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  **UNITED STATES SECURITIES AND EXCHANGE COMMISSION****Washington, D.C. 20549****FORM 10-K**** **(Mark One)   þ **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934****For the fiscal year ended December 31, 2006****OR**   o **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 (I.R.S. Employer Identification No.)incorporation or organization)     **Terra Centre** **51102-6000****600 Fourth Street** (Zip Code)**P. O. Box 6000**  **Sioux City, Iowa** **(712) 277-1340**(Address of principal executive offices) (Registrant’s telephone number)**Securities registered pursuant to Section 12(b) of the Act:**     Name of each exchangeTitle of each class on which registered   Common Shares, without par value New York Stock Exchange**Securities registered pursuant to section 12(g) of the Act:**NoneIndicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 ofthe Securities Act. Yes o No þIndicate by check mark if the registrant is not required to file reports pursuant to Section 13 orSection 15(d) of the Act. Yeso No þIndicate by check mark whether the registrant (1) has filed all reports required to be filed bySection 13 or 15(d) of the Exchange during the preceding 12 months (or for such shorter period thatthe registrant was required to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes þ No oIndicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K isnot contained herein, and will not be contained, to the best of Registrant’s knowledge, indefinitive proxy or information statement incorporated by reference in Part III of this Form 10-Kor any amendment to this Form 10-K. oIndicate 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 Rule12b-2 of the Act).Large Accelerated Filero      Accelerated Filer þ      Non-accelerated Filer oIndicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of theAct). Yeso No þThe aggregate market value of the voting and non-voting common shares held by non-affiliatescomputed by reference to the price at which the common shares were last sold, or the average bidand asked price of such common shares, as of the last business day of the registrant’s mostrecently completed second fiscal quarter was $580,794,088.42.The number of Common Shares, without par value, outstanding as of March 1, 2007 was 92,756,438.**Documents Incorporated by Reference**Certain portions of the proxy statement for the Annual Meeting of Shareholders of Registrantto be held on May 8, 2007 are incorporated herein by reference into Part III hereof.  
 

 
**Table of Contents**     **Part I**         Item 1. Business  1 Item 1A. Risk Factors  14 Item 1B. Unresolved Staff Comments  18 Item 2. Properties  18 Item 3. Legal Proceedings  20 Item 4. Submission of Matters to a Vote of Security Holders  20 Executive Officers of Terra  20      **Part II**    Item 5. Market for Terra’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities  21 Item 6. Selected Financial Data  22 Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations  22 Item 7A. Quantitative and Qualitative Disclosures About Market Risk  37 Item 8. Financial Statements and Supplementary Data  40 Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures  90 Item 9A. Controls and Procedures  90 Item 9B. Other Information  93      **Part III**    Item 10. Directors and Executive Officers of Terra  93 Item 11. Executive Compensation  93 Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters  93 Item 13. Certain Relationships and Related Transactions  94 Item 14. Principal Accounting Fees and Services  94      **Part IV**    Item 15. Exhibits and Financial Statement Schedules  95 Signatures  104 Index to Financial Statement Schedules, Reports and Consents  S-1  Ratio of Earnings to Financial Charges Subsidiaries Consent Certification Certification Certification Financial Statements
 

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**PART I****Item 1. Business**Terra Industries Inc., a Maryland corporation, is referred to as “Terra,” or “the Company”throughout this report. References to Terra also include the direct and indirect subsidiaries ofTerra Industries Inc. where required by the context. Subsidiaries not wholly-owned by Terrainclude a limited partnership, Terra Nitrogen Company, L.P. (“TNCLP”), which, through itssubsidiary, Terra Nitrogen, Limited Partnership, operates Terra’s manufacturing facility atVerdigris, Oklahoma. Terra is the sole general partner and the majority limited partner of TNCLP.Terra’s principal corporate office is located at Terra Centre, 600 Fourth Street, P.O. Box 6000,Sioux City, Iowa 51102-6000 and its telephone number is (712) 277-1340.Terra makes available free of charge through its website, www.terraindustries.com, its AnnualReport on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and allamendments to those reports as soon as reasonably practicable after such material iselectronically filed with the Securities and Exchange Commission. Terra’s internet website and theinformation contained or incorporated therein are not intended to be incorporated into this AnnualReport on Form 10-K.**Business Overview**Terra is a leading North American and U.K. producer and marketer of nitrogen products,serving agricultural and industrial markets. In addition, Terra owns a 50% interest in Point LisasNitrogen Limited (“PLNL”), an ammonia production joint venture in the Republic of Trinidad andTobago. Terra is one of the largest North American producers of ammonia, the basic building blockof nitrogen fertilizers. The Company upgrades a significant portion of the ammonia it producesinto higher value products, which are easier for distributors and farmers to transport, store andapply to crops than ammonia. Terra owns nine manufacturing facilities in North America and theU.K. capable of producing nitrogen products. Two of these facilities (Beaumont, Texas andWoodward, Oklahoma) can also produce methanol. The Beaumont, Texas facility, which historicallyhad been a significant methanol producer, was mothballed in December 2004 and the Donaldsonville,Louisiana ammonia plant was mothballed in the first quarter of 2005. These two facilities remainout of production.Terra’s business is organized into a nitrogen business segment and a methanol business segment.The methanol segment has become less significant to the Company’s business since the closing ofthe Beaumont, Texas facility.Nitrogen is both a global and local commodity: global because it is produced and traded in almostall regions of the world, local because fertilizer customers display preferences for nitrogen inone of four basic forms based upon local conditions. The principal forms of globally tradednitrogen fertilizer are ammonia (82% nitrogen by weight) and urea (46% nitrogen by weight).Ammonium nitrate (AN) (34% nitrogen by weight) is traded in international markets. Urea ammoniumnitrate solution (UAN) (28% to 32% nitrogen by weight) is used principally in North America andhas only recently been traded in international markets to a lesser extent. UAN’s high watercontent and need to be transported in tankers can cause transportation costs per ton of nitrogento be higher than other forms of internationally traded nitrogen products. Because transportationis a significant component of a customer’s total product cost, a key to competitiveness in thenitrogen business is proximity to the end user, which allows a supplier to have the lowestdelivered cost for the customer’s product of choice. In addition, a supplier must provide areliable source of product.
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The locations of Terra’s North American production facilities provide Terra a competitiveadvantage in serving agricultural customers in the Corn Belt and other major agricultural areas inthe United States and Canada. Terra’s U.K. facilities are able to serve competitively the entireBritish agricultural market. The Point Lisas ammonia production facility in Trinidad and Tobagoserves U.S. and international nitrogen markets and benefits from access to low-cost natural gassupplies. Terra’s facilities have the following production capacities:                       **Annual Capacity****1** **Location** **Ammonia****2**  **UAN****3**  **AN****4**  **Urea****5**  **Methanol****6**  Beaumont, Texas7  255,000   —   —   —   225,000,000 Donaldsonville, Louisiana8  500,000   —   —   —   — Port Neal, Iowa  370,000   840,000   —   60,000   — Verdigris, Oklahoma  1,050,000   2,200,000   —   —   — Woodward, Oklahoma9  440,000   340,000   —   25,000   40,000,000 Yazoo City, Mississippi10  500,000   600,000   775,00011  7,000   — Courtright, Ontario  480,000   400,000   —   175,000   — Severnside, U.K.  265,000   —   500,000   —   — Billingham, U.K.12  550,000   —   520,000   —   — Point Lisas, Trinidad and Tobago13  360,000   —   —   —   —  Total  4,770,000   4,380,000   1,795,000   267,000   265,000,000   1. Annual capacity includes an allowance for planned maintenance shutdowns. 2. Measured in gross tons of ammonia produced; net tons available for sale willvary with upgrading requirements. 3. Measured in tons of UAN containing 28% nitrogen by weight. 4. Measured in tons. 5. Urea is sold as urea liquor from the Port Neal, Woodward and Yazoo Cityfacilities and as either granular urea or urea liquor from the Courtright facility.Production capacities shown are for urea sold in tons. 6. Measured in gallons. 7. The Beaumont facility was mothballed in December 2004 and remains out ofproduction. The Beaumont plant capacity depends on product mix (ammonia/methanol). 8. The Donaldsonville facility’s manufacturing capacity consists of a singleammonia plant. This plant was mothballed in January 2005 and remains out ofproduction. 9. Woodward’s plant capacity depends on product mix (ammonia/methanol). 10. The Yazoo City facility also produces merchant nitric acid; sales for thetwelve months ended December 31, 2006 were 71,000 product tons. 11. Terra’s full AN capacity at Yazoo City is 835,000 tons, however such productionwould limit Yazoo City’s UAN production to approximately 450,000 tons and increaseurea production to 45,000 tons. The plant has the ability to produce bothagricultural grade AN and industrial grade AN (IGAN). 12. The Billingham, England facility also produces merchant nitric acid; sales forthe twelve months ended December 31, 2006 were 282,000 product tons. 13. The Point Lisas plant capacity represents Terra’s 50% interest.
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The principal customers for Terra’s North American nitrogen products are nationalagricultural retail chains, farm cooperatives, independent dealers and industrial customers.Industrial customers use nitrogen products to manufacture chemicals, plastics and other productssuch as acrylonitrile, polyurethanes, fibers, explosives and adhesives; to reduce nitrogen oxides(NOx) and other emissions from power plants; and in water treatment processes.Agricultural customers accounted for approximately 70% and industrial customers approximately 30%of Terra’s North American nitrogen product revenue in 2006. For more information on the nitrogenbusiness, see the discussion under “Nitrogen Business Segment” below.               **% of Total** **U.S.** **U.K.**  **2006 Terra** **Capacity** **Capacity****Product** **Revenues****1** **Position** **Position** Ammonia  34.9%  1   1 UAN  31.4%  1   * AN  16.6%  1   1 Solid Urea  2.2%  4*  * Methanol  2.0 %  1   *  1 Revenues from sales of carbon dioxide, nitric acid and othernitrogen products and services, as well as industrial sales inthe U.K., represented 12.9% of Terra’s total revenues for 2006. * Terra does not produce in these markets. Terra producesgranular urea at its Courtright, Ontario facility.In December 2003, Terra entered into contracts with the Methanex Corporation (“Methanex”),providing it exclusive rights to all methanol production at the Beaumont facility for five years.In December 2004, this facility was mothballed. As long as the Beaumont facility remains idlethrough the December 2008 termination of the Methanex contract, Terra will continue to realizerevenues relating to the facility of up to $16.4 million per year consisting of $4.4 million fromannual amortization of deferred revenues plus one-half of the annual cash margin, if any, based onthe plant’s methanol production capacity, reference prices and natural gas costs. In 2006, theCompany recorded $12.0 million in revenue related to the cash margin clause of the Methanexagreement. No revenue was recorded in 2005 relating to the cash margin clause of the Methanexagreement due to the high natural gas prices. Terra also entered into an agreement for Methanexto market, under a commission arrangement, all methanol produced at the Woodward facility. Formore information on the methanol business, see the discussion under “Methanol Business Segment”below.**Nitrogen Business Segment**Terra is a leading producer and marketer of nitrogen products, principally fertilizers. TheCompany upgrades a significant portion of the ammonia it produces into other nitrogen products,such as urea, ammonium nitrate (AN) and urea ammonium nitrate solutions (UAN). Ammonia, AN, ureaand UAN are the principal nitrogen products the Company produces and sells in North America. Terraproduces and sells primarily ammonia and AN in the U.K. The Point Lisas production facility inTrinidad provides ammonia for sale into both the U.S. and international nitrogen markets. Otherproducts Terra manufactures include nitric acid, dinitrogen tetroxide and carbon dioxide. Theseproducts, along with a portion of Terra’s ammonia, AN and urea production, are used innon-agricultural applications. In 2003, Terra formed its Terra Environmental Technologies divisionto provide products and services to customers using nitrogen products (primarily ammonia, aquaammonia and liquid and dry urea) to reduce nitrogen oxides (NOx) emissions from various sources,including power plants, and in other environmental processes such as water treatment plants.Although the different nitrogen fertilizer products are interchangeable to some extent, each hasits own characteristics which make one product or another preferable to the end-user. Terra’splants are designed to provide the fertilizer products preferred by end-users in the regions inwhich they are located. These preferences vary according to the crop planted, soil and weatherconditions, regional farming practices,
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relative prices, and the cost and availability of storage, handling and application equipment.Terra’s nitrogen products and its 2006 production are described in greater detail below.*Anhydrous Ammonia*Anhydrous ammonia (or “ammonia”) is the simplest form of nitrogen fertilizer and the feedstock forthe production of other nitrogen fertilizers, including urea, AN and UAN. Ammonia is also a vitalraw material for many industrial applications. Terra is the leading U.S. producer of ammonia.Ammonia is produced when natural gas reacts with steam and air at high temperatures and pressuresin the presence of catalysts. Ammonia has a nitrogen content of 82% by weight and is generally theleast expensive form of fertilizer on a per-pound-of- contained-nitrogen basis. Although generallythe cheapest source of nitrogen available to agricultural customers, ammonia can be less desirableto end-users than urea, AN and UAN because of its need for specialized application equipment andits limited application flexibility.In 2006, Terra produced approximately 2,632,000 tons of ammonia at its North American facilitiesand approximately 505,000 tons of ammonia at its U.K. facilities. The Company is obligated bycontract through 2018 to purchase one-half of the ammonia produced by Point Lisas Nitrogen inTrinidad at a discount to market, subject to a minimum price. In 2006, Terra purchasedapproximately 307,000 tons pursuant to its contract with Point Lisas Nitrogen. Terra sold a totalof 1,897,000 tons of ammonia worldwide in 2006 and consumed approximately 2,204,000 tons ofammonia as a raw material to manufacture its other nitrogen products.*Urea Ammonium Nitrate Solutions (UAN)*UAN is a liquid fertilizer and, unlike ammonia, is odorless and does not require refrigeration orpressurization for transportation or storage. UAN is produced by combining liquid urea, liquidammonium nitrate and water. The nitrogen content of UAN ranges from 28% to 32% by weight. (Unlessspecifically stated to the contrary, all references to UAN herein shall be to 28%.) Because of itshigh water content, UAN is relatively expensive to transport, making it largely a regionallydistributed product.UAN can be applied to crops directly or mixed with crop protection products, permitting theapplication of several materials simultaneously, reducing energy and labor costs and acceleratingfield preparation for planting. UAN may be applied from ordinary tanks and trucks and sprayed orinjected into the soil, or applied through irrigation systems. In addition, UAN may be appliedthroughout the growing season, providing significant application flexibility. Due to itsstability, UAN (like AN) may be used for no-till row crops where fertilizer is spread on thesurface of the soil and is subject to evaporation losses.Terra produced approximately 3,710,000 tons of UAN at its North American facilities in 2006 andsold approximately 4,368,000 tons of UAN in 2006, primarily to U.S. fertilizer dealers anddistributors.*Ammonium Nitrate (AN)*Terra is the largest manufacturer and marketer of agricultural-grade AN fertilizer in the U.S. andproduces AN at two facilities in the U.K. AN is produced by combining nitric acid and ammonia intoa liquid form which is then converted to a solid, largely for fertilizer applications. Thenitrogen content of AN is 34% by weight. AN is less subject to volatilization (evaporation) lossesthan other nitrogen products. Due to its stability, AN is often the product of choice for pasturesand “no-till” crops (that is, where the soil is not plowed prior to planting) where fertilizer isspread upon the surface and is subject to evaporation losses.
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Industrial grade AN prills and ammonium nitrate solution is utilized as explosives in the miningindustry as well as a raw material in the production of catalyst materials.The Company produced approximately 508,000 tons of solid AN, 452,000agricultural grade AN and54,000 industrial grade ammonium nitrate (IGAN), at its Yazoo City, Mississippi facility andapproximately 775,000 tons of solid AN at its U.K. facilities in 2006. During this period, theCompany sold approximately 555,000 tons in the U.S. and 561,000 tons in the U.K.*Urea*Urea is produced by converting ammonia and carbon dioxide into liquid urea, which can be furtherprocessed into a solid, granular form. Urea is used for fertilizer and animal feed as well as inindustrial applications as a raw material to produce resins and environmentally as a reagent toreduce NOx emissions. Granular urea has a nitrogen content of 46% by weight, the highest level ofany solid nitrogen product. Terra produces both a granulated form of urea, generally for thefertilizer market, and urea liquor (liquid) for animal feed supplements and industrialapplications.In 2006, Terra produced approximately 220,000 tons of urea and urea liquor, all of it at NorthAmerican plants. During this period, the Company sold approximately 244,000 tons of urea and urealiquor.*Nitric Acid*Nitric acid is made by oxidizing ammonia with air. The product is used as a raw material for othernitrogen products and by industrial customers to produce such products as nylon fibers,polyurethane foams and specialty fibers. In 2006, the Company produced approximately 893,000 tonsof nitric acid worldwide. Approximately 366,000 of these tons were sold to industrial users andthe remainder was used as a raw material for the production of Terra’s other nitrogen products.*Dinitrogen Tetroxide*Dinitrogen tetroxide (N2O4) is the propellant oxidizer used in various satellite, rocket andmissile propulsion systems. It is also used by industrial customers in the manufacturing ofpharmaceuticals. Dinitrogen tetroxide is produced by cooling and condensing a slipstream ofprocess gas from a nitric acid plant containing various oxides of nitrogen. The recovered productis filtered and its composition adjusted to meet final product specifications. Terra manufacturedapproximately 90,000 pounds of the product in 2006.*Marketing and Distribution*Terra’s customers are broadly segregated into two groups: (1) North American customers, includingthose receiving shipments of imported product from the Point Lisas Nitrogen facility, and (2) U.K.customers, including export sales to continental Europe and Australia.The principal customers for Terra’s North American manufactured nitrogen products fall into twobroad categories – agricultural fertilizer customers and industrial customers. The agriculturecustomers consist of independent dealers, national retail chains, and cooperatives. Theseagricultural customers, in turn, sell product to dealers, farmers and other users. Industrialcustomers use nitrogen products as a feedstock for a variety of chemical processes, in themanufacture of pulp, paper, fibers and to control nitrous oxide (NOx) emissions from power plants.Nearly all of Terra’s industrial customers are end-users. The Company’s agricultural andindustrial customers are located primarily in the Gulf, midwestern plains and southern regions ofthe U.S. where the Company’s facilities are located. It is Terra’s objective to ship as much ofits North American production as possible directly from its manufacturing facilities to its
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customers. Its five North American production facilities have total storage capacity for 190,000tons of ammonia and 240,000 tons of UAN.Terra’s Donaldsonville terminal has ready access to rail, truck and ammonia pipelinetransportation and permits economical oceangoing vessel and barge transportation for imports andexports of nitrogen products. The terminal includes two ammonia storage tanks, each with acapacity of 30,000 tons, and can receive ocean-going vessels carrying50,000 tons or more ofammonia. During 2006, the terminal received and shipped approximately 729,000 and 729,000 tons ofammonia, respectively. Terra expanded the terminal’s capabilities by constructing a new UANsolution tank with a 50,000-ton capacity. This tank and related receiving and shipping equipmentwas completed in December 2006 at a cost of $9.2 million.In July 2005 Terra sold to a subsidiary of Kinder Morgan Energy Partners its terminal assets inBlytheville, Arkansas, consisting of storage and supportinginfrastructure for 40,000 tons of ammonia,9,500 tons of UAN and 40,000 tons of urea. In conjunction with this sale of assets, Terra hasentered into a long-term agreement to lease from Kinder Morgan exclusively these terminal assets.This arrangement will maintain Terra’s distribution capabilities in the Blytheville, Arkansasregion.Terra owns a 50% interest in the Houston Ammonia Terminal, located on the Houston Ship Channelnear Pasadena, Texas. This entity has two 15,000 ton ammonia storage tanks which provide ammoniato industrial customers in the area via a pipeline system capable of shipping approximately 1,000tons per day. The terminal can receive ocean-going vessels.In the U.K., agricultural customers accounted for approximately 57% and industrial customersapproximately 43% of sales in 2006. Terra engages merchants and buying groups to sell its Nitrambrand bagged AN fertilizer directly to British farmers. Terra also bags AN for other U.K.suppliers and sells it in bulk to suppliers who blend it with potash and phosphates, bag it anddistribute it to farmers. Terra exports a small quantity of AN to continental Europe. Terra’s U.K.industrial products include ammonia, nitric acid and liquid carbon dioxide. Most industrial salesare to customers where Terra has a freight advantage.**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 rolein the photosynthesis process. Potassium is an important regulator of plants’ physiologicalfunctions. Nitrogen is an essential element for most organic compounds in plants because itpromotes protein formation. Nitrogen is also a major component of chlorophyll, which helps promotegreen healthy growth and high yields. There are no known substitutes for nitrogen fertilizers inthe cultivation of high-yield crops. These three nutrients occur naturally in the soil to acertain extent, but must be replaced because crops remove them from the soil. Nitrogen, to agreater extent than phosphate and potash, must be reapplied each year in areas of intenseagricultural usage because of nitrogen absorption by crops and its tendency to escape from thesoil by evaporation or leaching. Consequently, demand for nitrogen fertilizer tends to be moreconsistent on a year-by-year, per-acre-planted basis than is demand for phosphate or potashfertilizer.The major nitrogen consuming crop in North America is corn and in the United Kingdom, wheat.Certain crops, such as soybeans and other legumes, can use atmospheric nitrogen and do not requirenitrogen fertilizers.
