periods, and the effect of their inclusion would be antidilutive.

4.	Inventories

Inventories consisted of the following:


(in thousands)	June 30, 2005		December 31, 2004		June 30, 2004
Raw materials	$	38,400	$	38,386	$	23,652
Supplies		37,296		36,543		21,900
Finished goods		74,765		73,879		44,463

Total	$	150,461	$	148,808	$	90,015

Inventory is valued at actual first in - first out cost. Costs include raw material, labor and overhead.

5.	Acquisition

On December 21, 2004, Terra acquired Mississippi Chemical Corporation (“MCC”) for a purchase price valued at $210.6 million consisting of 15 million common shares, 172,690 Series B preferred shares and cash of $54.2 million, including costs directly related to the acquisition. MCC manufactures nitrogen-based fertilizers and industrial use products and has 50% ownership interests in an ammonia production facility in Point Lisas, Trinidad and in an ammonia storage joint venture located in Houston, Texas. In connection with the acquisition, Terra assumed $125.0 million of MCC long-term debt and $34.1 million of unfunded pension liabilities.

The Company has prepared a preliminary estimate of the fair values assigned to each major asset and liability caption of Terra as of the December 21, 2004 effective date of the acquisition. This preliminary estimate reflects a purchase price allocation based on estimates of the fair values of certain assets and liabilities. These values are subject to change until certain third party valuations have been finalized and changes in these values could have a material impact on the purchase price allocation and the resulting amounts of the assets and liabilities disclosed below.


(in thousands)	As of December 21, 2004
Current assets	$	101,985
Property, plant and equipment		133,856
Equity investments		197,781
Intangible assets		16,484

Total assets acquired		450,106

Current liabilities		37,169
Long-term debt		125,000
Pension and other long-term liabilities		36,314
Deferred income taxes		41,574

Total liabilities assumed		240,057

Net assets acquired	$	210,049

Differences between the amounts reflected above and the amounts disclosed in the Company’s 2004 Annual Report on Form 10-K are due to updated information about certain estimates obtained by management subsequent to the filing of such Form 10-K.

The amortizable intangible assets reflected in the table above were determined by management to have finite lives. The intangible asset is comprised of $10.3 million related to MCC’s customer base, $3.5 million related to deferred financing fees and $2.7 million of other intangible assets. The useful life of five years for the customer base intangible asset was based on management’s forecasts of customer turnover. The deferred financing fees are amortized over the remaining life of the related long-term debt; as of June 30, 2005, all of MCC’s long-term debt has been repaid and the unamortized deferred financing fees have been charged to expense. The other intangible assets will be amortized over their useful lives.

The following represents unaudited pro forma summary results of operations as if the acquisition of MCC had occurred at the beginning of 2004.


(in thousands, except per-share amounts)	Three Months Ended June 30, 2004		Six Months Ended June 30, 2004
Revenues	$	495,168	$	949,356
Operating income		43,379		102,941
Net income		18,323		42,623
Basic income per share		0.20		0.47
Diluted income per share		0.19		0.45

The pro forma operating results were adjusted to include depreciation of the fair value of acquired assets based on estimated useful lives at the acquisition dates, amortization of intangible assets, interest expense on acquisition borrowings, the issuance of common stock and the effect of income taxes. Pro forma operating results were also adjusted to exclude MCC discontinued operations as well as reorganization expenses and gains on the extinguishment of pre-petition liabilities in connection with its emergence from Chapter 11.

The pro forma information listed above does not purport to be indicative of the results that would have been obtained if the operations were combined during the above periods, and is not intended to be a projection of future operating results or trends.

6.	Derivative Financial Instruments

Terra manages risk using derivative financial instruments for (a) changes in natural gas supply prices (b) interest rate fluctuations (c) changes in nitrogen prices and (d) currency. Derivative financial instruments have credit risk and market risk.

To manage credit risk, Terra enters into derivative transactions only with counter-parties who are currently rated as BBB or better or equivalent as recognized by a national rating agency. Terra will not enter into transactions with a counter-party if the additional transaction will result in credit exposure exceeding $20 million. The credit rating of counter-parties may be modified through guarantees, letters of credit or other credit enhancement vehicles.

Terra classifies a derivative financial instrument as a hedge if all of the following conditions are met:

The item to be hedged must expose Terra to currency, interest or price risk.

It must be probable that the results of the hedge position substantially offset the effects of currency, interest or price changes on the hedged item (e.g., there is a high correlation between the hedge position and changes in market value of the hedge item).

The derivative financial instrument must be designated as a hedge of the item at the inception of the hedge.

Natural gas supplies to meet production requirements at Terra’s North American production facilities are purchased at market prices. Natural gas market prices are volatile and Terra effectively fixes prices for a portion of its natural gas production requirements and inventory through the use of futures contracts, swaps and options. These contracts reference physical natural gas prices or appropriate NYMEX futures contract prices. Contract physical prices are frequently based on prices at the Henry Hub in Louisiana, the most common and financially liquid location of reference for financial derivatives related to natural gas. However, natural gas supplies for Terra’s North American production facilities are purchased at locations other than Henry Hub, which often creates a location basis differential between the contract price and the physical price of natural gas. Accordingly, the use of financial derivatives may not exactly offset the change in the price of physical gas. The contracts are traded in months forward and settlement dates are scheduled to coincide with gas purchases during that future period.

A swap is a contract between Terra and a third party to exchange cash based on a designated price. Option contracts give the holder the right to either own or sell a futures or swap contract. The futures contracts require maintenance of cash balances generally 10% to 20% of the contract value and option contracts require initial premium payments ranging from 2% to 5% of contract value. Basis swap contracts require payments to or from Terra for the amount, if any, that monthly published gas prices from the source specified in the contract differ from the prices of a NYMEX natural gas futures during a specified period. There are no initial cash requirements related to the swap and basis swap agreements.

The following summarizes open natural gas derivative contracts at June 30, 2005 and 2004:


(in thousands)	2005				2004
(in thousands)	Contract MMBtu	Unrealized Gain (Loss)			Contract MMBtu	Unrealized Gain
Swaps	15,429	$	10,904		14,880	$	2,909
Options	12,780		(3,316	)	15,470		(3,111	)

	28,209	$	7,588		30,350	$	(202	)

Gains and losses on settlement of these contracts and premium payments on option contracts are credited or charged to cost of sales in the month in which the hedged transaction closes. The risk and reward of outstanding natural gas positions are directly related to increases or decreases in natural gas prices in relation to the underlying NYMEX natural gas contract prices. Realized (losses) gains on closed contracts relating to future periods for the three and six month periods ending June 30, 2005 were $(0.4) million and $2.0 million, respectively.

Compared with spot prices, natural gas derivative activities increased Terra’s 2005 first six month natural gas costs by $8.3 million and reduced 2004 first six month natural gas costs by $10.4 million.

The following table presents the carrying amounts and estimated fair values of Terra’s derivative financial instruments as of June 30, 2005 and 2004. SFAS 107, “Disclosures about Fair Value of Financial Instruments” defines the fair value of a financial instrument as the amount at which the instrument could be exchanged in a current transaction between willing parties.


(in millions)	2005				2004
(in millions)	Carrying Amount		Fair Value		Carrying Amount		Fair Value
Natural gas	$	2.0	$	7.6	$	0.6	$	(0.2	)

The activity to other comprehensive income (loss), net of income taxes, relating to a current period hedging transactions for the three- and six-month periods ended June 30, 2005 and 2004 follow:


	Three Months Ended June 30						Six Months Ended June 30
(in thousands)	2005			2004			2005			2004
Beginning accumulated gain (loss)	$	14,487		$	3,160		$	(19,307	)	$	3,979
Reclassification into earnings		(3,310	)		(7,477	)		7,419			(10,066	)
Net change associated with current period hedging transactions		(5,042	)		4,400			18,023			6,170

Ending accumulated gain (loss)	$	6,135		$	83		$	6,135		$	83

Approximately $4.3 million of the accumulated gain at June 30, 2005 will be reclassified into earnings during 2005.

7.	Long-term Debt and Other Borrowings

Long-term debt and other borrowings consisted of the following:


(in thousands)	June 30, 2005		December 31, 2004		June 30, 2004
Secured Senior Notes, 12.875% due 2008	$	200,000	$	200,000	$	200,000
Term loan, due 2008, net of $24.1 million unamortized discount at December, 31, 2004		—		103,900		—
Second Priority Senior Secured Notes, 11.5%, due 2010		131,300		131,300		202,000
Other		121		205		280

		331,421		435,405		402,280
Less current maturities		113		167		157

Total	$	331,308	$	435,238	$	402,123

In March 2005, Terra repaid $50.0 million of the term loan. The discounted book value of debt prior to repayment was $41.9 million. As a result, Terra recognized a loss on the repayment of $8.1 million and other related prepayment charges of $2.7 million during the first quarter of 2005.

In June 2005, the company repaid $75.0 million of the term loan. The discounted book value of the debt prior to repayment was $63.7 million. As a result, the company recognized a loss on the repayment of $11.3 million and other prepayment charges of $5.1 million during the second quarter of 2005.

8.	Pension Plans

Terra maintains defined benefit pension plans that cover substantially all salaried and hourly employees. Benefits are based on a pay formula. The defined benefit plans’ assets consist principally of equity securities and corporate and government debt securities. The company also has certain non-qualified pension plans covering executives, which are unfunded. Terra accrues pension costs based upon annual actuarial valuations for each plan and funds these costs in accordance with statutory requirements.

The estimated components of net periodic pension expense follow:


	Three Months Ended June 30						Six Months Ended June 30
(in thousands)	2005			2004			2005			2004
Service cost	$	683		$	502		$	1,366		$	1,004
Interest cost		3,917			3,754			7,834			7,508
Expected return on plan assets		(3,070	)		(3,065	)		(6,140	)		(6,130	)
Amortization of prior service cost		5			7			11			14
Amortization of actuarial loss		1,222			1,191			2,444			2,382
Amortization of net transition assets		13			(28	)		25			(58	)
Termination charge		—			—			—			—

Pension Expense	$	2,770		$	2,361		$	5,540		$	4,720

Cash contributions to the defined benefit pension plans for the three months ended June 30, 2005 and 2004 were $2.7 million and $3.2 million, respectively. Cash contributions to the defined benefit pension plans for the six months ended June 30, 2005 and 2004 were $4.3 million and $4.7 million, respectively.

Terra also sponsors defined contribution savings plans covering most full-time employees. Contributions made by participating employees are matched based on a specified percentage of employee contributions. The cost of the company contributions to these plans for the three month periods ending June 30, 2005 and 2004 totaled $1.1 million and $0.8 million, respectively. Contributions to these plans for the six month periods ending June 30, 2005 and 2004 were $2.1 million and $1.6 million, respectively.

Terra provides health care benefits for certain U.S. employees who retired on or before January 1, 2002. Participant contributions and co-payments are subject to escalation. The plan pays a stated percentage of most medical expenses reduced for any deductible and payments made by government programs. These costs are funded as paid.

9.	Accumulated other comprehensive income/(loss)

Accumulated other comprehensive income (loss) refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States are recorded as an element of shareholders’ equity but are excluded from net income. Terra’s other comprehensive income (loss) is comprised of (a) adjustments that result from translation of Terra’s foreign entity financial statements from their functional currencies to United States dollars, (b) adjustments that result from translation of intercompany foreign currency transactions that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future) between entities that are consolidated in Terra’s financial statements, (c) the offset to the fair value of derivative assets and liabilities (that qualify as hedged relationships) recorded on the balance sheet, and (d) minimum pension liability adjustments.

The components of accumulated other comprehensive income (loss) for the six months ended June 30, 2005 and 2004 follow:


(in thousands)	Foreign Currency Translation Adjustment			Fair Value of Derivatives, net of taxes			Minimum Pension Liability, net of taxes			Total
Balance December 31, 2004	$	14,287		$	(19,307	)	$	(50,974	)	$	(55,994	)
Change in foreign translation adjustment		(19,215	)		—			—			(19,215	)
Reclassification to earnings		—			7,419			—			7,419
Change in fair value of derivatives		—			18,023			—			18,023

Balance June 30, 2005	$	(4,928	)	$	6,135		$	(50,974	)	$	(49,767	)

Balance December 31, 2003	$	(10,928	)	$	3,979		$	(37,647	)	$	(44,596	)
Change in foreign translation adjustment		1,271			—			—			1,271
Reclassification to earnings		—			(10,066	)		—			(10,066	)
Change in fair value of derivatives		—			6,170			—			6,170

Balance June 30, 2004	$	(9,657	)	$	83		$	(37,647	)	$	(47,221	)

10.	Industry Segment Data

Terra classifies its operations into two business segments: nitrogen products and methanol. The nitrogen products business produces and distributes ammonia, urea, nitrogen solutions, ammonium nitrate and other products to farm distributors and industrial users. The methanol business manufactures and distributes methanol which is used in the production of a variety of chemical derivatives and in the production of methyl tertiary butyl ether (MTBE), an oxygenate and an octane enhancer for gasoline. Terra does not allocate interest, income taxes or corporate-related charges to business segments. Included in Other are general corporate activities not attributable to a specific industry segment.