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*Demand*Global demand for fertilizers typically grows at predictable rates and tends to correspond togrowth in grain production. Global fertilizer demand is driven in the long term primarily bypopulation growth, increases in disposable income and associated improvements in diet. Short-termdemand depends on world economic growth rates and factors creating temporary imbalances in supplyand demand. These factors include weather patterns, the level of world grain stocks relative toconsumption, agricultural commodity prices, energy prices, crop mix, fertilizer application rates,farm income and temporary disruptions in fertilizer trade from government intervention, such aschanges in the buying patterns of China or India. Grain consumption has historically grown atapproximately 1.2% per year. According to IFA, International Fertilizer Industry Association,over the last 45 years global fertilizer demand has grown 3.7% annually and global nitrogenfertilizer demand has grown at a faster rate of 4.8% annually. During that period, North Americannitrogen fertilizer demand has grown 3.3% annually.*Supply*Over the past six years, global ammonia capacity has remained relatively flat, growing at anaverage of less than 1% per annum. This result was the combination of new project capacity beingoffset by permanent plant closing in the U.S. and Europe. As global operating rates and priceshave risen, so have plans for new capacity.This new global capacity will likely come from advantaged natural gas regions of the world, suchas the Middle East and Africa. This expansion of capacity could be limited, however, by highcapital and construction costs, lower nitrogen prices and increasing natural gas prices. Russiahas recently announced plans to raise domestic gas prices as well as prices paid by their exportcustomers. This will raise the production costs for new and existing plants in the former SovietUnion and Europe.Imports account for a significant portion of U.S. nitrogen product supply. Producers from theformer Soviet Union, Canada, the Middle East, Trinidad and Venezuela are major exporters to theU.S. These export producers are often competitive in regions close to the point of entry forimports, primarily the Gulf coast and east coast of North America. Due to higher freight costs andlimited distribution infrastructure, importers are less competitive in serving the maincorn-growing regions of the U.S., which are more distant from these ports. According to Fertecon,a leading industry publication, world trade in ammonia grew from 15.4 million tons in 2000 to 19million tons by 2005 due to the exceptional increase in gas prices in the U.S. and Europe duringthis period and the consequent closure of U.S. capacity.*Outlook*Fertecon forecasts that global nitrogen fertilizer demand is expected to rise by around 1.8% peryear from 2005 to 2015, increasing by 16 million tons or close to 18% over the period. In NorthAmerica, nitrogen fertilizer consumption is expected to increase from 2005 to 2015 from 12.3million tons to 14.1 million tons, a 14%increase.Global grain inventories are currently at levels significantly below the ten-year average, andcurrent corn prices have increased significantly to $3.85 per bushel as of January 18, 2007 versus$1.90 per bushel one year prior. Both of these factors influence the improved outlook for demand.The emergence of ethanol as an alternative energy source has the potential to drive incrementalfertilizer demand. Corn, the primary feedstock for U.S. ethanol production, representsapproximately 40% of fertilizer demand in North America. New ethanol capacity is increasingdemand for corn and, according
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to Fertecon, is expected to contribute to a forecasted 21 million hectare increase in planted cornarea in the world by 2030. The amount of corn used in the U.S. for ethanol production has doubledin the last four years. In 2005-2006, around 1.6 billion bushels of corn were used for ethanolproduction. According to Fertecon, a 34% increase is forecast for the current 2006-2007 cropyear, bringing the total bushels used for ethanol to 2.15 billion. This number is expected torise to over 3 billion bushels by 2007-2008, equivalent to 25% of the U.S. corn crop.Due to the Clean Air Act, energy providers are required to reduce emissions of nitrogen oxides, orNOx. This presents a new market opportunity for ammonia, which can be used to reduce NOx from airemissions. We believe that this new application could increase ammonia demand by up to 1 milliontons, or 10% of U.S. capacity in 2010.The continued growth in demand for nitrogen products has helped stabilize global ammoniautilization rates, which averaged 86% between 2004 and 2005. According to Fertecon, globalammonia utilization rates are forecasted to remain in the mid-80’s through 2015. North Americanammonia utilization rates are forecast to decrease from 84% in 2006 to 78% by 2015 due in part toprojected long-term growth in worldwide capacity and in imports.To help meet the growing global demand for fertilizers, especially in high growth areas like Chinaand 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 a new 37.5 million tonsby 2015, a total increase of 22%. There are a number of new capacity projects expected orunderway in gas advantaged regions; however, increased construction costs and changes in marketdynamics have delayed a number of projects.World trade in ammonia is expected to increase by 1.6 million tons or 8% in the period to 2010,according to Fertecon, representing more modest growth than seen from 2000 to 2005. Ferteconprojects that higher gas costs for Russian and Ukrainian exporters and the lower-than-previous gasprice 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.**Methanol Business Segment**Terra’s methanol business segment has shrunk considerably since it mothballed its principalmethanol production facility at Beaumont, Texas in December 2004. The facility remained closedthroughout 2005 and 2006 and remains closed to date. Terra’s remaining manufacturing facilitycapable of producing methanol is in Woodward, Oklahoma.In December 2003, Terra entered into contracts with Methanex Corporation (“Methanex”) providingMethanex exclusive rights to all methanol production at Terra’s Beaumont, Texas facility for fiveyears. Methanex paid $25 million for these rights and agreed to purchase Terra’s methanolproduction at amounts expected to approximate cash production costs. Methanex also agreed to payTerra 50% of any gross profits earned from its sales of Beaumont product up to maximum payments of$12 million per year. The agreement also gave Methanex the right to terminate Beaumont’sproduction, with Terra being responsible for the costs of shutting down the facility. On December1, 2004, at the request of Methanex and under the terms of the parties’ agreement, Terra ceasedproduction at the Beaumont facility and mothballed the plant. The parties’ agreement stipulatesthat, beginning two years from the date of the shutdown, Terra may terminate the agreement bypaying Methanex approximately $417,000 per month remaining in the agreement’s term. As long as theBeaumont 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 yearconsisting of $4.4 million from annual amortization of deferred revenues
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plus one-half of the annual cash margin, if any, attributable to idled methanol production basedon reference prices and natural gas costs. Terra received the maximum payment of $12 million in2006.Terra has retained some employees to operate the Beaumont methanol storage and distributionterminal and potentially to operate the ammonia plant.*Manufacturing Facilities*Terra owns the plant and processing equipment at the Beaumont facility, which has an annualmethanol production capacity of 225 million gallons. Terra did not produce any methanol at theBeaumont plant in 2006. For a description of the Beaumont facility, see the Beaumont, Texasdescription under Item 2 Properties. The Woodward, Oklahoma facility produced 24.1 million, 30.4million and 37.3 million gallons of methanol in 2006, 2005 and 2004, respectively, and has anannual methanol production capacity of 40 million gallons. For a description of the Woodwardfacility, see the Woodward, Oklahoma listing under Item 2 Properties, Marketing and DistributionIn addition to the Beaumont production agreement, Terra also entered into an agreement withMethanex to market, under a commission arrangement, all methanol produced at the Woodward,Oklahoma facility. The customers served under these arrangements are primarily large domesticchemical producers.**Industry Overview**Methanol is a liquid made primarily from natural gas that is used as a feedstock in theproduction of formaldehyde, acetic acid, methyl tertiary-butyl ether (MTBE), and a variety ofother chemical intermediates which form the foundation of a large number of secondary derivatives.Methanol is a typical commodity chemical and the methanol industry is characterized by cycles ofoversupply resulting in lower prices and idled capacity, followed by periods of shortage andrapidly rising prices until increased prices justify new plant investments or the re-start ofidled capacity. Over the past several years significant industry restructuring has taken placewith most North American methanol capacity shut down. New methanol production facilities havegenerally been constructed in locations with access to low-cost natural gas, although thisadvantage is partially offset by higher distribution costs due to distance form major markets.**Credit**Terra’s credit terms are generally 15-30 days in the U.S. and 30 days in the U.K., but may beextended for longer periods during certain sales seasons, consistent with industry practices.**Seasonality and Volatility**The fertilizer business is highly seasonal, based upon the planting, growing and harvestingcycles. Nitrogen fertilizer inventories must be accumulated to permit uninterrupted customerdeliveries, and require significant storage capacity. This seasonality generally results in higherfertilizer prices during peak periods, with prices normally reaching their highest point in thespring, decreasing in the summer, and increasing again in the late fall – early winter period asdepleted inventories are restored.Nitrogen fertilizer prices can also be volatile as a result of a number of other factors. The mostimportant of these factors are: **•** Weather patterns and field conditions (particularly during periods of high fertilizerconsumption);  **•** Quantities of fertilizers imported to primary markets;
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 **•** Current and projected grain inventories and prices, which are heavily influenced by U.S.exports, worldwide grain markets, and domestic demand (food, feed, biofuel); and  **•** Price fluctuations in natural gas, the principal raw material used to produce nitrogenfertilizer.Governmental policies may directly or indirectly influence the number of acres planted, the levelof grain inventories, the mix of crops planted and crop prices, as well as environmental demands.While most U.S. methanol is sold pursuant to long-term contracts based on market index pricing andfixed volumes, the spot market price of methanol can be volatile. The industry has experiencedcycles of oversupply, resulting in depressed prices and idled capacity, followed by periods ofshortages and rapidly rising prices. Future demand for methanol will depend in part on theemerging regulatory environment with respect to reformulated gasoline.**Raw Materials**The principal raw material used to produce manufactured nitrogen products and methanol isnatural gas. Natural gas costs in 2006 accounted for approximately 46% of Terra’s totalmanufacturing costs and expenses. Significant increases in natural gas costs that are not hedgedor recovered through increased prices to customers would have an adverse impact on the Company’sbusiness, financial condition and results. Terra management believes there will be a sufficientsupply of natural gas for the foreseeable future and will, as opportunities present themselves,enter into firm transportation contracts to minimize the risk of interruption or curtailment ofnatural gas supplies during the peak-demand winter season. The Company uses a combination of spotand term purchases of varied duration from a variety of suppliers to obtain natural gas supply.Natural gas prices have moderated, averaging $6.54 and$6.46 per MMBtu in the third and fourthquarters of 2006. This follows a period of significant cost pressure after hurricanes hit theU.S. in late 2005 causing natural gas prices to increase and peak at an average price of $12.79per MMBtu in November 2005. This significantly increased costs for North American producers inthe fourth quarter of 2005 and first quarter 2006. Currently, natural gas storage in NorthAmerica exceeds five-year historic levels.Terra owns a 50% interest in Point Lisas Nitrogen Limited, a 50/50 ammonia production jointventure with KNC Trinidad Limited. Point Lisas Nitrogen Limited has a contract to purchase naturalgas from the National Gas Company of Trinidad and Tobago. The joint venture’s cost of natural gashas historically been significantly lower than U.S. natural gas costs, which has resulted in thejoint venture being substantially more profitable than comparable North American facilities.Pursuant to a policy approved by the board of directors, Terra employs natural gas hedges with agoal of mitigating risk from increases to natural gas prices. The Company has implemented a policysetting boundaries to ensure coverage of fixed forward sales as well as potential outstandingforward priced quotes and prepay programs. The Company’s policy is designed to achieve anacceptable gross margin on forward sales estimates. Terra hedges natural gas prices through theuse of supply contracts, financial derivatives and other instruments. Terra enters into thesepositions when it believes such arrangements would not result in costs greater than expectedselling prices for the finished products.If natural gas prices rise, Terra may benefit from the use of forward-pricing techniques.Conversely, if natural gas prices fall, the Company may incur costs above the then-available spotmarket price. The settlement dates of forward-pricing contracts coincide with gas purchase datesas well as shipment periods on forward committed sales. Forward-pricing contracts are based on aspecified price referenced to spot market prices or appropriate NYMEX futures contract prices.
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**Transportation**Terra uses several modes of transportation to distribute products to customers, includingrailroad cars, common carrier trucks, barges and common carrier pipelines.Railcars are the major mode of transportation at Terra’s North American manufacturing facilities.At December 31, 2006, Terra had 2,858 railcars under lease. Terra owns 10 nitric acid railcars. Inaddition, Terra operates Terra Express, Inc., a common carrier covering the 48 contiguous UnitedStates which is most active in the middle third of the country. Terra Express specializes intransporting liquid bulk products, including UAN, urea liquor, ethanol, ammonia and propane. TerraExpress employs two drivers and 42 owner-operators. In the U.K., Terra’s AN production istransported primarily by contract carrier trucks, and ammonia is transported primarily bypipelines that the Company owns.Terra transports purchased natural gas to its Woodward, Oklahoma facility via both intrastate andinterstate pipelines and to Terra’s Verdigris, Oklahoma facility via intrastate pipeline. Theintrastate pipelines serving Woodward and Verdigris are not open-access carriers, but arenonetheless part of a widespread regional system through which Woodward and Verdigris can receivenatural gas from any major Oklahoma source. Terra also has limited access to out-of-state naturalgas supplies for these facilities. Terra’s Beaumont, Texas facility sources natural gas via fourintrastate pipelines. The Courtright, Ontario facility sources natural gas at delivery points atParkway and Dawn, Ontario and a local utility. Terra transports purchased natural gas for its PortNeal, Iowa facility via interstate, open-access pipelines. At the Billingham and Severnside,England locations, purchased natural gas is transported to the facilities via a nationwide,open-access pipeline system. Terra’s Donaldsonville, Louisiana facility sources purchased naturalgas from two intrastate pipelines. Terra’s Yazoo City facility is served by three interstatepipelines and one intrastate pipeline.FMCL Limited Liability Company, Terra’s 50/50 ammonia shipping joint venture with KNC TrinidadLimited, leases a vessel for transportation of ammonia, primarily between the Point Lisas NitrogenLimited facility in Trinidad and the United States. Use of this vessel is shared between the jointventure partners, Terra and KNC Trinidad Limited.**Research and Development**At the present time, Terra is not undertaking any significant, ongoing research anddevelopment efforts.**Competition**The markets in which Terra operates are highly competitive. Competition in agricultural inputmarkets takes place largely on the bases of price, supply reliability, delivery time and qualityof service. Feedstock availability to production facilities and the cost and efficiency ofproduction, transportation and storage facilities are also important competitive factors.Government intervention in international trade can distort the competitive environment. Therelative cost and availability of natural gas are also important competitive factors. Significantdeterminants of a plant’s competitive position are the natural gas acquisition and transportationcontracts negotiated with its major suppliers as well as proximity to natural gas sources and/orend-users.Terra’s domestic competitors in the nitrogen fertilizer markets are primarily other independentfertilizer companies. Nitrogen fertilizers imported into the United States compete withdomestically produced nitrogen fertilizers, including those produced by Terra. Countries withinexpensive sources of natural gas (whether as a result of government regulation or otherwise) canproduce nitrogen fertilizers at a low cost. A substantial amount of new ammonia capacity isexpected to be added abroad in the foreseeable future.
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In the methanol segment, production and trade have become increasingly globalized and a number offoreign competitors produce methanol primarily for the export market. Many of these foreigncompetitors have access to favorably priced sources of natural gas and are relatively insensitiveto raw material price fluctuations. However, because of low domestic demand, foreign competitorsaggressively pursue the U.S. and other export markets.**Environmental and Other Regulatory Matters**Terra’s U.S. operations are subject to various federal, state and local environmental, healthand safety laws and regulations, including laws relating to air quality, hazardous or solid wastesand water quality. Terra’s operations in Canada are subject to various federal and provincialregulations regarding such matters, including the Canadian Environmental Protection Actadministered by Environment Canada, and the Ontario Environmental Protection Act administered bythe Ontario Ministry of the Environment. Terra’s U.K. operations are subject to similarregulations under a variety of acts governing hazardous chemicals, transportation and workerhealth and safety. All of Terra’s facilities require operating permits that are subject to reviewby governmental agencies. Terra is 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. The Company takes precautions to reduce thelikelihood of accidents involving these materials. If such materials have been or are disposed ofat sites that are targeted for investigation and/or remediation by federal or state regulatoryagencies, Terra may be responsible under CERCLA or analogous laws for all or part of the costs ofsuch investigation and remediation, and damages to natural resources.The State of Arizona designated Inspiration Consolidated Copper Company (“Inspiration”), a Terrasubsidiary that disposed of its assets in 1988 and no longer operates a business, as one ofseveral potentially responsible parties (“PRP”) under the state Superfund law at the Pinal CreekDrainage Basin Site (“Pinal Site”) in Globe/Miami, Arizona, based upon Inspiration’s priorownership and operation of copper mining and production facilities. Under state and federalSuperfund laws, all PRPs may be jointly and severally liable for the costs of investigation and/orremediation of an environmentally impaired site regardless of fault or the legality of originaldisposals. The Pinal Site is the subject of ongoing investigation and cleanup to addressgroundwater releases of acidic metal-bearing solutions from past copper mining and productionfacilities. 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 ofthe copper mining and production facilities (one of whom is the successor to Inspiration’s buyer),both of whom the State designated as PRPs, and Inspiration (collectively with Terra, the “Group”).The Group’s members are jointly financing and performing the work, but Inspiration no longer ownsassets or is conducting any activities at the Pinal Site. Also, the Group has filed an action forcost-recovery against other former owners and operators at the Pinal Site, a substantial portionof which has been settled. In a related matter, more than a decade ago, residents in an area ofthe Pinal Site brought a class action lawsuit against the Group seeking property damages andmedical monitoring for potential personal injuries allegedly related to the acidic metal-bearinggroundwater. The class action lawsuit was settled in September 2000, although plaintiffs reservedthe right to assert personal injury claims individually. In the 1988 sale agreement, Inspirationwas contractually indemnified by its buyer (which includes the buyer’s successor) for allenvironmental claims relating to the Pinal Site. In April 2005, Inspiration and its successorsettled most claims relating to the 1988 indemnity, confirming that the successor will indemnifyInspiration for past and future costs arising out of the 1997 Consent decree, for allocationclaims arising out of the cost-recovery lawsuit, and for legal fees of common counsel in thevarious lawsuits. After consideration of such factors as the number of
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PRPs and levels of financial responsibility, including the ongoing litigation and contractualindemnities, Terra believes its liability with respect to these matters will not be material.Terra retained a small number (less than 10%) of its retail locations after the sale of itsdistribution business in 1999. Some of these locations are now, or are expected in the future tobe, the subject of environmental clean-up activities for which the Company has retained liability.Terra does not believe that such environmental costs and liabilities will have a material effecton its results of operations, financial position or net cash flows. As of November 30, 2006, therewere 12 remaining locations, six of which were undergoing environmental clean-up activities priorto the sale or release of those properties to the landowner. The total net cost associated withthe former retail locations in 2007 and beyond (including environmental expenditures and proceedsfrom voluntary clean-up reimbursements and sale of properties) is not expected to exceed $2million.With respect to the Verdigris, Oklahoma facility, Freeport-McMoRan Resource Partners, LimitedPartnership (a former owner and operator of the facility) retained liability for certainenvironmental matters. With respect to the Beaumont, Texas facility, DuPont retains responsibilityfor certain environmental costs and liabilities stemming from conditions or operations to theextent such conditions or operations existed or occurred prior to its sale of the facility toTerra in 1991. Likewise, with respect to the Billingham and Severnside, England facilities, theseller, ICI, indemnified Terra, subject to certain conditions, for pre-December 31, 1997environmental contamination associated with the purchased assets. Known conditions are notexpected to result in material expenditures but discovery of unknown conditions or the failure ofprior owners and operators and indemnitors to meet their obligations could require significantexpenditures.In the wake of the September 11 tragedy, both the U.S. Congress and U.K. Parliament areconsidering various additional security and handling requirements for hazardous chemicals,including AN, which can be used to manufacture explosives. Terra’s facilities already have thebasic plans and vulnerability assessments in place that may be required under new legislation.Accordingly, such legislation is unlikely to have an adverse impact on Terra’s operations,financial position, or cash flow.Terra may be required to install additional air and water quality control equipment, such as lownitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors, at certainfacilities to comply with applicable environmental requirements. Terra estimates that the totalcost of additional equipment to comply with these requirements in 2007 and the next two years willbe less than $15 million.Terra endeavors to comply in all material respects with applicable environmental, health andsafety regulations and has incurred substantial costs in connection with such compliance. Becausethese regulations are expected to continue to change and generally to be more restrictive thancurrent requirements, the costs of compliance will likely increase. Terra does not expect itscompliance with such regulations to have a material adverse effect on its results of operations,financial position or net cash flows. However, there can be no guarantee that new regulations willnot result in material costs.Terra’s capital expenditures related to environmental control in 2006, 2005 and 2004 wereapproximately $1.2 million, $1.3 million and $2.4 million, respectively. Projected environmentalcapital expenditures are $6.7 million for 2007 and $5.2 million for 2008.Terra believes that its policies and procedures now in effect are in compliance with applicableenvironmental laws and with the permits relating to the facilities in all material respects.However, in the normal course of its business, Terra is exposed to risks relating to possiblereleases of hazardous substances into the environment. Such releases could cause substantialdamages or injuries. Although