The following summarizes operating results by business segment:


	Three Months Ended June 30						Six Months Ended June 30
(in thousands)	2005			2004			2005			2004
Revenues - Nitrogen Products	$	479,516		$	362,518		$	918,838		$	680,075
- Methanol		9,866			53,746			19,953			96,650
- Other		611			504			1,214			1,072

Total revenues	$	489,993		$	416,768		$	940,005		$	777,797

Income (loss) from operations
- Nitrogen Products	$	73,839		$	42,012		$	105,497		$	91,430
- Methanol		(2,415	)		(924	)		(3,089	)		(2,970	)
- Other - net		(1,663	)		(1,804	)		(1,825	)		(3,589	)

Income from operations	$	69,761		$	39,284		$	100,583		$	84,871

The following summarizes geographic revenues information for the three and six month periods ending June 30:


	Three Months Ended June 30				Six Months Ended June 30
(in thousands)	2005		2004		2005		2004
United States	$	393,982	$	320,188	$	730,924	$	565,512
Canada		18,806		19,504		30,475		30,836
United Kingdom		77,205		77,076		178,606		181,449

	$	489,993	$	416,768	$	940,005	$	777,797

11.	Guarantor Subsidiaries

The consolidating statement of financial position of Terra Industries Inc. (the “Parent”), Terra Capital, Inc. (“TCAPI”), the Guarantor Subsidiaries and subsidiaries of the Parent that are not guarantors of the Senior Secured Notes due 2008 for June 30, 2005; December 31 and June 30, 2004 are presented below for purposes of complying with the reporting requirements of the Guarantee Subsidiaries. Statements of operations for the three and six months and statements of cash flows for the six months ended June 30, 2005 and 2004 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries.

Guarantor subsidiaries include subsidiaries that own the Woodward, Oklahoma; Port Neal, Iowa and Beaumont, Texas plants as well as the corporate headquarters facility in Sioux City, Iowa. All other company facilities are owned by non-guarantor subsidiaries.

Consolidating Balance Sheet as of June 30, 2005:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Assets
Cash and cash equivalents	$	1		$	14,695		$	50,053		$	27,703		$	(1	)	$	92,451
Accounts receivable, net		—			(92	)		47,273			114,418			1			161,600
Inventories		—			—			28,050			122,411			—			150,461
Other current assets		6,285			5,359			7,997			11,554			—			31,195

Total current assets		6,286			19,962			133,373			276,086			—			435,707

Property, plant and equipment, net		—			—			288,678			491,273			—			779,951
Equity method investments		—			—			—			187,897			—			187,897
Intangible, other assets and deferred plant turnaround costs		2,543			12,146			10,484			27,349			—			52,522
Investments in and advances to (from) affiliates		741,456			602,265			1,334,486			702,224			(3,380,431	)		—

Total assets	$	750,285		$	634,373		$	1,767,021		$	1,684,829		$	(3,380,431	)	$	1,456,077

Liabilities
Debt due within one year	$	—		$	—		$	70		$	44		$	(1	)	$	113
Accounts payable		63			—			19,187			68,110			—			87,360
Accrued expenses and other current liabilities		2,325			78,501			31,390			22,126			(68,828	)		65,514

Total current liabilities		2,388			78,501			50,647			90,280			(68,829	)		152,987

Long-term debt and capital lease obligations		—			331,300			8			—			—			331,308
Deferred income taxes		(1,748	)		—			(2	)		75,784			2			74,036
Pension and other liabilities		115,081			(332	)		14,488			35,888			(2	)		165,123
Minority interest		—			19,180			78,878			—			1			98,059

Total liabilities		115,721			428,649			144,019			201,952			(68,828	)		821,513

Preferred stock		132,519			—			—			—			—			132,519

Shareholders’ Equity
Common stock		144,580			—			73			49,709			(49,782	)		144,580
Paid-in capital		693,875			150,218			1,774,396			1,485,227			(3,409,841	)		693,875
Accumulated other comprehensive loss and unearned compensation		(51,790	)		—			—			19,430			(19,430	)		(51,790	)
Retained earnings (deficit)		(284,620	)		55,506			(151,467	)		(71,489	)		167,450			(284,620	)

Total shareholders’ equity		502,045			205,724			1,623,002			1,482,877			(3,311,603	)		502,045

Total liabilities and shareholders equity	$	750,285		$	634,373		$	1,767,021		$	1,684,829		$	(3,380,431	)	$	1,456,077

Consolidating Statement of Operations for the three months ended June 30, 2005:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	150,187		$	336,069		$	1,159		$	487,415
Other income, net		—			—			3,358			378			(1,158	)		2,578

		—			—			153,545			336,447			1			489,993

Cost and Expenses
Cost of sales		—			—			131,203			276,955			429			408,587
Selling, general and administrative expenses		599			(2,452	)		13,102			2,937			1,860			16,046
Equity in the (earnings) loss of subsidiaries		(30,722	)		(40,527	)		—			(29,465	)		96,313			(4,401	)

Total cost and expenses		(30,123	)		(42,979	)		144,305			250,427			98,602			420,232

Income from operations		30,123			42,979			9,240			86,020			(98,601	)		69,761
Interest income		—			738			1,247			919			(1,237	)		1,667
Interest expense		(491	)		(11,588	)		(5	)		(3,662	)		1,616			(14,130	)
Loss on early retirement of debt		—			—			—			(16,389	)		—			(16,389	)
Change in fair value of warrant liability		3,960			—			—			—			—			3,960

Income before income taxes and minority interest		33,592			32,129			10,482			66,888			(98,222	)		44,869
Income tax provision		(11,890	)		—			—			(4,085	)		—			(15,975	)
Minority interest		—			(1,407	)		(5,785	)		—			—			(7,192	)

Net income	$	21,702		$	30,722		$	4,697		$	62,803		$	(98,222	)	$	21,702

Consolidating Statement of Operations for the six months ended June 30, 2005:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	279,561		$	651,513		$	4,264		$	935,338
Other income, net		—			—			8,127			804			(4,264	)		4,667

		—			—			287,688			652,317			—			940,005

Cost and Expenses
Cost of sales		—			—			255,892			567,230			(792	)		822,330
Selling, general and administrative expenses		1,097			(4,183	)		18,760			7,738			3,087			26,499
Equity in the (earnings) loss of subsidiaries		(33,684	)		(53,046	)		—			(34,472	)		111,795			(9,407	)

Total cost and expenses		(32,587	)		(57,229	)		274,652			540,496			114,090			839,422

Income from operations		32,587			57,229			13,036			111,821			(114,090	)		100,583
Interest income		—			1,504			2,364			1,917			(2,364	)		3,421
Interest expense		(981	)		(22,820	)		(10	)		(9,108	)		2,936			(29,983	)
Loss on early retirement of debt		—			—			—			(27,193	)		—			(27,193	)
Change in fair value
of warrant liability		8,860			—			—			—			—			8,860

Income before income taxes and minority interest		40,466			35,913			15,390			77,437			(113,518	)		55,688
Income tax provision		(14,333	)		—			—			(3,827	)		—			(18,160	)
Minority interest		—			(2,229	)		(9,167	)		—			1			(11,395	)

Net income	$	26,133		$	33,684		$	6,223		$	73,610		$	(113,517	)	$	26,133

Consolidating Statement of Cash Flows for the six months ended June 30, 2005:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Operating Activities
Net income	$	26,133		$	33,684		$	6,223		$	73,610		$	(113,517	)	$	26,133
Adjustments to reconcile net income to net cash flows from operating activities:
Loss on early retirement of debt		—			—			—			22,543			—			22,543
Change in fair value of warrants		(8,860	)		—			—			—			—			(8,860	)
Depreciation and amortization		—			—			21,533			38,603			(5	)		60,131
Deferred income taxes		22,707			—			—			297			(171	)		22,833
Minority interest in earnings		—			2,229			9,167			—			(1	)		11,395
Equity in (earnings) of subsidiaries		(33,684	)		(53,045	)		—			(34,472	)		111,794			(9,407	)
Amortization of unearned compensation		691			—			—			—			—			691
Term loan discount accretion		—			—			—			1,774			—			1,774
Change in operating assets and liabilities		(27,814	)		14,831			(64,674	)		(80,345	)		21,537			(136,465	)

Net Cash Flows from Operating Activities		(20,827	)		(2,301	)		(27,751	)		22,010			19,637			(9,232	)

Investing Activities
Capital expenditures		—			—			(1,846	)		(8,367	)		—			(10,213	)
Plant turnaround expenditures		—			—			—			(7,375	)		—			(7,375	)
Distributions received from unconsolidated affiliates		—			—			—			23,625			—			23,625

Net Cash Flows from Investing Activities		—			—			(1,846	)		7,883			—			6,037

Financing Activities
Principal payments on long-term debt		—			—			(52	)		(125,032	)		—			(125,084	)
Proceeds from exercise of stock options		114			—			—			—			—			114
Preferred stock dividends paid		(3,400	)		—			—			—			—			(3,400	)
Distributions to minority interests		—			(1,052	)		(4,483	)		—			—			(5,535	)
Change in investments and advances from (to) affiliates		24,113			(186,643	)		55,642			122,279			(15,391	)		—

Net Cash Flows from Financing Activities		20,827			(187,695	)		51,107			(2,753	)		(15,391	)		(133,905	)

Effect of Foreign Exchange Rate on Cash		—			—			—			—			(4,247	)		(4,247	)

Increase (decrease) in Cash and Cash Equivalents		—			(189,996	)		21,510			27,140			(1	)		(141,347	)

Cash and Cash Equivalents at Beginning of Year		1			204,691			28,543			563			—			233,798

Cash and Cash Equivalents at End of Year	$	1		$	14,695		$	50,053		$	27,703		$	(1	)	$	92,451

Consolidating Balance Sheet as of December 31, 2004:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Assets
Cash and cash equivalents	$	1		$	204,691		$	28,543		$	563		$	—		$	233,798
Accounts receivable		7			(75	)		31,181			119,158			—			150,271
Inventories		60			—			32,243			116,504			1			148,808
Other current assets		1,520			21,149			9,540			26,888			(991	)		58,106

Total current assets		1,588			225,765			101,507			263,113			(990	)		590,983

Property, plant and equipment, net		—			—			306,020			499,170			(7,212	)		797,978
Deferred plant turnaround costs, intangible and other assets		237			14,177			14,365			42,560			9,269			80,608
Equity method investments		—			—			—			215,939			—			215,939
Investment in and advanced to (from) affiliates		735,357			237,464			1,366,624			192,787			(2,532,232	)		—

Total Assets	$	737,182		$	477,406		$	1,788,516		$	1,213,569		$	(2,531,165	)	$	1,685,508

Liabilities
Debt due within one year	$	—		$	—		$	104		$	63		$	—		$	167
Accounts payable		515			1,600			26,385			94,218			(3,147	)		119,571
Accrued expenses and other current liabilities		50,466			7,426			79,233			84,058			(988	)		220,195

Total current liabilities		50,981			9,026			105,722			178,339			(988	)		339,933

Long-term debt and capital lease obligations		—			331,300			26			103,912			—			435,238
Deferred income taxes		(19,322	)		—			—			75,488			2,058			58,224
Pension and other liabilities		112,020			—			15,343			36,935			3,144			167,442
Minority interest		—			18,034			74,164			—			(1	)		92,197

Total liabilities and minority interest		143,679			358,360			195,255			394,674			1,066			1,093,034

Preferred Shares		133,069			—			—			—			—			133,069

Shareholders’ Equity
Common stock		144,531			—			72			49,709			(49,781	)		144,531
Paid in capital		681,639			150,218			1,750,879			892,400			(2,793,497	)		681,639
Accumulated other comprehensive income (loss) and unearned compensation		(58,562	)		(52,994	)		—			21,885			31,109			(58,562	)
Unearned compensation		(2,568	)		—			—			—			—			(2,568	)
Retained earnings (deficit)		(307,174	)		21,822			(157,690	)		(145,099	)		279,938			(308,203	)

Total shareholders’ equity		460,434			119,046			1,593,261			818,895			(2,532,231	)		459,405

Total liabilities and shareholders’ equity	$	737,182		$	477,406		$	1,788,516		$	1,213,569		$	(2,531,165	)	$	1,685,508