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environmental expenditures have not been material during the past year, it is impossible topredict or quantify the impact of future environmental liabilities associated with releases ofhazardous substances from Terra’s facilities. Such liabilities could have a material adverseimpact on the results of operations, financial position or net cash flows.**Revenues and Assets**Terra’s revenues from external customers, measure of profit and loss, total assets andrevenues and assets according to geography for the years 2004-2006 are set forth in Item 8 of thisAnnual Report on Form 10-K under the caption “Note 21 – Industry Segment Data” contained in the“Notes to Consolidated Financial Statements.”**Employees**Terra had 1,238 full-time employees at December 31, 2006. All 372 U.K. employees are coveredby a wage and working conditions arrangement similar to a collective bargaining agreement.**Item 1A. Risk Factors**In addition to the other information contained in this Form 10-K, the following risk factorsshould be considered carefully in evaluating Terra’s business. The Company’s business, financialcondition, or results of operations could be materially adversely affected by any of these risks.Please note that additional risks not presently known to Terra or that its management currentlydeems immaterial may also impair the Company’s business and operations.*A substantial portion of Terra’s operating expense is related to the cost of natural gas, and anincrease in such cost that is either unexpected or not accompanied by increases in selling pricesof 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 in2006 comprised about 46% of total costs and expenses. A significant increase in the price ofnatural gas (which can be driven by, among other things, supply disruptions, cold weather and oilprice spikes) that is not hedged or recovered through an increase in the price of related nitrogenproducts could result in reduced profit margins and lower product production. Terra has in therecent past idled one or more of its plants in response to high natural gas prices. A significantportion of Terra’s competitors’ global nitrogen production occurs at facilities with access tofixed-priced and/or product related natural gas supplies, similar to Terra’s gas supply contractin Trinidad. These competitors’ facilities’ natural gas costs have been and likely will continueto be substantially lower than Terra’s costs.*Declines in the prices of Terra’s products may reduce profit margins.*Prices for nitrogen products are influenced by the global supply and demand conditions for ammoniaand other nitrogen-based products. Long-term demand is affected by population growth and risingliving standards that determine food consumption. Short-term demand is affected by world economicconditions and international trade decisions. Supply is affected by increasing worldwide capacityand the increasing availability of nitrogen product exports from major producing regions such asthe former Soviet Union, Canada, the Middle East, Trinidad and Venezuela. New global ammoniacapacity is expected abroad in the foreseeable future. If this growth in new capacity exceeds thegrowth in demand, the price at which Terra sells its nitrogen products may decline, resulting inreduced profit margins, lower production of products and potential plant closures. Supply in theU.S. and Europe is also affected
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by trade regulatory measures, which restrict import supply into those markets. Changes in thosemeasures would likely adversely impact available supply and pricing.*Terra’s products are subject to price volatility resulting from periodic imbalances of supply anddemand, which may cause the results of operations to fluctuate.*Historically, Terra’s products’ prices have reflected frequent changes in supply and demandconditions. Changes in supply result from capacity additions or reductions and from changes ininventory levels. Demand for products is dependent on demand for crop nutrients by the globalagricultural industry and on the level of industrial production. Periods of high demand, highcapacity utilization and increasing operating margins tend to result in new plant investment andincreased production until supply exceeds demand, followed by periods of declining prices anddeclining capacity utilization until the cycle is repeated. In addition, markets for Terra’sproducts are affected by general economic conditions. As a result of periodic imbalances of supplyand demand, product prices have been volatile, with frequent and significant price changes. Duringperiods of oversupply, the price at which Terra sells its products may be depressed and this couldhave a material adverse effect on Terra’s business, financial condition and results of operations.*Terra’s products are global commodities and Terra faces intense competition from other nitrogenfertilizer producers.*Nitrogen fertilizer products are global commodities and can be subject to intense pricecompetition from both domestic and foreign sources. Customers, including end-users, dealers andother crop-nutrients producers and distributors, base their purchasing decisions principally onthe delivered price and availability of the product. Terra competes with a number of U.S.producers and producers in other countries, including state-owned and government-subsidizedentities. The U.S. and the European Commission each have trade regulatory measures in effectwhich are designed to address this type of unfair trade. Changes in these measures could have anadverse impact on Terra’s sales and profitability of the particular products involved. Some ofTerra’s principal competitors have greater total resources and are less dependent on earnings fromnitrogen fertilizer sales. In addition, a portion of global production benefits from natural gascontracts that have been, and could continue to be, substantially lower priced than our naturalgas. Terra’s inability to compete successfully could result in the loss of customers, which couldadversely affect sales and profitability.*The Company’s business is subject to risks related to weather conditions.*Adverse weather conditions may have a significant effect on demand for the Company’s nitrogenproducts. Weather conditions that delay or intermittently disrupt field work during the plantingand growing season may cause agricultural customers to use less or different forms of nitrogenfertilizer, which may adversely affect demand for the product that Terra sells. Weather conditionsfollowing harvest may delay or eliminate opportunities to apply fertilizer in the fall. Weathercan also have an adverse effect on crop yields, which lowers the income of growers and couldimpair their ability to pay Terra’s customers.*Terra’s risk measurement and hedging activities might not prevent losses.*The Company manages commodity price risk for its businesses as a whole. Although the Company hasrisk measurement systems in place that use various methodologies to quantify risk, these systemsmight not always be followed or might not always work as planned. Further, such risk measurementsystems do not in themselves manage risk, and adverse changes involving volatility, adversecorrelation of commodity prices and the liquidity of markets might still adversely affect earningsand cash flows, as
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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 theuse of financial derivatives may be affected by limitations imposed by Terra’s bank agreementcovenants.In an effort to manage financial exposure related to commodity price and market fluctuations,Terra has entered into contracts to hedge certain risks associated with its assets and operations.In these hedging activities, the Company has used fixed-price, forward, physical purchase andsales contracts, futures, financial swaps and option contracts traded in the over-the-countermarkets or on exchanges. Nevertheless, no single hedging arrangement can adequately address allrisks present in a given contract or industry. Therefore, unhedged risks will always continue toexist. The Company may not be able to successfully manage all credit risk and as such, future cashflows could be impacted by counterparty default.*Terra is substantially dependent on its manufacturing facilities, and any operational disruptioncould result in a reduction of sales volumes and could cause Terra to incur substantialexpenditures.*Terra’s manufacturing operations may be subject to significant interruption if one or more of itsfacilities were to experience a major accident or were damaged by severe weather or other naturaldisaster. In addition, Terra’s operations are subject to hazards inherent in nitrogen fertilizermanufacturing. Some of those hazards may cause personal injury and loss of life, severe damage toor destruction of property and equipment and environmental damage, and may result in suspension ofoperations and the imposition of civil or criminal penalties. For example, an explosion at Terra’sPort Neal, Iowa facility in 1994 required Terra to rebuild nearly the entire facility and a June1, 2006 explosion shut down the ammonia production plant in Billingham, England until repairs werecompleted in August. In addition, approximately four weeks of unplanned outages at Terra’s PointLisas Nitrogen facility during the 2006 third quarter to repair failing heat exchangers were onlypartly successful and the plant will be operating at about 80% of capacity until replacementexchangers are installed during a scheduled turnaround in early 2007. Also, a mechanical outage atthe Courtright, Ontario facility in April 2001 required Terra to shut down that facility forapproximately two months. Terra currently maintains property insurance, including businessinterruption insurance, but it may not have sufficient coverage, or may be unable in the future toobtain sufficient coverage at reasonable costs.*Terra may be adversely affected by environmental laws or regulations to which it is subject.*Terra’s U.S., Canadian and U.K. operations and properties are subject to various federal, stateand local environmental, safety and health laws and regulations, including laws relating to airquality, hazardous and solid materials and wastes, water quality, investigation and remediation ofcontamination, transportation and worker health and safety. Terra could incur substantial costs,including capital expenditures for equipment upgrades, fines and penalties and third-party claimsfor damages, as a result of compliance with, violations of or liabilities under environmental lawsand regulations. Terra is also involved in the manufacture, handling, transportation, storage anddisposal 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 orreleased at sites that require investigation and/or remediation, Terra may be responsible underthe Comprehensive Environmental Response, Compensation and Liability Act of 1980, or “CERCLA,” oranalogous laws for all or part of the costs of such investigation and/or remediation, and fordamages to natural resources. Under some of these laws, responsible parties may be held jointlyand severally liable for such costs, regardless of fault or the legality of the original disposalor release.
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Terra has liability as a potentially responsible party at certain sites under certainenvironmental remediation laws. The Company has also been subject to related claims by privateparties alleging property damage and possible personal injury arising from contamination relatingto discontinued operations. Terra may be subject to additional liability or additional claims inthe future. Some of these matters may require the Company to expend significant amounts forinvestigation and/or cleanup or other costs.*Terra may be required to install additional pollution control equipment at certain facilities inorder to maintain compliance with applicable environmental requirements.*Continued government and public emphasis on environmental issues can be expected to result inincreased future investments for environmental controls at ongoing operations. Terra may berequired to install additional air and water quality control equipment, such as low emissionburners, scrubbers, ammonia sensors and continuous emission monitors, at certain of its facilitiesin order to maintain compliance with applicable environmental requirements. Such investments wouldreduce income from future operations. Present and future environmental laws and regulationsapplicable to operations, more vigorous enforcement policies and discovery of unknown conditionsmay require substantial expenditures and may have a material adverse effect on results ofoperations, financial position or net cash flows.*Government regulation and agricultural policy may reduce the demand for Terra’s products.*Existing and future government regulations and laws may reduce the demand for Terra products.Existing and future agricultural and/or environmental laws and regulations may impact the amountsand locations of fertilizer application and may lead to decreases in the quantity of nitrogenfertilizer applied to crops. Any such decrease in the demand for fertilizer products could resultin 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, themix of crops planted and crop prices could also affect the demand and selling prices of Terra’sproducts. In addition, Terra manufactures and sells ammonium nitrate (AN) in the U.K. and in theU.S. Ammonium nitrate can be used as an explosive and was used in the Oklahoma City bombing inApril 1995. It is possible that either the U.S. or U.K. governments could impose limitations onthe use, sale or distribution of AN, thereby limiting Terra’s ability to manufacture or sell thisproduct.*Terra is subject to risks associated with international operations.*Terra’s 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 withholdingrequirements; and the imposition of tariffs, exchange controls or other restrictions. During 2006Terra derived approximately 24% of its net sales from outside of the U.S. Terra’s businessoperations include a 50% interest in an ammonia production joint venture in the Republic ofTrinidad and Tobago and a 50% interest in an ammonia shipping joint venture that providestransportation of ammonia from the Trinidad facility to the U.S. and other world markets.
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*Terra’s business may be adversely impacted by the Company’s leverage, which may require theuse of a substantial portion of excess cash flow to service debt and may limit Terra’s access toadditional capital.*Terra’s debt could have important consequences on its business. For example, it could (i) increaseTerra’s vulnerability to adverse economic and industry conditions by limiting flexibility inreacting to changes in the business industry, (ii) reduce Terra’s cash flow available to fundworking capital, capital expenditures and other general corporate purposes, (iii) place Terra at acompetitive disadvantage compared to competitors that have less leverage and (iv) limit Terra’sability to borrow additional funds and increase the cost of funds that Terra can borrow. Terra maynot be able to reduce its financial leverage when it chooses to do so, and may not be able toraise capital to fund growth opportunities.*Terra may not be able to finance a change of control offer.*If Terra considers an offer that would result in a “change of control” (as defined in its bondindentures and the instruments governing its Series A convertible preferred shares), it may needto refinance large amounts of debt. If a change of control occurs, Terra must offer to buy backthe notes under its indentures governing its 7% senior notes due 2017 and the Series A convertiblepreferred shares for a price equal to 101% of the notes’ principal amount or 100% of theliquidation value of the Series A convertible preferred shares, as applicable, plus any interestor dividends which has accrued and remains unpaid as of the repurchase date. There can be noassurance that there will be sufficient funds available for any repurchases that could be requiredby a change of control.**Item 1B.****Unresolved Staff Comments**Not applicable.**Item 2.****Properties**Terra’s manufacturing facilities and the Point Lisas manufacturing facility in which it ownsa 50% interest, are designed to operate continuously, except for planned shutdowns (usuallybiennial) for maintenance and efficiency improvements. Capacity utilization (gross tons produceddivided by capacity tons at expected operating rates and on-stream factors) of the nitrogenproducts manufacturing facilities (excluding 2004 production at the Blytheville, Arkansas plantwhich closed in May 2004, and the 2004 production at the plants acquired in the MississippiChemical Corporation acquisition) was approximately 83%, 96% and 99% in 2006, 2005 and 2004,respectively.Terra owns all of its manufacturing facilities, unless otherwise indicated below. Substantiallyall of Terra’s manufacturing facilities are mortgaged to secure indebtedness under the Company’scredit agreements.***Beaumont, Texas.***The Beaumont facility is located six miles south of Beaumont, Texas on the NechesRiver. Terra owns the plant and processing equipment at the Beaumont facility, which has an annualmethanol production capacity of 225 million gallons. The facility also contains an “ammonia loop”which provides an annual ammonia production capacity of 255,000 tons. The facility’s real estateis leased from E.I. DuPont de Nemours and Company (“DuPont”) at a nominal rate under a lease thatexpires in 2090. The facility is entirely contained within an industrial complex owned andoperated by DuPont, and DuPont provides access to the facility as well as essential services suchas security, emergency response, product loading and unloading, and a waste water effluent system.The facility also contains a methanol storage and distribution terminal containing two 7.5 milliongallon methanol storage tanks and one 20,000 ton ammonia storage tank. The Beaumont facility iscurrently out of production,
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however Terra continues to operate the terminal. See further discussion of the Beaumont facilityunder the “Methanol Business Segment” heading.***Donaldsonville, Louisiana.***The Donaldsonville facility is located on approximately 766 acresfronting the Mississippi River and, in 2004, included two ammonia plants, a urea plant and twomelamine 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 has been mothballed.The facility contains a deep-water port facility on the Mississippi River, allowing for bargetransportation and making Donaldsonville one of the northernmost points on the river capable ofreceiving economical ocean-going vessels.***Port Neal, Iowa.***The Port Neal facility is located approximately 12 miles south of Sioux City,Iowa on the Missouri River. The facility consists of an ammonia plant, two urea plants, two nitricacid 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. Thefacility 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.Terra renewed its leasehold interest in the port terminal for five years in April 2004, and has anoption to renew the lease for an additional five-year term in 2009.***Woodward, Oklahoma.***The Woodward facility is located in rural northwest Oklahoma and consists ofan 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 YazooCounty, Mississippi with approximately 60 acres of such land subject to a long-term lease withYazoo County. The facility includes two ammonia plants, one of which was sold to Dyno Nobel, Inc.in July 2006, five nitric acid plants, an AN plant, two urea plants, a UAN plant and a dinitrogentetroxide production and storage facility.In July 2005, Terra entered into a 10-year agreement to supply industrial grade ammonium nitrate(IGAN) and ammonium nitrate solution (ANS) to Orica USA Inc. Under the terms of this arrangement,Terra modified the smaller of its Yazoo City facility ammonium nitrate (AN) towers, which wascurrently limited to converting ANS to agricultural grade AN. Themodifications are complete and thetower is now equipped to convert ANS to either agricultural grade AN or IGAN, a prilled,low-density industrial grade product.***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, anitric acid plant and two urea plants.***Billingham, U.K.***The Billingham facility, located in the Teesside chemical area, is geographicallysplit among three separate areas: the main site contains an ammonia plant, three nitric acidplants and a carbon dioxide plant; the Portrack site approximately two miles away contains an ANfertilizer plant and the north Tees site approximately five miles away has an ammonia storagewhich Terra operates under a 99-year lease with a third-party and import/export facility thatTerra uses under license from the Crown and under an agreement with a third-party operator.***Severnside, U.K.***The Severnside facility is located in southwestern England. The facility consistsof two ammonia plants, two nitric acid plants and an AN plant.
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***Trinidad.***The Point Lisas Nitrogen facility in the Republic of Trinidad and Tobago is owned by a50/50 joint venture with KNC Trinidad Limited. This facility has the capacity to produce annually720,000 tons of ammonia from natural gas supplied under contract with the National Gas Company ofTrinidad and Tobago. Terra is obligated to buy 50% of the joint venture’s ammonia output at marketprices, which is transported primarily to the U.S. Gulf Coast and resold to Terra’s customers. Thejoint venture’s natural gas costs have recently been significantly lower than U.S. natural gascosts, which has made the joint venture substantially more profitable than comparable NorthAmerican facilities.Point Lisas produced 593,000 tons of ammonia in 2006 of which Terra purchased 307,000 tons. All ofthe Point Lisas ammonia tons purchased by Terra was delivered to Terra’s Donaldsonville terminalfor subsequent sale or delivery. In 2006 Terra received $33.8 million of cash distributions fromPoint Lisas.**Item 3.****Legal Proceedings**From time to time, the Company is involved in litigation, administrative proceedings andclaims, including environmental matters, arising in the ordinary course of business. Terra doesnot believe that the matters in which it is currently involved, either individually or in theaggregate, will have a material adverse effect on its business, results of operations, financialposition or net cash flows.**Item 4.****Submission of Matters to a Vote of Security Holders**No matters were submitted to a vote of security holders of Terra during the fourth quarter of2006.
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**Executive Officers of Terra**The following paragraphs set forth the name, age and offices of each present executiveofficer of Terra, the period during which each executive officer has served as such and eachexecutive officer’s business experience during the past five years:     **Present positions and offices with the Company****Name** **and principal occupations during the past five years** Michael L. Bennett President and Chief Executive Officer of Terra since April 2001. Age 53.   Joe A. Ewing Vice President, Investor Relations and Human Resources of Terra since December 2004; Vice President,Human Resources of Mississippi Chemical Corporation from April 2003 to December 2004; Vice President,Marketing and Distribution of Mississippi Chemical Corporation from 1999 to April 2003. Age 56.   Joseph D. Giesler Senior Vice President, Commercial Operations of Terra since December 2004; Vice President of IndustrialSales and Operations of Terra from December 2002 to December 2004; Global Director, Industrial Sales ofTerra from September 2001 to December 2002. Age 48.   Daniel D. Greenwell Vice President, Controller of Terra since April 2005; Corporate Controller for Belden CDT Inc. from2002 to 2005; and Chief Financial Officer of Zoltek Companies Inc. from 1996 to 2002. Age 44.   John W. Huey Vice President, General Counsel and Corporate Secretary of Terra since October 2006; Counsel withShughart Thomson & Kilroy, P.C. from 2005-2006; Attorney with Butler Manufacturing Company from1978-2004, Vice President of Administration from 1993-1998, Vice President, General Counsel andCorporate Secretary from 1998-2004. Age 59.   Francis G. Meyer Senior Vice President and Chief Financial Officer of Terra since November 1995. Age 54.   Richard S. Sanders Jr. Vice President, Manufacturing of Terra since August 2003; Plant Manager, Verdigris, Oklahomamanufacturing facility from 1995 to August 2003. Age 49.   Douglas M. Stone Vice President, Corporate Development and Strategic Planning since 2006; Director, Industrial salesfrom 2003 to 2006; Manager, Methanol and Industrial Nitrogen from 2000 to 2003. Age 41.   Paul Thompson Vice President, Sales and Marketing of Terra since December 2004; Global Director, Ag Sales and TerraU.K. Managing Director from August 1999 to December 2004. Age 52.There are no family relationships among the executive officers and directors of Terra orarrangements or understandings between any executive officer and any other person pursuant to
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which any executive officer was selected as such. Officers of Terra are elected annually to serveuntil their respective successors are elected and qualified.**PART II****Item 5.****Market for Terra’s Common Equity and Related Stockholder Matters andIssuer Purchases of Equity Securities**The main market in which Terra’s common shares are traded is the NYSE. Set forth below arethe high and low sales prices of Terra’s common shares during each quarter specified as reportedon the NYSE.                 (per-share data and stock prices) March 31  June 30  Sept. 30  Dec. 31  **2006**                Common Share Price:                High $7.40  $9.19  $7.99  $12.40 Low  5.45   5.93   6.07   7.80 2005                Common Share Price:                High $9.27  $7.88  $8.59  $6.65 Low  7.29   6.27   6.10   4.87 As of March 1, 2007 there were approximately 6,005 record holders of Terra’s common stock.Terra does not currently intend to declare or pay dividends on its common stock. Further, Terra’sability to pay dividends is restricted by certain covenants contained in its credit facility, aswell as certain restrictions contained in the indenture governing its senior notes. See Note 7 ofNotes to the Consolidated Financial Statements.*Company Purchases of Equity Securities*On April 25, 2006, the Board of Directors authorized the Company to repurchase a maximum of 10percent, or 9,516,817 shares, of its outstanding common stock. The stock buyback program has beenand will be conducted on the open market, in private transactions or otherwise at such times priorto June 30, 2008, and at such prices, as determined appropriate by the Company. During 2006, theCompany repurchased 2,675,100 shares at an average price of $7.03. The remaining number of sharesthat the Company is authorized to repurchase is 6,841,717 at December 31, 2006.The following table provides information about shared repurchases by the Company during the quarterended December 31, 2006.                           Total Number of    Total     Shares Purchased as Maximum Number ofMonth of Number of Average Part of Publicly Shares that May Yet BeShare Shares Price Paid Announced Plans or Purchased Under thePurchases Purchased per Share Programs Plans or Programs April 2006  —  $—   —   9,516,817 May 2006  488,100   7.49   488,100   9,028,717 June 2006  1,556,500   6.92   2,044,600   7,472,217 July 2006  —   —   2,044,600   7,472,217 August 2006  560,000   6.93   2,604,600   6,912,217 September 2006  70,500   7.03   2,675,100   6,841,717 October 2006  —   —   2,675,100   6,841,717 November 2006  —   —   2,675,100   6,841,717 December 2006  —   —   2,675,100   6,841,717 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.