Consolidating Balance Sheet as of June 30, 2004:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Assets
Cash and cash equivalents	$	—		$	109,896		$	88		$	960		$	—		$	110,944
Accounts receivable, net		—			15			44,487			84,912			—			129,414
Inventories		—			—			25,391			64,624			—			90,015
Other current assets		2,592			18,852			6,546			8,749			—			36,739

Total current assets		2,592			128,763			76,512			159,245			—			367,112

Property, plant and equipment, net		—			—			323,076			355,993			(1,801	)		677,268
Investments in and advanced to (from) affiliates		414,967			416,798			1,285,102			112,133			(2,229,000	)		—
Other assets and deferred plant turnaround costs		(445	)		16,554			5,635			24,900			801			47,445

Total assets	$	417,114		$	562,115		$	1,690,325		$	652,271		$	(2,230,000	)	$	1,091,825

Liabilities
Debt due within one year	$	—		$	—		$	96		$	61		$	—		$	157
Accounts payable		56			—			31,365			45,519			—			76,940
Accrued and other liabilities		(15,283	)		21,376			24,345			42,359			—			72,797

Total current liabilities		(15,227	)		21,376			55,806			87,939			—			149,894

Long-term debt and capital lease obligations		—			402,000			79			44			—			402,123
Deferred income taxes		43,552			—			—			(12,116	)		—			31,436
Pension and other liabilities		89,907			(278	)		21,566			5,041			(1	)		116,235
Minority interest		—			18,241			75,014			—			—			93,255

Total liabilities		118,232			441,339			152,465			80,908			(1	)		792,943

Shareholders’ Equity
Common stock		129,094			—			72			49,709			(49,781	)		129,094
Paid-in capital		555,684			150,218			1,774,243			680,836			(2,605,297	)		555,684
Accumulated other comprehensive income (loss)		(47,221	)		(47,221	)		—			11,087			36,134			(47,221	)
Retained earnings (deficit)		(338,675	)		17,779			(236,455	)		(170,269	)		388,945			(338,675	)

Total shareholders’ equity		298,882			120,776			1,537,860			571,363			(2,229,999	)		298,882

Total liabilities and shareholders’ equity	$	417,114		$	562,115		$	1,690,325		$	652,271		$	(2,230,000	)	$	1,091,825

Consolidating Statement of Operations for the three months ended June 30, 2004:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	164,520		$	249,338		$	2,406		$	416,264
Other income, net		—			—			2,722			188			(2,406	)		504

		—			—			167,242			249,526			—			416,768

Cost and Expenses
Cost of sales		—			—			154,411			216,951			(784	)		370,578
Selling, general and administrative expenses		925			(914	)		5,936			2,567			781			9,295
Recovery of product claim costs		—			—			—			(2,389	)		—			(2,389	)
Equity in the (earnings) loss of subsidiaries		(16,080	)		(28,246	)		(1	)		—			44,327			—

		(15,155	)		(29,160	)		160,346			217,129			44,324			377,484

Income from operations		15,155			29,160			6,896			32,397			(44,324	)		39,284
Interest income		—			279			997			415			(1,079	)		612
Interest expense		(770	)		(12,662	)		(8	)		(1,095	)		1,095			(13,440	)
Income (loss) from operations before income taxes and minority interest		14,385			16,777			7,885			31,717			(44,308	)		26,456
Income tax benefit (provision)		3,480			—			—			(8,506	)		—			(5,025	)
Minority interest		—			(697	)		(2,869	)		—			—			(3,566	)

Net income	$	17,865		$	16,080		$	5,016		$	23,211		$	(44,307	)	$	17,865

Consolidating Statement of Operations for the six months ended June 30, 2004:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	227,008		$	495,647		$	4,070		$	776,725
Other income, net		—			—			4,849			293			(4,070	)		1,072

		—			—			281,857			495,940			—			777,797

Cost and Expenses
Cost of sales		—			—			265,260			429,128			(163	)		694,225
Selling, general and administrative expenses		1,831			(1,405	)		10,655			5,167			356			16,604
Recovery of product claim costs		—			—			—			(17,903	)		—			(17,903	)
Equity in the (earnings) loss of subsidiaries		(41,749	)		(66,358	)		(861	)		—			108,968			—

		(39,918	)		(67,763	)		275,054			416,392			109,161			692,926

Income (loss) from operations		39,918			67,763			6,803			79,548			(109,161	)		84,871
Interest income		—			640			1,969			588			(2,208	)		989
Interest expense		(1,539	)		(25,383	)		(16	)		(2,243	)		2,240			(26,941	)
Income (loss) from operations before income taxes and minority interest		38,379			43,020			8,756			77,893			(109,129	)		58,919
Income tax provision		(2,284	)		—			—			(14,041	)		—			(16,325	)
Minority interest		—			(1,271	)		(5,228	)		—			—			(6,499	)

Net income (loss)	$	36,095		$	41,749		$	3,528		$	63,852		$	(109,129	)	$	36,095

Consolidating Statement of Cash Flows for the six months ended June 30, 2004:


(in thousands)	Parent			TCAPI			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Operating Activities
Net income	$	36,095		$	41,749		$	3,528		$	63,852		$	(109,129	)	$	36,095
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Depreciation and amortization		—			2,096			23,517			24,871			—			50,484
Deferred income taxes		13,273			—			—			332			2,921			16,526
Minority interest in earnings		—			1,271			5,228			—			—			6,499
Recovery of product
claim costs		—			—			—			(12,874	)		—			(12,874	)
Equity in earnings (loss) of subsidiaries		41,749			66,358			861			—			(108,968	)		—
Change in operating assets and liabilities		(12,122	)		(15,280	)		2,275			(40,092	)		(1,395	)		(66,614	)

Net Cash Flows from Operating Activities		78,995			96,194			39,409			36,089			(216,571	)		30,116

Investing Activities
Capital expenditures		—			—			(412	)		(3,013	)		—			(3,425	)
Plant turnaround expenditures		—			—			(666	)		(153	)		—			(819	)

Net Cash Flows from Investing Activities		—			—			(1,078	)		(3,166	)		—			(4,244	)

Financing Activities
Principal payments on long-term debt and capital lease obligations		—			—			(50	)		(29	)		—			(79	)
Change in investments and advances from (to) affiliates		(79,264	)		(60,479	)		(38,076	)		(38,898	)		216,717			—
Stock issuance, net		269			—			—			—			—			269
Distributions to minority interests		—			(450	)		(1,856	)		—			—			(2,306	)

Net Cash Flows from Financing Activities		(78,995	)		(60,929	)		(39,982	)		(38,927	)		216,717			(2,116	)

Effect of Foreign Exchange Rate on Cash		—			—			—			—			(146	)		(146	)

Increase (decrease) in Cash and Cash Equivalents		—			35,265			(5,651	)		(6,004	)		—			23,610

Cash and Cash Equivalents at Beginning of Year		—			74,631			5,739			6,964			—			87,334

Cash and Cash Equivalents at End of Year	$	—		$	109,896		$	88		$	960		$	—		$	110,944

12.	Related Party Transactions

At December 31, 2004, Perry Corporation and its affiliates are the beneficial owners of 11.7% of Terra’s outstanding shares.

In connection with the acquisition of MCC, an affiliate of Perry is co-joint lead arranger and a lender for a portion of the $125.0 million term loan due in 2008. During the first six months of 2005, Terra paid interest of $1.0 million on the portion of the term loan held by the Perry affiliate. In March 2005, Terra prepaid an aggregate of $50.0 million of the term loan. The Perry affiliate received $23.3 of the $50.0 million payment. In June 2005, Terra prepaid an aggregate of $75.0 million of the term loan. The Perry affiliate received $34.9 of the $75.0 million payment.

In connection with the $50.0 million prepayment, Terra paid a prepayment penalty of $1.4 million. The Perry affiliate received $0.6 million of the prepayment penalty. In connection with the $75.0 prepayment, the company paid a prepayment penalty of $3.3 million. The Perry affiliate received $1.5 million of the prepayment penalty.

13.	Subsequent Event

On June 20, 2005, the company announced the redemption of the 167,184 outstanding Series B Cumulative Redeemable Preferred Shares (“Series B Preferred Shares”). On July 25, 2005, the Series B Preferred Shares expired and the Series B Preferred Shares will convert to the company’s Common Stock at a conversion rate of 12.3762 shares of Common Stock for each Series B Preferred Share, or approximately 2,069,103 shares of Common Stock. All other rights associated with the Series B Preferred Shares have expired. The company will issue Common Stock as the Series B Preferred Shares certificates are presented to the company.

Of the 167,184 Series B Preferred Shares that were outstanding as of June 30, 2005, 100,000 shares were held in escrow for the settlement of any claims against the company to satisfy obligations resulting from the breach of representation, warranties or covenants contained the MCC Stock Purchase Agreement.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION

Introduction

Terra produces and markets nitrogen products for agricultural and industrial markets with production facilities located in North America and the United Kingdom. Nitrogen products are commodity chemicals that are sold at prices reflecting global supply and demand conditions. The nitrogen products industry has cycles of oversupply, resulting in lower prices and idled capacity, followed by supply shortages, resulting in high selling prices and higher industry-wide production rates. In order to be viable in this industry, a producer must be among the low-cost suppliers in the markets it serves and have a financial position that can sustain it during periods of oversupply.

Natural gas is the most significant raw material in the production of nitrogen products. North American natural gas costs have increased substantially since 1999. Since Terra competes with nitrogen products imported from regions with lower natural gas costs, the oversupply situation during most of the three years ending December 31, 2003 did not allow the company and other North American producers to increase selling prices to levels necessary to cover the natural gas cost increases. This resulted in curtailments of North American nitrogen production that have contributed to higher nitrogen product prices through reductions to global supplies.

Imports, most of which are produced at facilities with access to fixed-price natural gas supplies, account for a significant portion of U.S. nitrogen product supply. Imported products’ natural gas costs have been and could continue to be substantially lower than the delivered cost of natural gas to Terra’s facilities. Off-shore producers are most competitive in regions close to the point of entry for imports, including the Gulf Coast and East Coast of North America.

Terra’s sales volumes depend primarily on its plants’ operating rates. The company may purchase product from other manufacturers or importers for resale, but gross margins on those volumes are rarely significant. Profitability and cash flows from Terra’s nitrogen products business are affected by the company’s ability to manage its costs and expenses (other than natural gas), most of which do not materially change for different levels of production or sales. Other factors affecting Terra’s nitrogen products results include the level of planted acres, transportation costs, weather conditions (particularly during the planting season), grain prices and other variables described in Items 1 and 2 “Business and Properties” section of Terra’s most recent Form 10-K filing with the Securities and Exchange Commission.

RESULTS OF OPERATIONS

QUARTER ENDED JUNE 30, 2005 COMPARED WITH QUARTER ENDED JUNE 30, 2004

Consolidated Results

Terra reported net income of $21.7 million for the 2005 second quarter compared with a 2004 net income of $17.9 million. The increase is due to a 17% increase in revenue and a gain of $4.0 million on the fair value adjustment of warrants, offset by a 10% increase in cost of sales and a $16.4 million loss on the early retirement of debt. The increase in revenues was primarily due to sales increases related to the MCC operations acquired in December 2004 and higher sales prices offset by the volume decrease associated with the company’s Blytheville, Arkansas and Beaumont, Texas operations which were closed during 2004. Sales prices were higher due to increased demand and lower supplies primarily due to reduced production capacity in North America. The increase in cost of sales was primarily due to higher gas costs and the cost of additional volumes sold by MCC, offset by lower volumes from the closed facilities. Selling, general and administrative expenses were $6.7 million higher than the 2004 second quarter due primarily to continuing expenses associated with the MCC operations and higher incentive accruals.

Terra classifies its operations into two business segments: nitrogen products and methanol. The nitrogen products segment represents operations directly related to the wholesale sales of nitrogen products from the company’s ammonia production and upgrading facilities. The methanol segment represents wholesale sales of methanol produced by Terra’s two methanol manufacturing plants.

Total revenues and income (loss) from operations by segment for the three-month period ended June 30, 2005 and 2004 follow:


(in thousands)	2005			2004
REVENUES:
Nitrogen Products	$	479,516		$	362,518
Methanol		9,866			53,746
Other - net		611			504

	$	489,993		$	416,768

INCOME (LOSS) FROM OPERATIONS:
Nitrogen Products	$	73,839		$	42,012
Methanol		(2,415	)		(924	)
Other - net		(1,663	)		(1,804	)

	$	69,761		$	39,284

Nitrogen Products

Volumes and prices for the three-month periods ended June 30, 2005 and 2004 follow:

VOLUMES AND PRICES


	2005			2004
(quantities in thousands of tons)	Sales Volumes	Average Unit Price*		Sales Volumes	Average Unit Price*
Ammonia	527	$	294	452	$	248
Nitrogen solutions	1,097		162	1,108		126
Urea	40		259	135		183
Ammonium nitrate	333		201	176		173

*	After deducting outbound freight costs

Nitrogen products segment revenues increased $117.0 million to $479.5 million in the 2005 second quarter compared with $362.5 million in the 2004 second quarter primarily as a result of $85.7 million sales increase related to the MCC operations and higher sales prices of approximately $78.2 million, offset by volume decreases of approximately $46.9 million primarily resulting from the Blytheville facility closure. Sales prices were higher as the result of increased demand and lower supplies primarily due to reduced production capacity in North America.