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**Item 6.****Selected Financial Data****Financial Summary**                     (in thousands, except per share data) **2006**  2005  2004(1)  2003(2)  2002(3)  **Income Statement Data:**                    Revenues $1,836,722  $1,939,065  $1,509,110  $1,351,055  $1,043,983 Income (loss) from operations  66,280   113,696   134,746   (23,560)  (5,407)Net income (loss) fromcontinuing operations  4,213   22,087   67,596   (12,481)  (36,174)Net income (loss)  4,213   22,087   67,596   (12,481)  (258,325)Preferred share dividends  (5,100)  (5,134)  (1,029)  —   —  Basic income per share:                    Continuing operations  (0.01)  0.18   0.87   (0.16)  (3.43)Discontinued operation  —   —   —   —   (0.22)Cumulative effect of change inaccounting principle  —   —   —   —   (2.73) Basic income per share  (0.01)  0.18   0.87   (0.16)  (3.43)Diluted income per share $(0.01) $0.18  $0.85  $(0.16) $(3.43)                      **Balance Sheet Data:**                    Total assets $1,572,713  $1,523,625  $1,685,508  $1,125,062  $1,128,110 Long-term debtand capital leases $331,300  $331,300  $435,238  $402,206  $400,358 Preferred stock $115,800  $115,800  $133,069  $—  $—  (1) The 2004 selected financial data includes the effects of the December 21, 2004acquisition of Mississippi Chemical Corporation and the issuance of preferred shares duringthe 2004 fourth quarter. (2) The 2003 selected financial data includes a $53.1 million charge for impairment oflong-lived assets. *(3)* The 2002 selected financial data includes a $16.2 million loss from discontinuedoperations and a $206.0 million charge related to a cumulative effect of change inaccounting principle for the adoption of Statement of Financial Accounting Standards No.142, *“Goodwill and Other Intangibles.”***Item 7.****Management’s Discussion and Analysis of Financial Condition****and Results of Operations**The following discussion of historical results of operations and financial condition shouldbe read in conjunction with the audited financial statements and notes thereto which appearelsewhere in this report.**Introduction**Terra Industries Inc. (“Terra” or “the Company”) produces and markets nitrogen products foragricultural and industrial markets with production facilities located in North America and theUnited Kingdom. During December 2004, the Company acquired Mississippi Chemical Corporation (MCC).As a result of the acquisition, the Company owns a 50% interest in Point Lisas Nitrogen Limited(“PLNL”), an ammonia production joint venture in the Republic of Trinidad and Tobago.
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During the 2006 fourth quarter, the Company entered into a Memorandum of Understanding with KemiraGrowHow Oyj to create a joint venture to operate the fertilizer and associated process chemicalbusinesses of both companies in the U.K. The Memorandum of Understanding is a non-legally bindingagreement and is subject to clearance from the U.K. competition authorities, negotiation ofdefinitive documents and lender consent. During the 2007 first quarter, the U.K. Office of FairTrading referred the proposed joint venture to the Competition Commission.The Company classifies its operations into two business segments: nitrogen products and methanol.The nitrogen products segment represents operations directly related to the wholesale sales ofnitrogen products from its ammonia production and upgrading facilities. The methanol segmentrepresents wholesale sales of methanol produced by its methanol manufacturing plant.Natural gas is the most significant raw material in the production of nitrogen and methanolproducts. During periods of significant increases in natural gas prices, the Company may curtailor shut down its production facilities if finished goods prices do not allow the Company to covervariable production costs. The Company’s cost of natural gas increased to unprecedented levels inthe 2005 third quarter due to supply disruptions caused by Hurricanes Katrina and Rita. During the2006 second quarter, North American natural gas prices declined to pre-hurricane prices.Nitrogen products are commodity chemicals that are sold at prices reflecting global supply anddemand conditions. Imported nitrogen products, most of which are produced at facilities withaccess to fixed-priced natural gas supplies, account for a significant portion of U.S. nitrogenproduct supply. Imported products’ natural gas costs have been and could continue to besubstantially lower than the delivered cost of natural gas to our facilities. Off-shore producersare most competitive in regions close to North American points of entry for imports, including theGulf Coast and East Coast. Since some of the Company’s products compete with nitrogen productsimported from regions with lower natural gas costs, the Company and other North American producershave not always been able to increase selling prices to levels necessary to cover the natural gascost increases. This led to curtailments of North American nitrogen production in late 2005 andearly 2006.During the nine month period ending September 30, 2006, the Company’s U.S. and U.K. manufacturingplants operated at approximately 79% of capacity in response to slow demand and high natural gascosts. Much of the curtailed production was replaced with purchased product from other suppliers.During the three month period ending December 31, 2006, the same plants operated at approximately97% of capacity as operations normalized in response to higher grain prices and stable natural gascosts.During the 2006 second quarter, the Company’s ammonia plant at Billingham, England incurred damagedue to an explosion from a ruptured pipe. The repairs were completed and ammonia productionresumed during the 2006 third quarter.The nitrogen products industry has cycles of oversupply, resulting in lower prices and idledcapacity, followed by supply shortages, resulting in high selling prices and higher industry-wideproduction rates. To be viable in this industry, a producer must be among the low-cost suppliersin the markets it serves and have a financial position that can sustain it during periods ofoversupply.The Company’s nitrogen sales volumes depend primarily on its plants’ operations and imports fromPLNL. The Company may purchase product from other manufacturers or importers for resale; however,gross margins on those volumes have historically been insignificant. Profitability and cash flowsfrom the Company’s nitrogen products business are affected by the Company’s ability to manage itscosts and expenses (other than natural gas), most of which do not materially change for differentlevels of production or sales. Other factors affecting the Company’s nitrogen products resultsinclude the number
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of planted acres, transportation costs, weather conditions (particularly during planting season),grain prices and other variables described in Item 1 “Business” and Item 2 “Properties.”The Company also produces methanol in the U.S. Similar to nitrogen products, methanol is acommodity chemical manufactured from natural gas. Consequently, natural gas costs and thesupply/demand balance for methanol significantly affect methanol earnings and cash flows. Asignificant portion of U.S. methanol demand is met by imports from regions with natural gas costslower than those available to U.S. producers. In December 2003, the Company entered into contractswith the Methanex Corporation (“Methanex”) assigning it the Company’s sales contracts andproviding it exclusive rights to all methanol production at the Beaumont facility for five yearsas more fully described in Item 1 “Business” and Item 2 “Properties.” As permitted under thesecontracts, Methanex elected to shut down the Beaumont facility as of December 1, 2004. As long asthe Beaumont, Texas facility remains idle through the December 2008 termination of the Methanexcontract, the Company may realize revenues relating to the facility of up to $16.4 million peryear due to $4.4 million from annual amortization of deferred revenues plus one-half of the annualcash margin based on the plant’s methanol production capacity, methanol reference prices andnatural gas costs. Profit sharing cash margin during 2006 was $12.0 million. Due to the high costof natural gas, there was no cash margin realized during 2005.**Overview of Consolidated Results**The Company’s revenues were $1.8 billion, $1.9 billion and $1.5 billion during 2006, 2005 and2004, respectively. Terra generated net income of $4.2 million, $22.1 million and $67.6 million in2006, 2005 and 2004, respectively. Diluted income (loss) per share was $(0.01), $0.18 and $0.85 in2006, 2005 and 2004, respectively.Income from operations was $66.3 million in 2006, $113.7 million in 2005 and $134.7 million in2004. The 2006 revenues decreased $102.3 million from 2005 primarily as a result of lower UAN andammonium nitrate sales volumes, which were affected by lower overall fertilizer consumption duringthe 2006 planting season. The 2006 operating income decreased $47.4 million from 2005 dueprimarily to curtailed production rates during the first half of 2006. The 2006 first halfoperating rates averaged 74% of plant capacity, which resulted in higher costs for purchasedproduct and reduced plant efficiencies.The 2005 revenues and cost of sales increased $430.0 million and $452.2 million from 2004,primarily as a result of the acquisition of Mississippi Chemical Company (MCC) in December 2004.Natural gas prices increased in 2005 due to Hurricanes Katrina and Rita, which also increased costof sales. The 2005 net income included a $27.2 million charge related to early retirement of debtand a $8.9 million gain in a change in fair value of warrants issued in connection with the MCCacquisition.The 2004 net income included a $27.9 million income tax benefits due to a favorable settlementwith a foreign taxing authority. The 2004 net income also included $11.6 million attributable toan insurance recovery of product claim costs (representing $17.9 million of operating income less$6.3 million of related income taxes) and a $7.1 million loss from the early retirement oflong-term debt (representing $11.1 million of losses less $4.0 million of related income taxes).**Factors That Affect Operating Results**Factors that may affect the Company’s operating results include: the relative balance ofsupply and demand for nitrogen fertilizers, industrial nitrogen and methanol, the availability andcost of natural gas, the number of agriculture-planted acres (which is affected by both worldwidedemand and government policies), the types of crops planted, the effect of general weatherpatterns on the timing and duration of field work for crop planting and harvesting, the effect ofenvironmental legislation on supply and
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demand for the Company’s products, the availability of financing sources to fund seasonal workingcapital needs, and the potential for interruption to operations due to accidents or naturaldisasters.The principal raw material used to produce nitrogen products and methanol is natural gas. Naturalgas purchases in 2006 and 2005 accounted for approximately 46% and 53%, respectively, of theCompany’s total operating costs and expenses. A significant increase in the price of natural gasthat is not hedged or recovered through an increase in the price of the Company’s nitrogen andmethanol products would have an adverse effect on the Company’s business, financial condition andresults of operations. A portion of global nitrogen products and methanol production is atfacilities with access to fixed-price natural gas supplies that have been, and could continue tobe, substantially lower priced than natural gas costs at the Company’s North American and U.K.facilities. The Company’s facility at Point Lisas Nitrogen Limited, an unconsolidated subsidiary,is located in Trinidad with access to such lower-cost natural gas.The Company enters into forward pricing contracts for a portion of its natural gas requirementswhen such arrangements would not result in costs greater than expected North American and U.K.selling prices for the Company’s finished products. The Company’s December 31, 2006 forwardpositions covered 17% of the Company’s expected 2007 natural gas requirements (excluding thenatural gas requirements of Point Lisas Nitrogen Limited which purchases its gas under contractwith the Natural Gas Company of Trinidad and Tobago).Prices for nitrogen products are influenced by the world supply and demand balance for ammonia andother nitrogen-based products. Long-term demand is affected by population growth and rising livingstandards that determine food consumption. Short-term demand is affected by world economicconditions, international trade decisions and grain prices. Supply is affected by increasingworldwide capacity and the availability of nitrogen product exports from major producing regionssuch as the former Soviet Union, the Middle East and South America.Weather can have a significant effect on demand for the Company’s nitrogen products. Weatherconditions that delay or intermittently disrupt field work during the planting and growing seasonsmay cause agricultural customers to use forms of nitrogen fertilizer that are more or lessfavorable to the Company’s products. Weather conditions following harvest may delay or eliminateopportunities to apply fertilizer in the fall. Weather can also have an adverse effect on cropyields, which lowers the income of growers and could affect their ability to pay for crop inputspurchased from the Company’s dealer customers.The Company’s nitrogen business segment is seasonal, with the majority of nitrogen productsconsumed during the second quarter in conjunction with spring planting activity. Due to thebusiness’ seasonality and the relatively brief periods during which customers consume nitrogenproducts, the Company and its customers generally build inventories during the second half of theyear in order to ensure product availability during the peak sales season. For the Company’scurrent level of sales, it maintains lines of credit to fund inventory increases and to supportcustomer credit terms. The Company believes that its credit facilities are adequate for expected2007 sales levels.Methanol is used as a raw material in the production of formaldehyde, methyl tertiary-butyl ether(MTBE), acetic acid and numerous other chemical derivatives. The price of methanol is influencedby the supply and demand for each of these products. Environmental initiatives to ban or reducethe use of MTBE as a fuel additive, such as those currently underway in the United States, couldaffect demand for methanol.
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The Company’s manufacturing operations may be subject to significant interruption if one or moreof its facilities were to experience a major accident or were damaged by severe weather or othernatural disaster. The Company currently maintains insurance, including business interruptioninsurance, which it believes is sufficient to allow it to recover from major damage to any of itsfacilities.**Application of Critical Accounting Policies and Estimates**The preparation of financial statements and related disclosures in conformity with accountingprinciples generally accepted in the United States requires management to make judgments,assumptions and estimates that affect the amounts reported in the Company’s Consolidated FinancialStatements and accompanying notes. Note 1 to the Consolidated Financial Statements in Item 8 ofthis Form 10-K describes the significant accounting policies and methods used in preparing theConsolidated Financial Statements. Management considers the accounting policies described below tobe the Company’s most critical accounting policies because they are impacted significantly byestimates that management makes. Management bases its estimates on historical experience orvarious assumptions that they believe to be reasonable under the circumstances, and the resultsform the basis for making judgments about the reported values of assets, liabilities, revenues andexpenses. Management has discussed the development and selection of the Company’s criticalaccounting estimates, and the disclosure regarding them, with the audit committee of the Company’sBoard of Directors, and do so on a regular basis. Actual results may differ materially from theseestimates.*Derivative and Financial Instruments*The Company enters into derivative financial instruments, including swaps, basis swaps and put andcall options, to manage the effect of changes in natural gas costs, the prices of the Company’snitrogen products and foreign currency risk. Management evaluates each derivative transaction andmakes an election of whether to designate the derivative as a fair-value or cash flow hedge or notto elect hedge designation for the derivative. Upon election of hedge designation, and to theextent such hedge is determined to be effective, changes in fair value are either (a) offset bythe change in fair value of the hedged asset or liability or (b) reported as a component ofaccumulated other comprehensive income (loss) in the period of change, and subsequently recognizedin 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 derivativeis determined to be ineffective, changes in fair value are recognized in earnings in the period ofchange.Until the Company’s derivatives settle, management tests the derivatives for ineffectiveness. Thisincludes assessing the correlation of NYMEX pricing, which is commonly used as an index in naturalgas derivatives, to the natural gas pipelines’ pricing at the Company’s manufacturing facilities.This assessment requires management judgment to determine the statistically- andindustry-appropriate analysis of prior operating relationships between the NYMEX prices and thenatural gas pipelines’ prices at the Company’s facilities.To the extent possible, the Company bases its market value calculations on third party data. Dueto multiple types of settlement methods available, not all settlement methods for future periodtrades are available from third party sources. In the event that a derivative is measured for fairvalue based on a settlement method that is not readily available, management estimates the fairvalue based on forward pricing information for similar types of settlement methods.
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*Revenue Recognition*Revenue is recognized when persuasive evidence of a transaction exists, delivery has occurred, theprice is fixed or determinable, no obligations remain and collectibility is probable.Revenue from sales is generally recognized upon shipment of product to the customer in accordancewith the terms of the sales agreement. As part of the revenue recognition process, the Companydetermines whether collection of trade receivables are reasonably assured based on variousfactors, including evaluation of whether there has been deterioration in the credit quality of theCompany’s customers that could result in the inability to collect the receivable balance. Insituations where it is unclear whether the Company will be able to collect the receivable, revenueand related costs are deferred. Related costs are recognized when it has been determined that thecollection of the receivable is unlikely.*Inventory Valuation*Inventories are stated at the lower of cost or estimated net realizable value. The cost ofinventories is determined by using the first-in, first-out method. The Company performs a monthlyanalysis of its inventory balances to determine if the carrying amount of inventories exceedstheir net realizable value. The analysis of estimated realizable value is based on customerorders, market trends and historical pricing. If the carrying amount exceeds the estimated netrealizable value, the carrying amount is reduced to the estimated net realizable value.*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 fairmarket value of plan assets and differences between the actual return on plan assets and theexpected return on plan assets will affect the amount of pension expense ultimately recognized.The Company’s pension projected benefit obligation was $504.2 million at December 31, 2006, whichwas $149.1 million higher than pension plan assets. The December 31, 2006 liability was computedbased on an average 5.5% discount rate, which was based on yields for high-quality corporate bondswith a maturity approximating the duration of the Company’s pension liability. The long-termreturn on plan assets is determined based on historical portfolio results and management’sexpectations of the future economic environment. In addition, the pension liability for theCompany’s U.K. pension plan, which includes provisions to adjust benefit payments for generalinflation rates, was estimated based on an average 3.0% annual inflation rate. Declines incomparable bond yields or higher U.K. inflation rates would increase the Company’s pensionliability. The Company’s net pension liability, after deduction of plan assets, could increase ordecrease depending on the extent to which returns on pension plan assets are lower or higher thanthe discount rate. The Company engages third party actuarial specialists to assist management inappropriately measuring pension expense and valuing pension liabilities.*Deferred Income Taxes*Deferred income tax assets and liabilities reflect (a) differences between financial statementcarrying amounts and corresponding tax bases and (b) temporary differences resulting fromdiffering treatment of items for tax and accounting purposes. Deferred tax assets also include theexpected benefits of carrying forward the Company’s net operating losses. The Company regularlyreviews deferred tax assets for recoverability and reduces them if the Company cannot sufficientlydetermine that they will be realized. The Company bases this determination on projected futuretaxable income and the expected timing of the reversals of existing temporary differences.
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At December 31, 2006, deferred tax assets, net of valuation allowances, representing futurebenefits for the Company’s U.S. net operating loss carryforwards totaled $105 million. If there isa material change in the effective tax rates or time period when temporary differences becometaxable or deductible, the Company may have to additionally reduce all or a significant portion ofits deferred tax assets.*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 andestimates. Factors that management must estimate when performing impairment tests include salesdemand, production levels, prices and costs, inflation, discount rates, currency exchange ratesand capital spending. Significant management judgment is involved in estimating these factors, andthey include inherent uncertainties. All assumptions utilized in the impairment analysis areconsistent with management’s internal planning.During 2006, no events occurred that indicated that the carrying amount of any of the Company’sassets may not be recoverable. However, due to the mothballed status of the Beaumont, Texasfacility, management performs an annual impairment analysis of such assets. As of December 31,2006, the Beaumont assets had a carrying value, net of $10 million of deferred revenues, ofapproximately $86 million. The Company estimated the remaining useful life of the Beaumontfacility at 12 years, assuming normal investment in maintenance and replacement capital throughoutthis 12-year period. The estimated cash flows over this 12-year period were based on the Company’sbest estimate of future market and operating conditions at December 31, 2006. The estimated cashflows exceeded the carrying value of the Beaumont assets, therefore, no impairment charge wasrecorded. The cash flow estimates were made with the assumption that the Beaumont facility willremain idle through 2008, the term of the Company’s contract with Methanex, and that oncerestarted, the Beaumont facility will produce at historic rates and selling prices will beadequate to realize historic margins.**Results of Continuing Operations—2006 Compared with 2005****Consolidated Results**The Company reported 2006 net income of $4.2 million on revenues of $1.8 billion comparedwith a 2005 net income of $22.1 million on revenues of $1.9 billion. Diluted income (loss) pershare for 2006 was $(0.01) compared with $0.18 for 2005. The 2005 net income included a $27.2million ($24.9 million, net of tax) loss related to the early retirement of debt and a $8.9million ($8.9 million, net of tax) gain relating to change in fair value of warrants.The Company classifies its operations into two business segments: Nitrogen Products and Methanol.The Nitrogen Products segment represents the sale of nitrogen products including that produced atthe Company’s ammonia manufacturing and upgrading facilities. The Methanol segment representssales of methanol including that produced at the Company’s two methanol manufacturing facilities.Total revenues and operating income (loss) by segment for the years ended December 31, 2006 and2005 were:
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         (in thousands) **2006**  2005  **Revenues:**        Nitrogen products $1,793,759  $1,899,236 Methanol  34,955   31,347 Other revenues  8,008   8,482    $1,836,722  $1,939,065  **Operating Income (Loss):**        Nitrogen products $63,275  $131,474 Methanol  4,952   (14,089)Other expense—net  (1,947)  (3,689)   $66,280  $113,696  **Nitrogen Products**Volumes and prices for 2006 and 2005 were:                 **Volumes and Prices** **2006**  2005 (quantities in Sales  Average  Sales  Average thousands of tons) Volumes  Unit Price*  Volumes  Unit Price*  Ammonia  1,897  $315   1,898  $303 Nitrogen solutions  3,894   140   4,368   151 Urea  147   262   151   262 Ammonium nitrate  1,116   224   1,581   202  * After deducting outbound freight costsNitrogen product revenues decreased by $105.5 million to $1.8 billion for 2006, compared to $1.9billion for 2005. The decrease is primarily due to lower UAN and ammonium nitrate sales volumes,which were affected by lower overall fertilizer consumption during the 2006 planting season.Nitrogen product operating income decreased by $68.2 million to $63.3 million for 2006, comparedto $131.5 million for 2005. This decrease was primarily due to curtailed production rates duringthe first half of 2006 as a result of high natural gas prices. Operating rates averaged 74% ofplant capacity during the 2006 first half, which resulted in higher costs for purchased productand reduced plant efficiencies. These effects were partially mitigated during the 2006 second halfas operating results normalized in response to higher grain prices and stable natural gas costs.Natural gas unit costs, net of forward pricing gains and losses, were $7.14 per million Britishthermal units (“MMBtu”) during 2006 compared to $7.50 per MMBtu during 2005. Most of the 2005higher costs were absorbed into 2006 beginning inventory values and charged against first quarter2006 cost of sales. The Company enters into forward sales commitments by utilizing forward pricingand prepayment programs with customers. The Company hedges natural gas associated with theproducts sold forward in order to achieve an acceptable gross margin. As a result of forward pricecontracts, 2006 natural gas costs for the nitrogen products segment were $50.3 million higher thanspot prices.**Methanol**Methanol revenues were $35.0 million and $31.3 million for the years ended December 31, 2006and 2005. The 2006 revenues included $12.0 million of cash margin revenue under the Methanexcontract; there was no cash margin revenue realized in 2005 due to high fourth quarter natural gascosts. Methanol sales in 2006 and 2005 were 18.6 million and 31.6 million gallons,respectively. The decreased
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salesvolumes in 2006 were primarily due to partial production curtailment of the Woodward facility due to thehigh natural gas prices during the 2006 first half.The methanol segment had 2006 operating income of $5.0 million compared to an operating loss of$14.1 million in 2005. The 2006 improvement to operating results included was primarily due to$12.0 million of cash margin revenue under the Methanex contract and $4.6 million of highermargins on 2006 sales volumes. Ongoing costs at the idled Beaumont facility also declined $2.7million from 2005.**Other Operating Activities—Net**The Company had $1.9 million of charges from other operating activities in 2006 compared to$3.7 million in 2005. The decrease in expense relates primarily to administrative fees for generalcorporate activities not allocable to any particular business segment.**Interest Expense—Net**Net interest expense was $41.5 million in 2006 compared with $45.4 million in 2005. Thereduction in interest expense is primarily related to repayment of term debt during the 2005 firsthalf.**Income Taxes**The Company’s income tax expense in 2006 and 2005 was $9.2 million and $14.2 million,respectively. The 2006 effective tax rate was 69%, compared to 39% in 2005. The increase in the2006 effective tax rate was due primarily to currency fluctuations and disallowed interest expenseon intercompany loans to non-U.S subsidiaries.**Results of Continuing Operations—2005 Compared with 2004****Consolidated Results**The Company reported 2005 net income of $22.1 million on revenues of $1.9 billion comparedwith a 2004 net income of $67.6 million on revenues of $1.5 billion. Diluted income per share for2005 was $0.18 compared with $0.85 for 2004. The 2005 net income included a $27.2 million ($24.9million, net of tax) loss related to the early retirement of debt and a $8.9 million ($8.9million, net of tax) gain relating to change in fair value of warrants.The 2004 net income also included $27.9 million of income tax benefits due to a favorablesettlement with a foreign taxing authority, $11.6 million of income attributable to an insurancerecovery of product claim costs (representing $17.9 million of operating income less $6.3 millionof related income taxes) and a $7.1 million loss from the early retirement of long-term debt(representing $11.1 million of losses less $4.0 million of related income taxes.