The nitrogen products segment had operating income of $73.8 million for the 2005 second quarter compared with income from operations of $42.0 million for the 2004 period. The 2005 second quarter included $17.2 million of income from operations from the MCC operations acquired in December 2004. Second quarter natural gas costs increased approximately $49.0 million from the 2004 period. Natural gas unit costs, net of forward pricing gains and losses, were $6.40/MMBtu during the 2005 second quarter compared to $5.17/MMBtu during the same 2004 period. As a result of forward price contracts, second quarter 2005 natural gas costs for the nitrogen products segment were $2.2 million lower than spot prices.

Methanol

For the three months ended June 30, 2005 and 2004 the Methanol segment had revenues of $9.9 million and $53.7 million, respectively. The decrease was primarily due to the cessation of production at the company’s Beaumont, Texas facility.

In November 1, 2004, Terra received notification from Methanex Corporation, under the terms of its agreement, to cease production at Terra’s Beaumont, Texas methanol manufacturing facility on December 1, 2004. Terra sold to Methanex its sales contracts and rights to the full output of the Beaumont plant for five years ending December 31, 2008, for a received lump-sum payment of $25 million and a share of cash gross profits generated from Beaumont sales. The agreement gave Methanex the right to cease production at the Beaumont facility. Methanex elected to shut down the Beaumont facility as of December 1, 2004. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, Terra will continue to realize revenues relating to the facility of up to $16.4 million per year due to $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin based on the plant’s methanol production capacity, methanol referenced prices and natural gas costs.

The methanol segment had an operating loss of $2.4 million for the 2005 second quarter compared to an operating loss of $0.9 million for the 2004 second quarter. The increase to the operating loss reflected the result of lower volumes and idle facility costs. Terra recorded 2005 revenue of $1.2 million under the profit sharing provision of the Methanex contract based on published methanol prices and natural gas costs.

Other – Net

Terra had other operating losses of $1.7 million in the 2005 second quarter compared to $1.8 million operating loss in the 2004 second quarter. The reduction to expenses relates primarily to lower 2005 legal and administrative expenses related to corporate activities not assignable to either business segment.

Interest Expense - Net

Interest expense, net of interest income, remained relatively constant at $12.5 million during the 2005 second quarter as compared to $12.8 million for the prior year period due primarily to higher borrowings related to the MCC acquisition, offset by an increase in interest income from cash equivalents.

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 2005 and 2004 amounts are directly related to TNCLP earnings and losses.

Income Taxes

Income taxes for the second quarter 2005 were recorded based on the estimated annual effective tax rate for the individual jurisdictions in which Terra operates. The annual effective tax rate was 42.4% and 22.0% in the quarters ended June 30, 2005 and 2004, respectively. The tax rate increase was due primarily to permanent differences in book and taxable income relating to the prepayment of debt and the change in the fair value of the warrant liability for the three-month ended June 30, 2005 period as compared to the same period of 2004.

RESULTS OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 2005 COMPARED WITH SIX MONTHS ENDED JUNE 30, 2004

Consolidated Results

Terra reported net income of $26.1 million for the first six months ending June 30, 2005 compared to net income of $36.1 million for the same period in 2004. The decrease results from losses of $27.2 million associated with the early payment of debt, offset by an $8.9 million gain on the market value adjustment of the warrants. Sales increased by $162.2 million, primarily due to increased volume from the MCC acquisition and price increases, offset by volume decreases from the closure of the Beaumont and Blytheville facilities.

The increase in cost of sales was primarily due to higher gas costs and the cost of additional volumes sold by MCC, offset by lower volumes from the closed Blytheville facility. Selling, general and administrative expenses increased approximately $9.9 million primarily as a result of transition and continuing costs associated with the MCC acquisition, incentive accruals and professional fees.

Total revenues and operating income (loss) by segment for the six-month period ended June 30, 2005 and 2004 follow:


(in thousands)	2005			2004
REVENUES:
Nitrogen Products	$	918,838		$	680,075
Methanol		19,953			96,650
Other		1,214			1,072

	$	940,005		$	777,797

OPERATING INCOME (LOSS):
Nitrogen Products	$	105,497		$	91,430
Methanol		(3,089	)		(2,970	)
Other income - net		(1,825	)		(3,589	)

	$	100,583		$	84,871

Nitrogen Products

Volumes and prices for the six-month periods ended June 30, 2005 and 2004 follow:


	2005			2004
(quantities in thousands of tons)	Sales Volumes	Average Unit Price*		Sales Volumes	Average Unit Price*
Ammonia	1,018	$	283	763	$	257
Nitrogen solutions	2,185		149	1,983		120
Urea	86		249	292		186
Ammonium nitrate	738		194	424		182

*	After deducting outbound freight costs

Nitrogen products segment revenues increased $238.7 million to $918.8 million in the 2005 first half compared with $680.1 million in the 2004 first half primarily as a result of a $161.5 million increase related to the MCC operations acquired in December 2004 and higher sales prices of approximately

$101.1 million, offset by volume decreases of approximately $23.9 million primarily resulting from the Blytheville facility closure. Sales prices were higher as the result of increased demand and lower supplies primarily due to reduced production capacity in North America.

The nitrogen products segment had operating income of $105.5 million for the first half of 2005 compared with operating income of $91.4 million for the 2004 first half. The first half of 2005 included $25.7 million of income from operations from the MCC operations acquired in December 2004. Recovery of product claim costs contributed $17.9 million to 2004 first half operating income. First half natural gas costs increased approximately $82.9 million from the same period of 2004. Natural gas unit costs, net of forward pricing gains and losses, were $6.57/MMBtu during the 2005 first half compared to $5.14/MMBtu during the same 2004 period. As a result of forward price contracts, first half 2005 natural gas costs for the nitrogen products segment were $7.9 million higher than spot prices.