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Total revenues and operating income (loss) by segment for the years ended December 31, 2005 and2004 were:         (in thousands) 2005  2004  **Revenues:**        Nitrogen products $1,899,236  $1,320,142 Methanol  31,347   186,823 Other revenues  8,482   2,145    $1,939,065  $1,509,110  **Operating Income (Loss):**        Nitrogen products $131,474  $138,745 Methanol  (14,089)  1,479 Other expense—net  (3,689)  (5,478)   $113,696  $134,746  **Nitrogen Products**Volumes and prices for 2005 and 2004 were:                 **Volumes and Prices** 2005  2004 (quantities in Sales  Average  Sales  Average thousands of tons) Volumes  Unit Price*  Volumes  Unit Price*  Ammonia  1,898  $303   1,391  $266 Nitrogen solutions  4,368   151   3,869   120 Urea  151   262   376   195 Ammonium nitrate  1,581   202   988   178  * After deducting outbound freight costsNitrogen products revenues increased by $579.1 million to $1.9 billion for 2005 compared with $1.3billion for 2004 primarily as the result of the December 2004 acquisition of MCC and higher salesprices. Higher selling prices contributed $253.7 million to 2005 revenues as the result ofincreased demand and lower fertilizer supplies due to reduced production capacity in NorthAmerica. Sales volumes in 2005 were higher than those of the previous year due primarily to theMCC acquisition.Nitrogen products operating income decreased by $7.3 million to $131.5 million for 2005 from$138.7 million for 2004. Operating income in 2005 from the MCC business totaled $34.5 million, butwas more than offset by lower nitrogen margins on other operations and the absence of the $17.9million 2004 insurance recovery of product claim costs. Nitrogen margins declined principally asthe result of increases to natural gas costs that outpaced selling price changes.Natural gas costs increased $272.5 million from 2004 as unit costs, net of forward pricing gainsand losses, and were $7.50 per million MMBtu during 2005 compared to $5.37 per MMBtu during 2004.As a result of forward price contracts, 2005 natural gas costs for the nitrogen products segmentwere $0.7 million lower than spot prices.**Methanol**Methanol revenues were $31.3 million and $186.8 million for the years ended December 31, 2005and 2004, respectively. Sales volumes declined approximately 87% from the prior year primarily dueto cessation of production from the Beaumont facility.
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The methanol segment had an operating loss of $14.1 million during 2005 compared to operatingincome of $1.5 million in 2004. The 2005 operating loss reflected lower sales volumes and idlefacility costs.**Other Operating Activities—Net**The Company had $3.7 million of charges from other operating activities in 2005 compared to$5.5 million in 2004. The decrease in expense relates primarily to administrative and legal feesfor general corporate activities not allocable to any particular business segment.**Interest Expense—Net**Net interest expense was $45.4 million in 2005 compared with $49.8 million in 2004. Thereduction in interest expense primarily related to higher cash balances during 2005 as compared to2004, increased yields on the cash balances and a decrease in interest expense due to a 2004fourth quarter $70.7 million redemption of Senior Notes due in 2010.**Minority Interest**Minority interest represents interest in the earnings of the publicly held common units ofTerra Nitrogen Company, L.P. (TNCLP). The 2005 minority interest charge of $13.7 million reflectednitrogen earnings for TNCLP, which were included in their entirety in consolidated operatingresults. Minority interest charge of $11.2 million was recorded in 2004, which were included intheir entirety in consolidated operating results.**Income Taxes**Terra’s income tax expense was $14.2 million in 2005, or 39% of pretax income, basedprimarily on statutory rates in the jurisdictions where the earnings arise.Terra’s income tax benefit was $5.0 million in 2004 and included reductions to tax reservestotaling $27.9 million for a reduced assessment by a foreign taxing authority.**Liquidity and Capital Resources**The Company’s primary uses of cash and cash equivalents is to fund its working capitalrequirements, make payments on its debt and other obligations and make payments for plantturnarounds and capital expenditures. The principal sources of funds are cash flow from operationsand borrowings under available bank facilities.Unrestricted cash and cash equivalent balances at December 31, 2006, were $179.0 million. During2006, cash and cash equivalents increased $92.7 million. Net cash provided by operatingactivities was $159.3 million. Cash used in financing activities was $19.7 million, primarilyrelated to the payments under the Company’s share repurchase program, distributions to minorityinterests and preferred share dividend payments. Cash used for investing activities was $48.8million, primarily for capital expenditures and plant turnaround costs, offset by distributionsreceived from unconsolidated affiliates and proceeds from the sale of property, plant andequipment.Net cash provided by 2006 operating activities of $159.3 million was composed of $151.4 million ofcash provided from operations and $7.9 million provided from net working capital items. Cash fromworking capital items included $24.2 million of cash provided by additional customer prepaymentsduring 2006. The Company had $77.1 million in total customer prepayments at December 31, 2006 forthe selling price and delivery costs of nitrogen products that it expects to ship during the firsthalf of 2007.
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During 2006 and 2005, the Company funded plant and equipment purchases of $50.9 million and $30.8million, respectively. The 2006 capital expenditures included approximately $20 million to expandthe capabilities of the Company’s Yazoo City facility to handle industrial grade ammonium nitrateand add UAN solution handling capabilities at the Donaldsonville terminal. Other capitalexpenditures in 2006 and 2005 were primarily for replacement or stay-in-business capital needs.The Company expects 2007 plant and equipment purchases to approximate $35 million consistingprimarily of expenditures for replacement of equipment or to improve operating results at itsmanufacturing facilities.Plant turnaround costs represent cash used for the periodic scheduled major maintenance of theCompany’s continuous process production facilities that is performed at each plant, generallyevery two years. The Company funded $35.3 million and $22.3 million of plant turnaround costs in2006 and 2005, respectively. The increase to 2006 turnaround costs was primarily due tomanagement’s 2005 decision to extend the turnaround cycle to three years for selected facilities.The Company estimates 2007 plant turnaround costs will approximate $35 million.In February 2007, the Company completed a tender offer for $200.0 million in aggregate principalamount of its127/8% senior secured notes due 2008 and $131.3 in aggregate principal amount of its111/2% second priority senior secured notes. A total of $189.2 million, or 94.6% of the aggregateprincipal amount of the 127/8% senior secured notes due 2008 and a total of $128.8 million, or98.1% of the aggregate principle amount of the 11 1/2% second priority senior secured notes due2010, were validly tendered and not withdrawn prior to the close of the tender offer. The Companywill redeem the remaining 127/8% senior secured notes due 2008 in the first quarter of 2007, andplans to announce the redemption of the remaining 11 1/2% second priority senior secured notes due2010 in the second/third quarter of 2007. Proceeds from the Company’s offering of $330.0 millionin aggregate principal amount of its new 7% senior notes due 2017 were used to finance therepurchase of the127/8% and 11 1/2 % notes in the tender offer. The Company incurred costs relatedto tender premiums and transaction fees of approximately $40 million in connection with the tenderoffer that will be recorded as an earnings charge in the first quarter of 2007. In connection withthe notes refinancing, the Company’s revolving bank credit facility was extended until February2012.On December 21, 2004, the Company entered into revolving credit facilities totaling $200 millionthat expire in June 2008. In connection with the 2007 bond refinancing, the term of the creditfacility was extended until February 2012. Borrowing availability under the credit facility isgenerally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligibleinventory, less outstanding letters of credit. These facilities include $50 million only availablefor the use of TNCLP, one of the Company’s consolidated subsidiaries. There were no outstandingrevolving credit borrowings and there were $17.7 million in outstanding letters of credit,resulting in remaining borrowing availability of approximately $182.3 million under thefacilities. The Company is required to maintain a combined minimum unused borrowing availabilityof $30 million. The credit facility also requires that the Company adhere to certain limitationson additional debt, capital expenditures, acquisitions, liens, asset sales, investments,prepayments of subordinated indebtedness, changes in lines of business and transactions withaffiliates. In addition, if the Company’s borrowing availability falls below a combined $60million, it is required to have generated $60 million of operating cash flows, or earnings beforeinterest, income taxes, depreciation, amortization and other non-cash items (as defined in thecredit facility) for the preceding four quarters.The Company’s ability to meet credit facility covenants will depend on future operating cashflows, working capital needs, receipt of customer prepayments and trade credit terms. Failure tomeet these covenants could result in additional costs and fees to amend the credit facility orcould result in
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termination of the facility. Access to adequate bank facilities is critical to funding theCompany’s operating cash needs. Based on our December 31, 2006 financial position and the currentmarket conditions for the Company’s finished products and for natural gas, the Company anticipatesthat it will be able to comply with its covenants through 2007.In April 2006, the Board of Directors authorized the repurchase of up to 10%, or 9.5 millionshares, of the Company’s outstanding stock on the open market. During 2006, the Companyrepurchased 2.7 million shares for $18.8 million, or an average price of $7.03 per share.During 2004, the Company issued 4.25% Cumulative Convertible Perpetual Series A Preferred Shareswith a liquidation value of $120 million for net proceeds of $115.8 million. The Series Apreferred shares are not redeemable by the Company, are convertible into common stock at aconversion price of $9.96 per common share at the option of the holder and may at the Company’soption be automatically converted to common shares after December 20, 2009 if the closing pricefor common shares exceeds 140% of the conversion price for any twenty days within a consecutivethirty day period prior to such a conversion. Upon the occurrence of a fundamental change to theCompany’s capital structure, including a change of control, merger, or sale of the Company,holders of the Series A preferred shares may require the Company to purchase any or all of theirshares at a price equal to their liquidation value plus any accumulated, but unpaid, dividends.The Company also has the right, under certain conditions, to require holders of the Series Apreferred shares to exchange their shares for convertible subordinated debentures with similarterms. During 2006 and 2005, the Company paid $5.1 million and $6.0 million, respectively, forpreferred share dividends.The Company’s ability to manage its exposure to commodity price risk in the purchase of naturalgas through the use of financial derivatives may be affected by limitations imposed by its bankagreement covenants.Contractual obligations and commitments to make future payments at December 31, 2006 were:                   Payments Due In (in millions) 2007  2008-2009  2010-2011  Thereafter  Long-term debt (1) $—  $200.0  $131.3  $— Operating leases  22.3   34.7   24.8   17.3 Interest expense onfixed rate debt (1)  40.8   52.7   6.3   — Ammonia purchaseobligations (2)  83.4   166.8   166.8   583.7 Other purchase obligations  267.2   12.6   2.2   3.3  Total $413.7  $466.8  $331.4  $604.3  (1) In February 2007, the Company refinanced its outstanding notes by issuing $330.0million in aggregate principal amount of its new 7% senior notes due 2017. These notesmature in February 2017. The interest payments on the new notes will be approximately $23.1million per year through February 2017. (2) The Company has a contractual obligation to purchase one-half of the ammonia producedby Point Lisas Nitrogen Limited. The purchase price is based on the average market price ofammonia, F.O.B. Caribbean, less a discount. Obligations in the above table are based onpurchasing 360,000 short tons per year at the December 2006 average price paid. Thiscontract expires in October 2018.
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The Company’s pension projected benefit obligations were $504.2 million at December 31, 2006,which was $149.1 million higher than its pension plan assets. The pension projected benefitobligations were computed based on a 5.5% discount rate, which was based on yields forhigh-quality corporate bonds (Moody’s Investor Service “AA” rated or equivalent) with a maturityapproximating the duration of the Company’s pension obligation. Future declines in comparable bondyields would increase the Company’s pension obligation and future increases in bond yields woulddecrease the Company’s pension obligation. The Company’s pension obligation, net of plan assets,could increase or decrease depending on the extent that returns on pension plan assets are loweror higher than the discount rate. In addition, the pension obligation for the Company’s U.K.pension plan, which includes provisions to adjust benefit payments for general inflation rates,was estimated based on a 3.0% inflation rate. The Company’s pension obligation could increase ordecrease based on actual U.K. inflation rates. The Company’s cash contributions to pension planswere $15.1 million in 2006 and are estimated at $20.4 million in 2007. Actual contributions couldvary from these estimates depending on the Company’s funding decisions, actual returns for planassets, legislative changes to pension funding requirements and/or plan amendments.Expenditures related to environmental, health and safety regulation compliance are primarilycomposed of operating costs that totaled $18.6 million in 2006. Because environmental, health andsafety regulations are expected to continue to change and generally to be more restrictive thancurrent requirements, the costs of compliance will likely increase. The Company does not expectcompliance with such regulations will have a material adverse effect on the results of operations,financial position or net cash flows.The Company incurred $2.2 million of 2006 capital expenditures to ensure compliance withenvironmental, health and safety regulations. The Company may be required to install additionalair and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammoniasensors and continuous emission monitors to continue to achieve compliance with the Clean Air Actand similar requirements. These equipment requirements typically apply to competitors as well. TheCompany estimates that the cost of complying with these existing requirements in 2007, 2008 and2009 and beyond will be less than $20 million in the aggregate.The Company owns 75.3% of the common units of TNCLP, which in accordance with the partnershipagreement, permits it to call all common units that it does not own.During 2006, 2005 and 2004, TNCLP distributed $8.9 million, $13.6 million and $8.1 million,respectively, to the minority TNCLP common unitholders. TNCLP distributions are based on“Available Cash” (as defined in the Partnership Agreement).During 2006 and 2005, the Company paid $5.1 million and $6.0 million, respectively, for preferredshare dividends.**Recently Issued Accounting Standards**In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No.48, *“Accounting for Uncertainty in Income Taxes,”*(FIN 48). FIN 48 requires that realization ofan uncertain income tax position must be “more likely than not” (i.e. greater than 50% likelihoodof receiving a benefit) before it can be recognized in the financial statements. Further, FIN 48prescribes the benefit to be recorded in the financial statements as the amount most likely to berealized assuming a review by tax authorities having all relevant information and applying currentconventions. FIN 48 also clarifies the financial statement classification of tax-related penaltiesand interest and sets forth new disclosures regarding unrecognized tax benefits. FIN 48 iseffective in the first quarter 2007 for the
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Company. The Company has performed a preliminary analysis of its income tax position and does notexpect a significant impact to its financial statements as a result of adopting theInterpretation.In September 2006, the FASB issued SFAS 157, *“Fair Value Measurements,”*(SFAS 157). SFAS 157 isdefinitional and disclosure oriented and addresses how companies should approach measuring fairvalue when required by generally accepted accounting principles (GAAP); it does not create ormodify any current GAAP requirements to apply fair value accounting. SFAS 157 provides a singledefinition for fair value that is to be applied consistently for all accounting applications, andalso generally describes and prioritizes according to reliability the methods and input used invaluations. SFAS 157 prescribes various disclosures about financial statement categories andamounts which are measured at fair value, if such disclosures are not already specified elsewherein GAAP. The new measurement and disclosure and requirements of SFAS 157 are effective for theCompany in 2008 first quarter and the Company expects no significant impact from adopting theStandard.In September 2006, the FASB issued SFAS 158, *“Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans,”*(SFAS 158). SFAS 158 focuses primarily on balance sheet reportingfor the funded status of benefit plans and requires recognition of benefit liabilities forunder-funded plans and benefit assets for over-funded plans, with offsetting impacts toshareholders equity. These changes are required to be adopted prospectively, effective with theCompany’s December 31, 2006 financial statements. The Company is in a net under-funded positionfor its pension and retiree health care plans, which resulted in a $13.3 million impact as aresult of adopting SFAS 158. The $13.3 million impact of adopting SFAS 158 increased accumulatedother comprehensive income and deferred tax assets by $8.6 million and $4.7 million, respectively.SFAS 158 will also require companies to measure benefit plan assets and liabilities and determinethe discount rate for subsequent year expense recognition as of the balance sheet date forfinancial reporting purposes, thus eliminating the opportunity to use a measurement of date up to90 days prior to the balance sheet date. The effective date for this change is delayed untilyear-end 2008. The Company currently uses an October 1 measurement date and will adopt a December31 measurement date in 2008 as required. Switching to the new measurement date will require aone-time adjustment to retained earnings per the transition guidance in SFAS 158. None of thechanges prescribed by SFAS 158 will impact the Company’s results of operations or cash flows.In February 2007, the FASB issued SFAS 159, *“The Fair Value Option for Financial Assets andFinancial Liabilities”*(SFAS 159). This statement, which is expected to expand fair valuemeasurement, permits entities to choose to measure many financial instruments and certain otheritems at fair value. SFAS 159 is effective for the Company beginning in the first quarter of 2008.The Company is currently assessing the impact SFAS 159 may have on its financial statements.In September 2006, the SEC issued Staff Accounting Bulletin 108, *“Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in the Current Year Financial Statements,”*(SAB108). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrectedmisstatements should be considered when quantifying misstatements in the current year financialstatements. SAB 108 requires registrants to quantify misstatements using both an income statementand balance sheet approach and then evaluate whether either approach results in a misstatementthat, when all relevant quantitative and qualitative factors are considered, is material. If prioryear errors that had been previously considered immaterial now are considered material based oneither approach, no restatement is required so long as management properly applied its previousapproach and all relevant facts and circumstances were considered. If prior year’s financialstatements are not restated, the cumulative effect adjustment is recorded in opening accumulateddeficit as of the beginning of the fiscal year of adoption.