Methanol

For the six months ended June 30, 2005 and 2004 the Methanol segment had revenues of $19.9 million and $96.6 million, respectively. Sales volumes declined 88% from prior year levels primarily due to cessation of production from the Beaumont facility. Selling prices increased from $.67 /gallon in 2004 to $.85/gallon in 2005. Selling prices increased in response to increased natural gas costs.

The methanol segment had an operating loss of $3.1 million for the first six months of 2005 compared to an operating loss of $3.0 million for the first six months of 2004. The increase to the operating loss reflected the result of lower volumes and idle facility costs. Terra recorded 2005 revenue of $3.1 million under the profit sharing provision of the Methanex contract based on published methanol prices and natural gas costs.

Other Income – Net

Terra had other operating losses of $1.8 million in the 2005 first half compared to $3.6 million operating loss in the 2004 first half. The decrease in expenses relates primarily to legal and administrative expenses related to corporate activities not assignable to either business segment.

Interest Expense - Net

Interest expense, net of interest income, totaled $26.6 million during the first six months of 2005 compared with $26.0 million for the prior year period. The increase to interest expense primarily results from the MCC acquisition debt incurred in December 2004 offset by additional interest income from investments.

Minority Interest

Income Taxes

Income taxes for the first half of 2005 were recorded based on the estimated annual effective tax rate for the individual jurisdictions in which Terra operates. The annual effective tax rate was 41.0% and 31.1 % in the six months ended June 30, 2005 and 2004, respectively. The tax rate increase was due primarily to permanent differences in book and taxable income related to the prepayment of debt and the change in the fair value of warrants for the six month period ended June 30, 2005 as compared to the same period of 2004.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents totaled $92.5 million at June 30, 2005, all of which is unrestricted. Terra’s other primary uses of funds are to fund its working capital requirements, make payments on its debt and other obligations and fund plant turnarounds and capital expenditures. The principle sources of funds will be cash flow from operations and borrowings under available bank facilities.

Net cash used by operations in the first six months of 2005 was $9.2 million, composed of $127.2 million of cash provided from operating activities, offset by $136.5 million used to fund seasonal working capital needs. The primary working capital use of cash represented shipments to satisfy customer prepayments of $115.3 million at December 31, 2004.

During the first six months, Terra funded plant and equipment purchases of $10.2 million primarily for replacement or stay-in-business capital needs. The company expects 2005 plant and equipment purchases to approximate $25 million consisting primarily of expenditures for replacement of equipment at manufacturing facilities.

Plant turnaround costs represent cash used for the periodic scheduled major maintenance of the company’s continuous process production facilities that is performed at each plant generally every two years. Terra funded $7.4 million of plant turnaround costs in the first six months of 2005. The company estimates 2005 plant turnaround costs will approximate $35 million.

Terra has revolving credit facilities totaling $200 million that expire in June 2008. Borrowing availability under the credit facility 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 only available for the use of TNCLP, one of Terra’s consolidated subsidiaries. At June 30, 2005, borrowing availabilities exceeded the credit facilities’ $200 million maximum. There were no outstanding revolving credit borrowings and there were $17.2 million in outstanding letters of credit, resulting in remaining borrowing availability of approximately $182.8 million under the facilities. Terra is required to maintain a combined minimum unused borrowing availability of $30 million. The credit facility also requires that the company 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 Terra’s borrowing availability falls below a combined $60 million, the company is 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 credit facility) for the preceding four quarters.

In March 2005, Terra repaid $50.0 million of the term loan from available cash. In June 2005, Terra repaid $75.0 million of the term loan from available cash.

Terra paid dividends on the outstanding preferred stock of $2.1 million and $1.3 million in March 2005 and June 2005, respectively.

Terra’s ability to meet credit facility 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 credit facility or could result in termination of the facility. Access to adequate bank facilities is critical to funding the company’s operating cash needs. Based on current market conditions for our finished products and natural gas, the company anticipates

that Terra will be able to meet its covenants through 2005. If there were to be any adverse changes in the factors discussed above, Terra may need a waiver of its credit facility covenants and there is no assurance it could receive such waivers.

Terra’s cash contributions to pension plans are estimated at $10 million in 2005. Actual contributions could vary from these estimates depending on actual returns for plan assets, legislative changes to pension funding requirements and/or plan amendments.

Distributions paid to the minority TNCLP common unitholders in the first six months of 2005 and 2004 were $5.5 million and $2.3 million, respectively. TNCLP distributions are based on “Available Cash” (as defined in the Partnership Agreement).

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks relating to Terra’s operations result primarily from interest rates, foreign exchange rates, natural gas prices and nitrogen prices. Terra manages its exposure to these and other market risks through regular operating and financing activities and through the use of derivative financial instruments. Terra intends to use derivative financial instruments as risk management tools and not for speculative investment purposes. Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of Terra’s Annual Report on Form 10-K for the year ended December 31, 2004 provides more information as to the types of practices and instruments used to manage risk. There was no material change in Terra’s exposure to market risks since December 31, 2004.

ITEM 4. CONTROLS AND PROCEDURES

Our Chief Executive Officer and Chief Financial Officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures are effective to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms.

There were no changes in our internal control over financial reporting that occurred during our most recent fiscal quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

FORWARD-LOOKING PRECAUTIONS

Information contained in this report, other than historical information, may be considered forward looking. Forward-looking information reflects management’s current views of future events and financial performance that involve a number of risks and uncertainties. The factors that could cause actual results to differ materially include, but are not limited to, the following: changes in financial markets, general economic conditions within the agricultural industry, competitive factors and price changes (principally, sales prices of nitrogen and methanol products and natural gas costs), changes in product mix, changes in the seasonality of demand patterns, changes in weather conditions, changes in agricultural regulations, and other risks detailed in the “Factors that Affect Operating Results” section of Terra’s most recent Form 10-K.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The Company is involved in various claims and legal actions arising in the ordinary course of business, including employee injury claims. In the opinion of management, the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operations or liquidity and the likelihood that a loss contingency will occur in connection with these claims is remote.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

None

ITEM 5. OTHER INFORMATION

None

ITEM 6. EXHIBITS

(a)

Exhibits


Exhibit 31.1		Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 31.2		Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

Exhibit 32		Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

SIGNATURE

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		TERRA INDUSTRIES INC.

Date: August 9, 2005		/s/ Francis G. Meyer
		Francis G. Meyer
		Senior Vice President and Chief Financial Officer and a duly authorized signatory

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