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SAB 108 is effective for the fiscal year ending after November 15, 2006. The Company adopted theprovisions of SAB 108 on December 31, 2006. Adoption of SAB 108 had no impact on the Company’sfinancial statements.In December 2006, the FAB issued FASB Staff Position No. EITF 00-19-2, *“Accounting forRegistration Payment Arrangements,”*(FSP EITF 00-19-2). FSP EITF 00-19-2 specifies that thecontingent obligation to make future payments or otherwise transfer consideration under aregistration payment arrangement, whether issued as a separate agreement or included as aprovision of a financial instrument or other agreement, should be separately recognized andmeasured in accordance with SFAS 5 *“Accounting for Contingencies.”*Adoption of FSP EITF 00-19-2during 2006 had no impact on the Company’s financial statements.**Forward-Looking Precautions**Information contained in this report, other than historical information, may be consideredforward-looking. Forward-looking information reflects management’s current views of future eventsand financial performance that involve a number of risks and uncertainties. The factors that couldcause actual results to differ materially include, but are not limited to, the following: changesin financial markets, general economic conditions within the agricultural industry, competitivefactors and price changes (principally, sales prices of nitrogen and methanol products and naturalgas costs), changes in product mix, changes in the seasonality of demand patterns, changes inweather conditions, changes in agricultural regulations, and other risks detailed in the “Factorsthat Affect Operating Results” section of this discussion.**Item 7A.****Quantitative and Qualitative Disclosures About Market Risk****Risk Management and Financial Instruments**Market risk represents the risk of loss that may impact the Company’s financial position,results of operations or cash flows due to adverse changes in financial and commodity marketprices and rates. The Company uses derivative financial instruments to manage risk in the areas of(a) foreign currency fluctuations, (b) changes in natural gas prices and (c) changes in nitrogenprices and (d) changes in interest rates. See Note 3 to the Consolidated Financial Statements foradditional information on the use of derivative financial instruments.The Company’s policy is to avoid unnecessary risk and to limit, to the extent practical, risksassociated with operating activities. The Company’s management may not engage in activities thatexpose the Company to speculative or non-operating risks and is expected to limit risks toacceptable levels. The use of derivative financial instruments is consistent with the Company’soverall business objectives. Derivatives are used to manage operating risk within the limitsestablished by our Board of Directors, and in response to identified exposures, provided theyqualify as hedge activities. As such, derivative financial instruments are used to manage exposureto interest rate fluctuations, to hedge specific assets and liabilities denominated in foreigncurrency, to hedge firm commitments and forecasted natural gas purchase transactions, to set afloor for nitrogen selling prices and to protect against foreign exchange rate movements betweendifferent currencies that impact revenue and earnings expressed in U.S. dollars.The use of derivative financial instruments subjects the Company to some inherent risks associatedwith future contractual commitments, including market and operational risks, credit riskassociated with counterparties, product location (basis) differentials and market liquidity. TheCompany continuously monitors the valuation of identified risks and adjusts the portfolio based oncurrent market conditions.
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*Foreign Currency Fluctuations*The Company’s policy is to manage risk associated with foreign currency fluctuations by enteringinto forward exchange and option contracts covering specific currency obligations or net foreigncurrency operating requirements, as appropriate. Such hedging is limited to the amounts andduration of the specific obligations being hedged and, in the case of operating requirements, nomore than 75% of the forecasted requirements. The primary currencies to which the Company isexposed are the Canadian dollar and the British pound. At December 31, 2006, the Company hadnominal forward currency positions that were matched with committed capital expenditures.*Natural Gas Prices—North American Operations*Natural gas is the principal raw material used to manufacture nitrogen and methanol. Natural gasprices are volatile and the Company mitigates some of this volatility through the use ofderivative commodity instruments. The Company’s current policy is to hedge natural gas providedthat such arrangements would not result in costs greater than expected selling prices for itsfinished products. North American natural gas requirements for 2007 are approximately 100 millionMMBtu. The Company has hedged 22% of its expected 2007 North American requirements and none of itsrequirements beyond December 31, 2007. The fair value of these instruments is estimated based, inpart, on quoted market prices from brokers, realized gains or losses and the Company’scomputations. These instruments and other natural gas positions fixed natural gas prices at $19.1million more than published prices for December 31, 2006 forward markets. Market risk is estimatedas the potential loss in fair value resulting from a hypothetical price change. Changes in themarket value of these derivative instruments have a high correlation to changes in the spot priceof natural gas. Based on the Company’s derivatives outstanding at December 31, 2006, whichincluded swaps, basis swaps and put options, a $1 per MMBtu increase in NYMEX would increase theCompany’s natural gas costs by approximately $11.1 million and a $1 per MMBtu decrease in NYMEXpricing would decrease the Company’s natural gas costs by approximately $13.4 million.*Natural Gas Prices—Trinidad Operation*The natural gas requirements of Point Lisas Nitrogen Limited are supplied under contract with theNatural Gas Company of Trinidad and Tobago. The cost of natural gas to the joint venturefluctuates based on changes in the market price of ammonia.*Natural Gas Prices—United Kingdom Operations*To meet natural gas production requirements at the Company’s U.K. production facilities, theCompany may enter into gas supply contracts to fix prices for approximately 20% to 80% of totalannual volume requirements. Procurement requirements for 2007 U.K. natural gas are approximately32 million MMBtu. As of December 31, 2006, the Company did not have any fixed-price contracts.*Nitrogen Prices*The prices for nitrogen products can be volatile and the Company mitigates some of this volatilitythrough the use of derivative commodity instruments. The Company’s current policy is to hedge nomore than 20% of its expected production for the upcoming 12 months and no more than 50% of anysingle month’s expected production. The Company has hedged less than 5% of its 2007 North Americansales of nitrogen solutions.
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*Interest Rate Fluctuations*The table below provides information about the Company’s financial instruments that are sensitiveto changes in interest rates. For debt obligations, the table presents principal cash flows andrelated weighted average interest rates by expected maturity dates. The Company had no interestrate financial derivatives outstanding at December 31, 2006.**Interest Rate Sensitivity**                                 (in millions) Expected Maturity Date   2007  2008  2009  2010  2011  Thereafter  Total  Fair Value    **Long Term Debt**                                Senior Secured Notes (1),fixed rate of 12.88% ($US) $—  $200.0  $—  $—  $—  $—  $200.0  $197.9 Senior Second PrioritySecured Notes (1),fixed rate 11.50% ($US)  —   —   —   131.3   —   —   131.3   123.9  Total Long Term Debt $—  $200.0  $—  $131.3  $—  $—  $331.3  $321.8  **Short Term Borrowings**                                Revolving credit facility(2),notional amount ($US) $150.0  $150.0  $—  $—  $—  $—  $—  $— Variable interest rate,LIBOR based  7.10%  7.10%  —   —   —   —   —   — TNLP revolving creditfacility(2), notionalamount ($US) $50.0  $50.0  $—   —  $—   —   —   — Variable interest rate,LIBOR based  7.10%  7.10%  —   —   —   —   —   —  (1) In February 2007, the Company refinanced its outstanding notes by issuing new,unsecured notes of $330.0 million with a face interest rate of 7.0%. The new notes havea maturity date of 2017. (2) In February 2007, the Company amended its revolving credit facilities to extend theterm of the facilities to February 2012.
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**Item 8.****Financial Statements and Supplementary Data****Consolidated Statements of Financial Position**           At December 31, (in thousands) **2006**  2005  **Assets**        Cash and cash equivalents $179,017  $86,366 Restricted cash  —   8,595 Accounts receivable, less allowance fordoubtful accounts of $333 and $234  198,791   206,407 Inventories  211,017   190,314 Other current assets  31,680   54,578  Total current assets  620,505   546,260  Property, plant and equipment, net  720,897   733,536 Deferred plant turnaround costs  44,558   27,447 Equity investments  164,099   183,884 Intangible assets  5,645   7,526 Other assets  17,009   24,972  Total assets $1,572,713  $1,523,625  **Liabilities**        Accounts payable $156,493  $125,863 Customer prepayments  77,091   52,913 Accrued and other current liabilities  75,863   85,034  Total current liabilities  309,447   263,810  Long term debt and capital lease obligations  331,300   331,300 Deferred income taxes  63,851   65,998 Pension liabilities  134,444   120,236 Other liabilities  40,188   41,320 Minority interest  94,687   92,258  Total liabilities and minority interest  973,917   914,922           **Commitments and contingencies**(Note 10)  —   —          **Preferred Shares**liquidation value of $120,000  115,800   115,800          **Common Stockholders’ Equity**        Capital stock        Common Shares, authorized 133,500 shares;92,630 and 95,171 shares outstanding  144,976   146,994 Paid in capital  693,896   712,671 Accumulated other comprehensive loss  (63,739)  (70,143)Unearned compensation  —   (5,369)Accumulated deficit  (292,137)  (291,250) Total stockholders’ equity  482,996   492,903  Total liabilities and stockholders’ equity $1,572,713  $1,523,625           *See accompanying Notes to the Consolidated Financial Statements*        
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**Consolidated Statements of Operations**               Year ended December 31, (in thousands, except per-share amounts) **2006**  2005  2004  Revenues $1,828,714  $1,930,583  $1,506,965 Other income, net  8,008   8,482   2,145  Total Revenue  1,836,722   1,939,065   1,509,110  **Cost and Expenses**            Cost of sales  1,732,222   1,800,236   1,348,077 Selling, general and administrative expense  55,233   46,548   44,190 Equity in earnings of unconsolidated affiliates  (17,013)  (21,415)  — Recovery of product claim costs  —   —   (17,903)    1,770,442   1,825,369   1,374,364  Income from operations  66,280   113,696   134,746 Interest income  6,457   8,086   3,307 Interest expense  (47,991)  (53,478)  (53,134)Loss on early retirement of debt  —   (27,193)  (11,116)Change in fair value of warrant liability  —   8,860   —  Income before income taxes and minority interest  24,746   49,971   73,803 Income tax benefit (provision)  (9,247)  (14,217)  5,000 Minority interest  (11,286)  (13,667)  (11,207) Net income  4,213   22,087   67,596 Preferred share dividends  (5,100)  (5,134)  (1,029) **Income (Loss) Available to Common Stockholders** $(887) $16,953  $66,567               **Basic and Diluted Income (Loss) Per Share:**            Basic $(0.01) $0.18  $0.87 Diluted  (0.01)  0.18   0.85              **Basic and Diluted Weighted Average Shares Outstanding:**            Basic  92,676   92,537   76,478 Diluted  92,676   94,935   79,859              *See accompanying Notes to the Consolidated Financial Statements*            
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**Consolidated Statements of Cash Flows**               Year ended December 31, (in thousands) **2006**  2005  2004  **Operating Activities**            Net income $4,213  $22,087  $67,596 Adjustments to reconcile net income (loss)to net cash flows from operating activities:            Depreciation and amortization  108,069   110,342   102,230 Deferred income taxes  3,777   13,538   (6,058)Non-cash loss on derivatives  933   4,091   — Minority interest in earnings (loss)  11,286   13,667   11,207 Distributions in excess of (less than)equity earnings  9,202   (6,941)  — Share-based compensation  7,010   2,431   1,205 Amortization of intangible and other assets  6,878   5,243   — Non-cash loss on early retirement of debt  —   22,543   2,985 Change in fair value of warrant liability  —   (8,860)  — Term loan discount accretion  —   1,773   — Recovery of product claim costs  —   —   (12,874)Change in operating assets andliabilities, net of acquisition:            Accounts receivable  16,135   (59,591)  27,647 Inventories  (14,003)  (45,579)  (11,352)Accounts payable and customer prepayments  37,960   (60,136)  48,394 Other assets and liabilities, net  (32,200)  (3,733)  (18,508) **Net Cash Flows from Operating Activities**  159,260   10,875   212,472  **Investing Activities**            Purchase of property, plant and equipment  (50,856)  (30,820)  (18,472)Plant turnaround costs  (35,281)  (22,331)  (28,878)Acquisition, net of cash acquired  —   —   (54,168)Distributions received from unconsolidatedaffiliates  9,660   31,901   — Changes in restricted cash  8,595   (8,595)  — Proceeds from the sale of property, plantand equipment  19,100   7,560   —  **Net Cash Flows used in Investing Activities**  (48,782)  (22,285)  (101,518) **Financing Activities**            Payments under share repurchase program  (18,796)  —   — Preferred share dividends paid  (5,100)  (5,950)  — Distributions to minority interests  (8,861)  (13,607)  (8,072)Changes in overdraft protectionarrangements  11,443   —   — Excess tax benefits from equitycompensation plans  1,255   —   — Payments under borrowing arrangements  (37)  (125,167)  (70,854)Proceeds from exercise of stock options  363   142   447 Preferred share issuance, net of $4,200issuance costs  —   —   115,800 Deferred financing costs  —   —   (2,598) **Net Cash Flows used in Financing Activities**  (19,733)  (144,582)  34,723  **Effect of Exchange Rate Changes on Cash**  1,906   8,560   787  **Increase (Decrease) in Cash and CashEquivalents**  92,651   (147,432)  146,464 **Cash and Cash Equivalents at Beginning ofYear**  86,366   233,798   87,334  **Cash and Cash Equivalents at End of Year** $179,017  $86,366  $233,798  
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**Consolidated Statements of Cash Flows (continued)**               Year ended December 31, (in thousands) **2006**  2005  2004  **Supplemental cash flow information:**            Interest paid $42,150  $42,110  $50,455 Income tax refunds received  —   11,933   — Income taxes paid  1,930   1,526   1,123  **Supplemental schedule of non-cash investing andfinancing activities:**            **Conversion of Series B preferred stockto common stock:**            Common Stock $—  $2,066  $— Paid in Capital $—  $14,646  $— **Consideration to fund acquisitions:**            **Common shares** $—  $—  $135,750 **Series B preferred shares** $—  $—  $17,269 **Assumed debt** $—  $—  $125,000 **Stock Incentive Plan** $4,218  $5,020  $2,908 **Supplemental schedule of unconsolidated affiliatesdistributions received:**            Equity in earnings of unconsolidated affiliates $17,013  $21,415  $— Distribution in excess of (less than) equity earnings  9,202   (6,941)  — Distributions received from unconsolidated affiliates  9,660   31,901   —  Total cash distributions received fromunconsolidated affiliates $35,875  $46,375  $—               *See accompanying Notes to the Consolidated Financial Statements*            
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**Consolidated Statements of Change in Common Stockholder’ Equity**                                               Accumulated                        Other            Common Stock  Paid-In  Comprehensive  Unearned  Accumulated  Comprehensive (in thousands) Shares  Amount  Capital  Loss  Compensation  Deficit  Total  Income  January 1, 2004  77,563  $128,968  $555,529  $(44,596) $—  $(374,770) $265,131      Comprehensive Income (Loss):                                Net income  —   —   —   —   —   67,596   67,596  $67,596 Foreign currencytranslation adjustments  —   —   —   25,216   —   —   25,216   25,216 Change in fair value ofderivatives, net of taxesof$690  —   —   —   (23,286)  —   —   (23,286)  (23,286)Minimum pension liability,net of taxes of $3,149  —   —   —   (13,328)  —   —   (13,328)  (13,328)                                Comprehensive income                             $56,198                                 Preferred share dividends  —   —   —   —   —   (1,029)  (1,029)    Issuance of common stock  14,995   14,995   120,755   —   —   —   135,750     Exercise of stock options  198   198   249   —   —   —   447     Nonvested stock  238   370   5,106   —   (4,081)  —   1,395     Share-based compensation  —   —   —   —   1,513   —   1,513          December 31, 2004  92,994   144,531   681,639   (55,994)  (2,568)  (308,203)  459,405          Comprehensive Income (Loss):                                Net income  —   —   —   —   —   22,807   22,087  $22,087 Foreign currencytranslation adjustments  —   —   —   (23,387)  —   —   (23,387)  (23,387)Change in fair value ofderivatives, net of taxesof $2,861  —   —   —   14,198   —   —   14,198   14,198 Minimum pension liability,net of taxes of $5,015  —   —   —   (4,960)  —   —   (4,960)  (4,960)                                Comprehensive income                             $7,938                                 Preferred share dividends  —   —   —   —   —   (5,134)  (5,134)    Conversion of preferred shares  2,066   2,066   14,646   —   —   —   16,712     Reclassification of warrant liability  —   —   12,240   —   —   —   12,240     Exercise of stock options  39   39   103   —   —   —   142     Nonvested stock  72   358   4,043   —   (4,798)  —   (397)    Share-based compensation  —   —   —   —   1,997   —   1,997          December 31, 2005  95,171   146,994   712,671   (70,143)  (5,369)  (291,250)  492,903          
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**Consolidated Statements of Changes in Common Stockholders’ Equity (continued)**                                               Accumulated                        Other            Common Stock  Paid-In  Comprehensive  Unearned  Accumulated  Comprehensive (in thousands) Shares  Amount  Capital  Loss  Compensation  Deficit  Total  Income  Comprehensive Income (Loss):                                Net income  —   —   —   —   —   4,213   4,213  $4,213 Foreign currencytranslation adjustments  —   —   —   33,618   —   —   33,618   33,618 Change in fair value ofderivatives, net of taxesof $3,513  —   —   —   (6,727)  —   —   (6,727)  (6,727)Pension and post-retirementbenefit liabilities,net of taxes of $4,289  —   —   —   (11,850)  —   —   (11,850)  (11,850)                                Comprehensive income                             $19,254                                 Adoption of SFAS 158,net of taxes of $4,650  —   —   —   (8,637)  —   —   (8,637)    Preferred share dividends  —   —   —   —   —   (5,100)  (5,100)    Exercise of stock options  95   95   268   —   —   —   363     Nonvested stock  39   562   (714)  —   —   —   (152)    Shares purchased and retiredunder share repurchaseprogram  (2,675)  (2,675)  (16,121)  —   —   —   (18,796)    Reclassification for adoptionof SFAS 123 R  —   —   (5,369)  —   5,369   —   —     Share-basedcompensation  —   —   3,161   —   —   —   3,161      December 31, 2006  92,630  $144,976  $693,896  $(63,739) $—  $(292,137) $482,996      *See accompanying Notes to the Consolidated Financial Statements*
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**Notes to the Consolidated Financial Statements****1. Summary of Significant Accounting Policies****Basis of presentation:**The Consolidated Financial Statements include the accounts of TerraIndustries Inc. and all majority owned subsidiaries (Terra). All intercompany accounts andtransactions have been eliminated. Minority interest in earnings and ownership has been recordedfor the percentage of limited partnership common units not owned by Terra Industries Inc. for eachrespective period presented.**Description of business:**Terra produces nitrogen products for agricultural dealers and industrialusers, and methanol for industrial users.**Foreign exchange:**Results of operations for the foreign subsidiaries are translated using averagecurrency exchange rates during the period; assets and liabilities are translated using period-endrates. Resulting translation adjustments are recorded as foreign currency translation adjustmentsin accumulated other comprehensive income (loss) in stockholders’ equity.**Cash and cash equivalents:**Cash and cash equivalents consist of all cash balances and all highlyliquid investments purchased with an original maturity of three months or less.**Restricted cash:**Restricted cash consists of cash and cash equivalents that have been pledged ascollateral on outstanding debt. The restrictions on the balances lapse with the payments forqualified expenditures at the Verdigris, Oklahoma facility.**Inventories:**Inventories are stated at the lower of cost or estimated net realizable value. Thecost of inventories is determined using the first-in, first-out method. The Company performs amonthly analysis of its inventory balances to determine if the carrying amount of inventoriesexceeds their net realizable value. The analysis of estimated realizable value is based oncustomer orders, market trends and historical pricing. If the carrying amount exceeds theestimated net realizable value, the carrying amount is reduced to the estimated net realizablevalue.The Company allocates fixed production overhead costs based on the normal capacity of itsproduction facilities and unallocated overhead costs are recognized as expense in the periodincurred.**Property, plant and equipment:**Expenditures for plant and equipment additions, replacements andmajor improvements are capitalized. Related depreciation is charged to expense on a straight-linebasis over estimated useful lives ranging from 15 to 22 years for buildings and 3 to 18 years forplants and equipment. Equipment under capital leases is recorded in property with thecorresponding obligations in long-term debt. The amount capitalized is the present value at thebeginning of the lease term of the aggregate future minimum lease payments. Maintenance and repaircosts are expensed as incurred.**Plant turnaround costs:**Costs related to the periodic scheduled major maintenance of continuousprocess production facilities (plant turnarounds) are deferred and charged to product costs on astraight-line basis during the period until the next scheduled turnaround, generally two years.**Equity investments:**Equity investments are carried at original cost adjusted for the Company’sproportionate share of the investees’ income, losses and distributions. The Company periodicallyassesses the carrying value of its equity investments and records a loss in value of theinvestment when the assessment indicates that an other-than-temporary decline in the investmentexists.**Intangible assets – customer relationships:**The Company’s customer relationships has a finiteuseful life and is amortized using the straight-line method over the estimated useful life of fiveyears. The Company monitors its intangible asset and records an impairment loss on the intangibleasset when circumstances indicate that the carrying amount is not recoverable and that thecarrying amount exceeds its fair value.The customer relationships were recorded at $9.4 million in connection with the acquisition ofMississippi Chemical Corporation in December 2004. During 2006 and 2005, the Company recorded $1.9million of amortization expense each year. There was no amortization expense recorded during 2004.The estimated amortization expense related to the customer relationships is $1.9 million annuallyfor 2007, 2008 and 2009.
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**Debt issuance costs:**Costs associated with the issuance of debt are included in other noncurrentassets and are amortized over the term of the related debt using the straight-line method.**Impairment of long-lived assets:**The Company reviews and evaluates its long-lived assets forimpairment when events and changes in circumstances indicate that the carrying amount of its assetmay not be recoverable. Impairment is considered to exist if the total estimated future cash flowson an undiscounted basis are less than the carrying value of the asset. Future cash flows includeestimates of production levels, pricing of the Company’s products, costs of natural gas andcapital expenditures. If the assets are impaired, a calculation of fair value is performed; if thefair value is less than the carrying value of the assets, the assets are reduced to their fairvalue.**Derivatives and financial instruments:**The Company enters into derivative financial instruments,including swaps, basis swaps, purchased put and call options and sold call options, to manage theeffect of changes in natural gas costs, to manage the prices of its nitrogen products and tomanage foreign currency risk. The Company reports the fair value of the derivatives on its balancesheet. If the derivative is not designated as a hedging instrument, changes in fair value arerecognized in earnings in the period of change. If the derivative is designated as a hedge, and tothe extent such hedge is determined to be effective, changes in fair value are either (a) offsetby the change in fair value of the hedged asset or liability or (b) reported as a component ofaccumulated other comprehensive income (loss) in the period of change, and subsequently recognizedin cost of sales in the period the offsetting hedged transaction occurs. If an instrument issettled early, any gains or losses are immediately recognized in cost of sales.**Revenue recognition:**Revenue is recognized when persuasive evidence of an arrangement exists,delivery has occurred, the price is fixed or determinable, no obligations remain andcollectibility is probable.Revenues are primarily comprised of sales of the Company’s nitrogen- and methanol-based products,including any realized hedging gains or losses related to nitrogen product derivatives, and arereduced by estimated discounts and trade allowances. Revenues include amounts related to shippingand handling charges to the Company’s customers.**Cost of sales and hedging transactions:**Costs of sales are primarily related to manufacturing andpurchased costs related to the Company’s nitrogen- and methanol-based products, including anyrealized hedging gains or losses related to natural gas derivatives. Costs of sales includeamounts related to shipping and handling charges to the Company’s customers.**Share-based compensation:**During the 2006 first quarter, the Company adopted Statement ofFinancial Accounting Standards No. 123 (revised 2004), *“Share-Based Payment,”*(SFAS 123 R) whichrequires the measurement and recognition of compensation expense for all share-based paymentawards made to employees and directors based on estimated fair values. SFAS 123 R supersedes theCompany’s previous accounting under Accounting Principles Board Opinion No. 25, *“Accounting forStock Issued to Employees”*(APB 25) for periods beginning in 2006. In March 2005, the SEC issuedStaff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123 R. The Company has applied theprovision of SAB 107 in its adoption of SFAS 123 R. The Company adopted SFAS 123 R using themodified prospective transition method, which requires the application of the accounting standardas of January 1, 2006 (See Note 15).**Per share results:**Basic earnings per share data are based on the weighted-average number ofcommon shares outstanding during the period. Diluted earnings per share data are based on theweighted-average number of common shares outstanding and the effect of all dilutive potentialcommon shares including convertible preferred shares, common stock options, restricted stock andcommon stock warrants.
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**Estimates:**The preparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements and the reported amountsof revenues and expenses during the reporting period. The significant areas requiring the use ofmanagement’s estimates relate to assumptions used to calculate pension and other post-retirementbenefits costs, valuation allowance for deferred tax assets, future cash flows from long-livedassets and the useful lives utilized for depreciation, amortization and accretion calculations.Actual results could differ from those estimates.**Recently issued accounting standards:**In July 2006, the Financial Accounting Standards Board(FASB) issued FASB Interpretation No. 48, *“Accounting for Uncertainty in Income Taxes,”*(FIN 48).FIN 48 requires that realization of an uncertain income tax position must be “more likely thannot” (i.e. greater than 50% likelihood of receiving a benefit) before it can be recognized in thefinancial statements. Further, FIN 48 prescribes the benefit to be recorded in the financialstatements as the amount most likely to be realized assuming a review by tax authorities havingall relevant information and applying current conventions. FIN 48 also clarifies the financialstatement classification of tax-related penalties and interest and sets forth new disclosuresregarding unrecognized tax benefits. FIN 48 is effective in the first quarter 2007 for theCompany. The Company has performed a preliminary analysis of its income tax position and does notexpect a significant impact to its financial statements as a result of adopting theInterpretation.In September 2006, the FASB issued SFAS 157, *“Fair Value Measurements,”*(SFAS 157). SFAS 157 isdefinitional and disclosure oriented and addresses how companies should approach measuring fairvalue when required by generally accepted accounting principles (GAAP); it does not create ormodify any current GAAP requirements to apply fair value accounting. SFAS 157 provides a singledefinition for fair value that is to be applied consistently for all accounting applications, andalso generally describes and prioritizes according to reliability the methods and input used invaluations. SFAS 157 prescribes various disclosures about financial statement categories andamounts which are measured at fair value, if such disclosures are not already specified elsewherein GAAP. The new measurement and disclosure and requirements of SFAS 157 are effective for theCompany in 2008 first quarter and the Company expects no significant impact from adopting theStandard.In September 2006, the FASB issued SFAS 158, *“Employers’ Accounting for Defined Benefit Pensionand Other Postretirement Plans,”*(SFAS 158). SFAS 158 focuses primarily on balance sheet reportingfor the funded status of benefit plans and requires recognition of benefit liabilities forunder-funded plans and benefit assets for over-funded plans, with offsetting impacts toshareholders equity. These changes are required to be adopted prospectively, effective with theCompany’s December 31, 2006 financial statements. The Company is in a net under-funded positionfor its pension and retiree health care plans, which resulted in a $13.3 million impact as aresult of adopting SFAS 158. The $13.3 million impact of adopting SFAS 158 increased accumulatedother comprehensive income and deferred tax assets by $8.6 million and $4.7 million, respectively.SFAS 158 will also require companies to measure benefit plan assets and liabilities and determinethe discount rate for subsequent year expense recognition as of the balance sheet date forfinancial reporting purposes, thus eliminating the opportunity to use a measurement of date up to90 days prior to the balance sheet date. The effective date for this change is delayed untilyear-end 2008. The Company currently uses an October 1 measurement date and will adopt a December31 measurement date in 2008 as required. Switching to the new measurement date will require aone-time adjustment to retained
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earnings per the transition guidance in SFAS 158. None of the changes prescribed by SFAS 158 willimpact the Company’s results of operations or cash flows.In February 2007, the FASB issued SFAS 159, *“The Fair Value Option for Financial Assets andFinancial Liabilities”*(SFAS 159). This statement, which is expected to expand fair valuemeasurement, permits entities to choose to measure many financial instruments and certain otheritems at fair value. SFAS 159 is effective for the Company beginning in the first quarter of 2008.The Company is currently assessing the impact SFAS 159 may have on its financial statements.In September 2006, the SEC issued Staff Accounting Bulletin 108, *“Considering the Effects of PriorYear Misstatements when Quantifying Misstatements in the Current Year Financial Statements,”*(SAB108). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrectedmisstatements should be considered when quantifying misstatements in the current year financialstatements. SAB 108 requires registrants to quantify misstatements using both an income statementand balance sheet approach and then evaluate whether either approach results in a misstatementthat, when all relevant quantitative and qualitative factors are considered, is material. If prioryear errors that had been previously considered immaterial now are considered material based oneither approach, no restatement is required so long as management properly applied its previousapproach and all relevant facts and circumstances were considered. If prior year’s financialstatements are not restated, the cumulative effect adjustment is recorded in opening accumulateddeficit as of the beginning of the fiscal year of adoption. SAB 108 is effective for the fiscalyear ending after November 15, 2006. The Company adopted the provisions of SAB 108 on December 31,2006. Adoption of SAB 108 had no impact on the Company’s financial statements.In December 2006, the FAB issued FASB Staff Position No. EITF 00-19-2, *“Accounting forRegistration Payment Arrangements,”*(FSP EITF 00-19-2). FSP EITF 00-19-2 specifies that thecontingent obligation to make future payments or otherwise transfer consideration under aregistration payment arrangement, whether issued as a separate agreement or included as aprovision of a financial instrument or other agreement, should be separately recognized andmeasured in accordance with SFAS 5 *“Accounting for Contingencies.”*Adoption of FSP EITF 00-19-2during 2006 had no impact on the Company’s financial statements.**2. Earnings Per Share**Basic income per share data is based on the weighted-average number of common sharesoutstanding during the period. Diluted income per share data is based on the weighted averagenumber of common shares outstanding and the effect of all dilutive potential common sharesincluding stock options, restricted shares, convertible preferred shares and common stockwarrants. Nonvested restricted stock carries dividend and voting rights, but is not involved inthe weighted average number of common shares outstanding used to compute basic income per share.The following table provides a reconciliation between basic and diluted income per share for theyear ended December 31, 2006, 2005 and 2004.
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             (in thousands, except per-share data) **2006**  2005  2004  **Basic income per share computation:**            Income from continuing operations $4,213  $22,087  $67,596 Less: Preferred share dividends  (5,100)  (5,134)  (1,029) Income (loss) available to common shareholders  (887)  16,953   66,567 Weighted average shares outstanding  92,676   92,537   76,478  Basic income (loss) per common share $(0.01) $0.18  $0.87  **Diluted income (loss) per share computation:**            Income (loss) available to common shareholders $(887) $16,953  $66,567 Add: Preferred share dividends  —   —   1,029  Income (loss) available to common shareholders andassumed conversions $(887) $16,953  $67,596  Weighted average shares outstanding  92,676   92,537   76,478 Add incremental shares from assumed conversions:            Preferred Shares  —   1,048   2,423 Restricted stock  —   577   750 Common stock options  —   179   208 Common stock warrants  —   594   —  Dilutive potential common shares  92,676   94,935   79,859  Diluted income (loss) per potential common share $(0.01) $0.18  $0.85  Common stock options totaling 0.1 million, 0.1 million and 0.1 million for the years endedDecember 31, 2006, 2005 and 2004, respectively, were excluded from the computation of dilutedearnings per share because the exercise prices of those options exceeded the average market priceof Terra’s stock for the respective periods, and the effect of their inclusion would beantidilutive.All dilutive instruments were excluded from computation of diluted earnings per share due to theloss available to common shareholders at December 31, 2006.**3. Derivative Financial Instruments**Terra manages risk using derivative financial instruments for (a) changes in natural gassupply 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 arecurrently rated as BBB or better or equivalent as recognized by a national rating agency. Terrawill not enter into transactions with a counter-party if the additional transaction will result incredit exposure exceeding $20 million. The credit rating of counter-parties may be modifiedthrough guarantees, letters of credit or other credit enhancement vehicles.Terra classifies a derivative financial instrument as a hedge if all of the following conditionsare met: 1. The item to be hedged must expose Terra to currency, interest or price risk.  2. It must be probable that the results of the hedge position substantially offset theeffects of currency, interest or price changes on the hedged item (i.e., there is a highcorrelation between the hedge position and changes in market value of the hedge item).  3. The derivative financial instrument must be designated as a hedge of the item at theinception of the hedge.Natural gas supplies to meet production requirements at Terra’s North American and United Kingdom(U.K.) production facilities are purchased at market prices. Natural gas market prices arevolatile and Terra effectively fixes prices for a portion of its natural gas productionrequirements and inventory through the use of futures contracts, swaps and options. The NorthAmerican contracts reference physical natural gas prices or appropriate NYMEX futures contractprices. Contract physical prices for North America are frequently based on prices at the Henry Hubin Louisiana, the most common and financially liquid location of reference for financialderivatives related to natural gas. However, natural gas supplies for Terra’s North Americanproduction facilities are purchased at locations other than Henry Hub, which
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often creates a location basis differential between the contract price and the physical price ofnatural gas. Accordingly, the use of financial derivatives may not exactly offset the change inthe price of physical gas. The U.K. forward contracts and physical delivery are based on theIntercontinental Exchanged (ICE) index price. Natural gas derivatives are designated as cash flowhedges, provided that the derivatives meet the conditions discussed above. The contracts aretraded in months forward and settlement dates are scheduled to coincide with gas purchases duringthat 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. Thefutures contracts require maintenance of cash balances generally 10% to 20% of the contract valueand 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 monthlypublished gas prices from the source specified in the contract differ from prices of NYMEX naturalgas futures during a specified period. There are no initial cash requirements related to the swapand basis swap agreements.Terra will also use a collar structure where it will enter into a swap, sell a call at a higherprice and buy a put. The collar structure allows for greater participation in a decrease tonatural gas prices and protects against moderate price increases. However, the collar exposesTerra to large price increases.The following summarizes values and balance sheet effects of open natural gas derivatives atDecember 31, 2006 and 2005:                   Other Other      Current Current Deferred Net Asset(in thousands) Assets Liabilities Taxes (Liability) December 31, 2006 $4,731  $(22,591) $6,373  $(11,487)December 31, 2005  22,152   (34,213)  2,861   (9,200)The Company determined that certain derivative contracts were ineffective hedges for accountingpurposes and recorded a charge of $0.9 million to cost of sales for the year ended December 31,2006. At December 31, 2005, the Company recorded an ineffective position of $4.1 million as acharge to cost of sales.The effective portion of gains and losses on derivative contracts that qualify for hedge treatmentare carried as accumulated other comprehensive income (loss) and credited or charged to cost ofsales in the month in which the hedged transaction settles. Gains and losses on the contracts thatdo not qualify for hedge treatment are credited or charged to cost of sales based on the positionsfair value. The risk and reward of outstanding natural gas positions are directly related toincreases or decreases in natural gas prices in relation to the underlying NYMEX and ICE naturalgas contract prices.The activity to accumulated other comprehensive loss, net of income taxes, relating to currentperiod hedging transactions for the twelve-month periods ended December 31, 2006 and 2005 follows:                   Twelve Months Ended  December 31,  2006 2005(in thousands) Gross Net of tax Gross Net of tax Beginning accumulated loss $(7,886) $(5,109) $(16,829) $(19,307)Net increase (decrease) inmarket value  (59,181)  (38,420)  4,171   11,139 Reclassification into earnings  48,857   31,693   4,772   3,059  Ending accumulated loss $(18,210) $(11,836) $(7,886) $(5,109) 
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Approximately $11.8 million of the net accumulated loss at December 31, 2006 will be reclassifiedinto earnings during 2007.At times, the Company also uses forward derivative instruments to fix or set floor prices for aportion of its nitrogen sales volumes. At December 31, 2006, the Company had 30,000 tons of opennitrogen solution swap contracts. Outstanding nitrogen solution contracts do not qualify for hedgetreatment due to inadequate trading history to demonstrate effectiveness. Consequently thesecontracts are marked-to-market and unrealized gains or losses are reflected in revenue in thestatement of operations. For the years ending December 31, 2006, 2005 and 2004, the Companyrecognized losses of $0.6 million, $2.2 million and $8.2 million, respectively on these forwardderivative instruments.**4. Inventories**Inventories consisted of the following at December 31:         (in thousands) **2006**  2005  Raw materials $26,583  $22,487 Supplies  54,542   55,647 Finished goods  129,892   112,180  Total $211,017  $190,314  Inventory is valued at actual first in-first out cost. Costs include raw materials, labor andoverhead.**5. Property, Plant and Equipment, Net**Property, plant and equipment, net consisted of the following at December 31:         (in thousands) **2006**  2005  Land $17,096  $16,086 Buildings and improvements  65,573   62,937 Plant and equipment  1,423,302   1,339,799 Construction in progress  24,372   27,510     1,530,343   1,446,332 Less accumulated depreciation and amortization  (809,446)  (712,796) Total $720,897  $733,536  Depreciation expense for property, plant and equipment for the years ending December 31, 2006,2005 and 2004 was $78.9 million, $80.8 million and $74.0 million, respectively.**6. Equity Investments**Terra’s investments in companies that are accounted for on the equity method of accountingconsist of the following: (1) 50% ownership interest in PLNL, an ammonia production plant inTrinidad (2) 50% interest in an ammonia storage joint venture located in Houston, Texas and (3)50% interest in a joint venture in Oklahoma CO2, located in Verdigris, Oklahoma which produces CO2at Terra’s plant. As of December 31, 2006, the Point Lisas Nitrogen Limited investment isconsidered significant as defined by applicable SEC regulations. These investments amounted to$164.1 million and $183.9 million at December 31, 2006 and 2005, respectively.
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The combined results of operations and financial position of Terra’s equity basis investments aresummarized below:         (in thousands) **2006**  2005  Condensed income statement information:        Net sales $171,906  $181,818           Net income $44,751  $62,723           Terra’s equity in net income of affiliates $17,013  $31,362           Condensed balance sheet information:        Current assets $59,553  $78,711 Long-lived assets  185,621   194,548  Total assets $245,174  $273,259           Current liabilities $22,311  $37,804 Long-term liabilities  —   75 Equity  222,863   235,380  Total liabilities and equity $245,174  $273,259  Thecarrying value of these investments at December 31, 2006 was$52.7 million more than Terra’sshare of the equity method investments’ book value. The excess fair value assigned at theacquisition date is attributable primarily to fixed asset values and will be amortized over aperiod of approximately 15 years.The Company has transactions in the normal course of business with PLNL, whereby the Company isobliged to purchase 50 percent of the ammonia produced by PLNL at current market prices. Duringthe twelve-month period ended December 31, 2006, the Company purchased approximately $76.0 millionof ammonia from PLNL. As of December 31, 2006, PLNL made cash distributions to its shareholders,of which the Company’s portion was $33.8 million for the 12-month period.The total distributions from all equity investments were $35.9 million and $46.4 million atDecember 31, 2006 and 2005, respectively.
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**7. Revolving Credit Facility, Long-Term Debt and Capital Lease Obligations**The Company has revolving credit facilities totaling $200 million that expire June 30, 2008.The revolving credit facility is secured by substantially all of the assets of the Company otherthan the assets collateralizing the Senior Secured Notes. Borrowing availability is generallybased on 100% of eligible cash balances, 85% of eligible accounts receivable and 60% of eligiblefinished goods inventory less outstanding letters of credit issued under the facility. Thesefacilities include $50 million only available for the use of TNCLP, one of the Company’sconsolidated subsidiaries. Borrowings under the revolving credit facility will bear interest at afloating rate plus an applicable margin, which can be either a base rate, or, at the Company’soption, a London Interbank Offered Rate (LIBOR). At December 31, 2006, the LIBOR rate was 5.32%.The base rate is the highest of (1) Citibank, N.A.’s base rate (2) the federal funds effectiverate, plus one-half percent (0.50%) per annum and (3) the base three month certificate of depositrate, plus one-half percent (0.50%) per annum, plus an applicable margin in each case. LIBOR loanswill bear interest at LIBOR plus an applicable margin. The applicable margin for base rate loansand LIBOR loans are 0.50% and 1.75%, respectively, at December 31, 2006. The revolving creditfacility requires an initial one-half percent (0.50%) commitment fee on the difference betweencommitted amounts and amounts actually borrowed.At December 31, 2006, the Company had no outstanding revolving credit borrowings and $17.7 millionin outstanding letters of credit. The $17.7 million in outstanding letters of credit reduced theCompany’s borrowing availability to $182.3 million at December 31, 2006. The credit facilitiesrequire that the Company adhere to certain limitations on additional debt, capital expenditures,acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changesin lines of business and transactions with affiliates. The Company was in compliance with allcredit facilities covenants at December 31, 2006. If the Company’s borrowing availability fallsbelow $60 million, the Company is required to have achieved minimum operating cash flows orearnings before interest, income taxes, depreciation, amortization and other non-cash items of $60million during the most recent four quarters.Long-term debt and capital lease obligations consisted of the following at December 31:         (in thousands) **2006**  2005  Senior Secured Notes, 12.875%,due 2008 $200,000  $200,000 Second Priority SeniorSecured Notes, 11.5%, due 2010  131,300   131,300 Capital lease obligations  1   38     331,301   331,338 Less current maturities in other current liabilities  1   38  Total long-term debt $331,300  $331,300  In connection with the December 2004 acquisition of MCC, the Company assumed obligations due underMCC’s $125.0 million bank term loan and provided the debt holders five-year warrants to purchaseTerra’s common shares. The warrants were valued at $21.1 million, which was treated as a discountto par value of the debt.In 2005, the Company repaid $125 million of the term loan from the MCC acquisition. The Companyrecorded a $27.2 million charge which related to the loss on the early repayment and other relatedprepayment charges.During 2003, Terra Capital, Inc., (“TCAPI”) a subsidiary of Terra Industries Inc., issued $202million of 11.5% Second Priority Senior Secured Notes due June 1, 2010. The notes were priced at99.402% to
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yield 11.625% and are unconditionally guaranteed by the Company and its U.S. subsidiaries. Part ofthe proceeds were used to repay existing debt. The Company redeemed $70.7 million of the 2010notes during 2004. These notes and guarantees are secured by a second priority security interestin all domestic inventory, domestic accounts receivable, intellectual property of Terra IndustriesInc. and its domestic subsidiaries and certain subsidiary capital stock. The security interest issecond in priority to a first priority security interest in the same assets in favor of thelenders under the Company’s revolving credit facility and is shared equally and ratably with theCompany’s outstanding 12.875% Senior Secured Notes due 2008. The Indenture governing these notescontains covenants that limit, among other things, the Company’s ability to incur additional debt,pay dividends on common stock of Terra Industries Inc. or repurchase shares of such common stock,make investments (other than in Terra Capital, Inc. or any guarantor), use assets as security inother transactions, sell any of the Company’s principal production facilities or sell other assetsoutside the ordinary course of business, enter into transactions with affiliates, limit dividendsor other payments by the Company’s restricted subsidiaries to the Company, enter into sale andleaseback transactions, engage in other businesses, sell all or substantially all of the Company’sassets or merge with or into other companies, and reduce the Company’s insurance coverage. Inaddition, the Company is obligated to offer to repurchase these notes upon a Change of Control (asdefined in the Indenture) at a cash price equal to 101% of the aggregate principal amountoutstanding at that time, plus accrued interest to the date of purchase. The Indenture governingthese notes contains events of default and remedies customary for a financing of this type.During 2001, TCAPI issued $200 million of 12.875% Senior Secured Notes due in 2008. The notes werepriced at 99.43% to yield 13%. The proceeds were used to repay existing debt. The notes aresecured by a first priority interest in ownership or leasehold interest in substantially all realproperty, machinery and equipment owned or leased in TCAPI and the guaranteeing subsidiaries, thelimited partnership’s interest in Terra Nitrogen Company, L.P. (“TNCLP”) owned by TCAPI and theguaranteeing subsidiaries, and certain intercompany notes issued to TCAPI by non-guaranteeingsubsidiaries. Payment obligations under the Senior Secured Notes are fully and unconditionallyguaranteed on a joint and several basis by Terra Industries Inc. (“Parent”) and certain of itsU.S. subsidiaries (“the Guarantor Subsidiaries”). Terra Nitrogen, Limited Partnership, TNCLP, thegeneral partner of TNCLP and the Parent’s foreign subsidiaries do not guarantee the notes (seeNote 23 – Guarantor Subsidiaries for condensed consolidating financial information). The Parents’ability to receive dividends from its subsidiaries is limited by the revolving credit facility toamounts required for the funding of operating expenses and debt service (not to exceed $40 millionper year), income tax payments on the earnings of TCAPI and its subsidiaries and liabilitiesassociated with discontinued operations (not to exceed $5 million per year). The Indenturegoverning the Senior Secured Notes consists of covenants that limit, among other things, theCompany’s ability to: incur additional debt, pay dividends on common stock of Terra IndustriesInc. or repurchase shares of such common stock, make investments (other than in Terra Capital orany guarantor), use assets as security in other transactions, sell any of the Company’s principleproduction facilities or sell other assets outside the ordinary course of business, enter intotransactions with affiliates, limit dividends or other payments by the Company’s restrictedsubsidiaries, enter into sale and leaseback transactions, engage in other businesses, sell all orsubstantially all of the Company’s assets or merge with or into other companies, and reduce theCompany’s insurance coverage. In addition, the Company is obligated to offer to repurchase thesenotes upon a Change of Control (as defined in the Indenture) at a cash price equal to 101% of theaggregate principal amount, plus accrued interest to the date of purchase. The Indenture governingthese notes contains events of default and remedies customary for a financing of this type.
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Scheduled principal payments of the Company’s long-term debt and capital leases are:                       Second Priority      Senior Secured Senior Secured Capital  (in thousands) Notes Notes Leases Total 2007 $—  $—  $   1  $    1 2008  200,000   —   —   200,000 2009  —   —   —   — 2010  —   131,300   —   131,300 2011  —   —   —   —    $200,000  $131,300  $1  $331,301  During February 2007, the Company repaid the 12.875% and 11.5% bonds due in 2008 and 2010,respectively. The Company issued $330 million of 7.0% unsecured notes to finance the repayment. Inaddition to the refinancing of the outstanding bonds, the Company amended its revolving creditfacility. The revolving credit facility remains essentially unchanged except for the term of thefacility, which has been extended to 2012 (See Note 22).**8. Accrued and Other Current Liabilities**Accrued and other current liabilities consisted of the following at December 31:         (in thousands) **2006**  2005  Derivative contracts $23,222  $34,213 Payroll and benefit costs  10,519   12,381 Pension liabilities  12,958   8,326 Accrued interest  6,740   6,737 Deferred revenue  5,057   5,224 Other  17,367   18,153  Total $75,863  $85,034  **9. Other Liabilities**Other liabilities consisted of the following at December 31:         (in thousands) **2006**  2005  Long-term medical andclosed facilities reserve $23,206  $24,415 Post retirement benefits  6,046   4,844 Deferred revenue  5,231   10,285 Other  5,705   1,776  Total $40,188  $41,320  
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**10. Commitments and Contingencies**The Company is committed to various non-cancelable operating leases for equipment, railcarsand production, office and storage facilities expiring on various dates through 2017.Total minimum rental payments are as follows:     (in thousands)     2007 $22,346 2008  18,721 2009  15,954 2010  13,968 2011  10,822 2012 and thereafter  17,314  Net minimum lease payments $99,125  Total rental expense under all leases, including short-term cancelable operating leases, was $18.7million, $17.5 million and $14.5 million for the years ended December 31, 2006, 2005 and 2004,respectively.The Company has entered into various contractual agreements that create an obligation into thefuture. These agreements expire on various dates through 2018 and are as follows:     (in thousands)     2007 $350,634 2008  91,921 2009  87,490 2010  84,490 2011  84,490 2012 and thereafter  587,017  Total obligations $1,286,042  Included above are purchase agreements for various services and products relating to operations.These commitments include open purchase orders, inventory purchase commitments and firm utilityand natural gas commitments.The Company has a contractual agreement to purchase one-half of the ammonia produced by PointLisas Nitrogen Limited, the Company’s 50-50 joint venture ammonia plant located in Trinidad. Thepurchase price is based on the average market price of ammonia, F.O.B. Caribbean, less a discount.The agreement is in place until October of 2018. Assuming the Company purchases 360,000 short tonsper year at the December 2006 average price paid, the annual purchase obligation would be $83.3million.The Company is liable for retiree medical benefits of employees of coal mining operations sold in1993, under the Coal Industry Retiree Health Benefit Act of 1992, which mandated liability forcertain retiree medical benefits for union coal miners. The Company has provided reserves adequateto cover the estimated present-value of these liabilities at December 31, 2006. The Company’slong-term medical and closed facilities reserve at December 31, 2006, includes $23.2 million forexpected future payments for the coal operation’s retirees and other former employees. The Companymay recover a portion of these payments through its rights in bankruptcy against Harman CoalCompany (a former coal subsidiary), and subject to damages received by Harman Coal Company throughits on-going litigation with Massey
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Energy Company. No provision for such recoveries has been made in the Company’s financialstatements.FASB Interpretation Number 47, “*Accounting for Conditional Asset Retirement Obligations*” (FIN 47)requires recognition of a liability for the fair value of a conditional asset retirementobligation if the fair value of the liability can be reasonably estimated. The Company has certainfacilities that contain asbestos insulation around certain piping and heated surfaces. Theasbestos insulation is in adequate condition to prevent leakage and can remain in place as long asthe facility is operated or remains assembled. The Company plans to maintain the facilities in anadequate condition to prevent leakage through its standard repair and maintenance activities. TheCompany has not recorded a liability relating to the asbestos insulation, as management believesthat it is not possible to reasonably estimate a settlement date for asbestos insulation removalbecause the facilities have an indeterminate life.The Company is required to dismantle its operations at the Beaumont, Texas site at the terminationof its lease in 2090. In accordance with FIN 47, the Company has estimated the costs associatedwith dismantling its operations. The Company has applied the guidance of SFAS 143, “*Accounting forAsset Retirement Obligations*” to these estimated costs to determine that the present value of theretirement obligation is not significant. The Company has not recorded a liability relating tothis obligation.The Company is involved in various legal actions and claims, including environmental matters,arising from the normal course of business. Management believes that the ultimate resolution ofthese matters will not have a material adverse effect on the results of the Company’s operations,financial position or net cash flows.**11. Preferred Shares**The components of preferred shares outstanding at December 31:                   **2006**  2005   Number  Carrying  Number  Carrying (in thousands) of shares  Value  of shares  Value  Series A Preferred Shares(120,000 shares authorized,$1,000 per share liquidation value)  120,000  $115,800   120,000  $115,800 During the 2004 fourth quarter, the Company issued 120,000 shares of cumulative convertibleperpetual Series A preferred shares with a liquidation value of $1,000 per share for net proceedsof $115.8 million. Cumulative dividends of $10.625 per share are payable quarterly. The Series Apreferred shares are not redeemable, but are convertible into the Company’s common stock at theoption of the holder for a conversion price of $9.96 per common share. The Series A shares mayautomatically be converted to common shares after December 20, 2009 if the closing price for theCompany’s common shares exceeds 140% of the conversion price for any twenty days within aconsecutive thirty day period prior to such conversion. Upon the occurrence of a fundamentalchange to the Company’s capital structure, including a change of control, merger, or sale of theCompany, holders of the Series A preferred shares may require the Company to purchase any or allof their shares at a price equal to their liquidation value plus any accumulated, but unpaid,dividends. The Company also has the right, under certain conditions, to require holders of theSeries A preferred shares to exchange their shares for convertible subordinated debentures withsimilar terms.
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**12. Financial Instruments and Concentrations of Credit Risk**The following table represents the carrying amounts and estimated fair values of Terra’sfinancial instruments at December 31, 2006 and 2005. SFAS 107 defines the fair value of afinancial instrument as the amount at which the instrument could be exchanged in a currenttransaction between willing parties.                   **2006**  2005   Carrying  Fair  Carrying  Fair (in millions) Amount  Value  Amount  Value  Financial Assets                Cash and short-term investments $179.0  $179.0  $86.4  $86.4 Receivables  198.8   198.8   206.4   206.4 Equity and other investments  164.1   164.1   183.9   183.9 Financial liabilities                Long-term debt  331.3   321.8   331.3   322.7 Preferred shares  115.8   161.7   115.8   102.6  The following methods and assumptions were used to estimate the fair value of each class offinancial instrument: **•** **Cash and receivables:**The carrying amounts approximate fair value because of the shortmaturity of those instruments.  **•** **Equity and other investments:**Investments in untraded companies are valued on the basisof management’s estimates and, when available, comparisons with similar companies whose shares are publicly traded.  **•** **Short-term borrowings and long-term debt:**The fair value of Terra’s short-termborrowings and long-term debt is estimated by discounting expected cash flows at the ratescurrently offered for debt of the same remaining maturities.  **•** **Preferred shares:**Preferred shares are valued on the basis of market quotes, whenavailable and management estimates based on comparisons with similar instruments that arepublicly traded.**Concentration of Credit Risk:**Terra is subject to credit risk through trade receivables andshort-term investments. Although a substantial portion of its debtors’ ability to pay depends uponthe agribusiness economic sector, credit risk with respect to trade receivables generally isminimized due to its geographic dispersion. Short-term cash investments are placed in shortduration corporate and government debt securities funds with well-capitalized, high qualityfinancial institutions.**Financial Instruments:**At December 31, 2006, Terra had letters of credit outstanding totaling$17.7 million, guaranteeing various insurance and financing activities.**13. Common Stockholders’ Equity**Terra allocates $1.00 per share upon the issuance of Common Shares to the Common Sharecapital account. The Common Shares have no par value. At December 31, 2006, 1.8 million commonshares were reserved for issuance upon award of restricted shares and exercise of employee stockoptions.In connection with the MCC acquisition, Terra issued warrants to purchase 4.0 million of itscommon shares at $5.48 per share. These warrants were valued at $21.1 million at the MCC closing.During 2005, shareholders approved the issuance of the underlying shares and the warrant value wasreclassified to common stockholders’ equity.
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On April 25, 2006, the Board of Directors authorized the Company to repurchase a maximum of 10percent, or 9,516,817 shares, of its outstanding common stock. The stock buyback program has beenand will be conducted on the open market, in private transactions or otherwise at such times priorto September 30, 2008, and at such prices, as determined appropriate by the Company. Purchases maybe commenced or suspended at any time without notice. During 2006, the Company’s repurchases underthe stock buyback program were:               Number of  Average Price  Total Cost (in thousands, except average Shares  of Shares  of Shares price of shares repurchased) Repurchased  Repurchased  Repurchased  April 2006  —  $—  $— May 2006  488   7.49   3,655 June 2006  1,557   6.92   10,767 July 2006  —   —   — August 2006  560   6.93   3,879 September 2006  70   7.03   495 October 2006  —   —   — November 2006  —   —   — December 2006  —   —   —     2,675  $7.03  $18,796  **14. Acquisition**On December 21, 2004, Terra acquired Mississippi Chemical Corporation (“MCC”) for a purchaseprice valued at $213.5 million consisting of 15 million common shares, 172,690 Series B preferredshares and cash of $54.2 million, including costs directly related to the acquisition. MCCmanufactured nitrogen-based fertilizers and industrial use products; had a 50% ownership interestin Point Lisas Nitrogen Limited (PLNL), an ammonia production plant in Trinidad; and had a 50%interest in an ammonia storage joint venture located in Houston, Texas. These equity investmentswere acquired by the Company with the purchase of MCC. In connection with the acquisition, Terraassumed $125.0 million of MCC long-term debt and $34.1 million of unfunded pension liabilities.
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The following table summarizes the fair market values of the assets acquired and the liabilitiesassumed at the acquisition date to the final purchase price allocation:       Final  Purchase  Price(in thousands) Allocation Current assets $99,177 Property, plant and equipment  140,955 Equity investments  201,520 Other assets  3,464 Intangible assets  9,408  Total assets acquired  454,524       Current liabilities  37,169 Long-term debt and warrants  125,000 Pension and other long-term liabilities  36,314 Deferred income taxes  42,527  Total liabilities assumed  241,010       Net Assets acquired $213,514  Intangible assets acquired represent customer relationships that will be amortized on astraight-line basis over a period of approximately five years. The useful life of five years forthe customer base intangible asset was based on management’s forecasts of customer turnover.The following represents unaudited pro forma summary results of operations as if the acquisitionof MCC had occurred at the beginning of 2004.       Year ended (in thousands, except per share data) December 31, 2004  Revenues $1,886,953 Operating income (loss)  179,349 Net income (loss)  78,204 Basic income (loss) per share  0.85      Selected costs included above:    Interest expense  72,639 Depreciation and amortization  117,994 Impairment losses included above  — The pro forma operating results were adjusted to include depreciation of the fair value ofacquired assets based on estimated useful lives at the acquisition dates, amortization ofintangible assets, interest expense on acquisition borrowings, the issuance of common stock andthe effect of income taxes. Pro forma operating results were also adjusted to exclude MCCdiscontinued operations as well as reorganization expenses and gains on the extinguishment ofpre-petition liabilities in connection with MCC’s emergence from Chapter 11.
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The pro forma information listed above does not purport to be indicative of the results that wouldhave been obtained if the operations were combined during the above periods, and is not intendedto be a projection of future operating results or trends.**15. Share-Based Compensation**The Company sponsors three share-based compensation plans – the Inspiration ResourcesCorporation 1992 Stock Incentive Plan (the “1992 Plan”), the Terra Industries Inc. 1997 StockIncentive Plan (the “1997 Plan”) and the Terra Industries Inc. Stock Incentive Plan of 2002 (the“2002 Plan”). Upon the adoption of the 2002 Plan, the Company no longer issues share-based awardsfrom the 1992 Plan or the 1997 Plan, however, approximately 458,000 authorized shares have beenreserved for awards that were issued prior to the adoption of the 2002 plan. As of December 31,2006, there were approximately 3,958,000 shares of common stock authorized for issuance under theplans, including approximately 3,500,000, 454,000 and 4,000 authorized for the 2002 Plan, 1997Plan and 1992 Plan, respectively. Shares for approximately 1,620,000 and 1,834,000 were availableand reserved, respectively, for share-based compensation grants as of December 31, 2006.Awards granted under the plans may consist of incentive stock options (ISOs) or non-qualifiedstock options (NQSOs), stock appreciation rights (SARs), nonvested stock awards or othershare-based awards (i.e. performance shares), with the exception that non-employee directors maynot be granted SARs and only employees of the Company may be granted ISOs.The Compensation Committee of the Company’s Board of Directors administers the plans anddetermines the exercise price, exercise period, vesting period and all other terms of the grant.All share-based awards to directors, officers and employees expire ten years after the date of thegrant. ISOs and NQSOs, which are not exercised after vesting, expire ten years after the date ofthe award. The vesting period for nonvested stock is determined at the grant date of the award;the vesting period is usually three years. The vesting date for other share-based awards is alsoset at the time of the award but can vary in length; there is usually no expiration date for othershare-based awards.Prior to January 1, 2006, the Company accounted for awards issued under its share-basedcompensation plans using the intrinsic-value method. The Company did not recognize compensationexpense on stock options in the year ended December 31, 2005 and 2004 as all options granted underthe Company’s plans had an exercise price equal to the market price of the Company’s stock on thedate of grant and were fully vested. The Company recognized compensation expense of $2.0 millionand $1.5 million on nonvested stock awards and phantom share awards in the year ended December 31,2005 and 2004, respectively, based on intrinsic value, which was equal to the market price of theCompany’s stock on the date of grant.On January 1, 2006, the Company adopted SFAS 123 R using the modified prospective method. ThisStatement requires the Company to recognize in net income an estimate of expense for stock awardsand options over their vesting periods, typically determined as of the date of grant. Under themodified prospective application, this Statement applies to new awards and to awards modified,repurchased or cancelled after January 1, 2006. Additionally, the Company recognized compensationcost for the portion of awards for which the requisite service has not been rendered that wereoutstanding on January 1, 2006. The compensation cost for that portion of awards was based on thegrant-date fair value of those awards as calculated for either recognition or pro formadisclosures under SFAS No. 123. Beginning January 1, 2006, the unearned compensation related tothe unvested awards was reclassified as a component of paid-in capital. The cumulative effect ofthe adoption of SFAS 123 R related to estimating forfeitures of outstanding awards was notsignificant. Results for prior periods have not been restated.
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The following table illustrates the effect on net income and net income per share if the Companyhad accounted for share-based compensation using the fair value method in the year ended December31, 2005 and 2004:           Year Ended December 31, (in thousands, except per-share amounts) 2005  2004  Net income available to common shareholders $16,953  $66,567 Add: Share based employee compensation expenseincluded in reported net income, net of related tax effects  1,218   1,205 Deduct: Share based employee compensation expensedetermined under fair value based method for allawards, net of related tax effects  (1,218)  (1,205) Pro forma net income available to common shareholders $16,953  $66,567           Income per share:        Basic – as reported $0.18  $0.87  Basic – pro forma $0.18  $0.87           Diluted – as reported $0.18  $0.85  Diluted – pro forma $0.18  $0.85  Compensation cost charged against income and the total income tax benefit recognized forshare-based compensation arrangements is included below:               Year Ended December 31, (in thousands) **2006**  2005  2004  Compensation cost charged to SG&A expense $7,010  $2,431  $1,205  Total compensation cost charged to income $7,010  $2,431  $1,205  Income tax benefit $2,454  $851  $422  *Stock Options*The Company has stock options with service conditions. No compensation cost is recognized for thestock options as these instruments were fully vested upon adoption of SFAS 123 R.
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A summary of stock option activity as of December 31, 2006, and changes during the year then endedis presented below:               WeightedAverage      Exercise(options in thousands) Number Price Outstanding – beginning of period  592  $5.24 Expired/terminated  (39)  14.01 Exercised  (95)  3.82  Outstanding – end of period  458  $4.78  The aggregate intrinsic value of the vested stock options outstanding at December 31, 2006 was$3.3 million.The following table summarizes information about stock options outstanding and exercisable atDecember 31, 2006:                         (options in thousands)        Options Outstanding  Options Exercisable            Weighted  Weighted      Weighted           Average  Average      Average   Range of  Number  Remaining  Exercise  Number  Exercise   Exercise Prices  Outstanding  Life (years)  Price  Exercisable  Price    $1.43           -       $3.88   399   2.6  $3.72   399  $3.72    7.81           -        7.81   6   1.6   7.81   6   7.81    12.13           -       14.75   53   0.9   12.33   53   12.33  Total      458   2.4  $4.78   458  $4.78  No options were granted during 2006, 2005 and 2004.*Nonvested Stock Shares and Phantom Share Awards*The Company currently has outstanding nonvested shares and phantom share awards with both serviceconditions and performance conditions. Nonvested stock shares and phantom share awards withservice and performance conditions usually “cliff vest” in three years from the grant date. Theperformance conditions of the nonvested shares and phantom share awards are based on a calculatedreturn on capital over a three-year period. For awards with performance conditions, the grantswill be forfeited if the performance conditions are not achieved.The Company recognizes compensation expense for nonvested stock share awards over the vestingperiods based on fair value, which is equal to the market price of the Company’s stock on the dateof grant. During 2006, 2005 and 2004, the Company recorded compensation expense of $4.3 million,$1.9 million and $1.0 million, respectively. The Company recognizes compensation expense for thephantom share awards over the vesting periods based on fair value, which is equal to the marketprice of the Company’s stock at each reporting period date. The phantom share awards settle incash. During 2006, 2005 and 2004, the Company recorded compensation expense of $2.7 million, $0.5million and $0.2 million, respectively. Compensation costs for nonvested stock shares and phantomshare awards are reduced for estimated forfeitures and then amortized to expense using thestraight-line method. For awards with performance conditions, the Company estimates the expectednumber of awards to vest at the time of the award grant. The Company records the compensationexpense for the awards with
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performance conditions ratably over the requisite service period related to the performancecondition, taking into consideration any changes to the expected shares to vest as such mattersarise.A summary of the status of the Company’s nonvested share awards as of December 31, 2006, andchanges during the year then ended, is:               Weighted       Average       Grant-Date (in thousands, except fair values) Shares  Fair Value  Outstanding at January 1, 2006  1,590  $5.12 Granted  686   6.74 Vested  (697)  2.03 Terminated  (203)  6.95  Outstanding at December 31, 2006  1,376  $7.23  The fair value of the nonvested shares that vested during 2006 was $4.9 million.At December 31, 2006, the total unrecognized compensation cost related to all nonvested shareawards was $9.9 million. That cost is expected to be recognized over a weighted-average period of1.5 years.**16. Retirement Benefit Plans**The Company maintains defined benefit pension plans that cover certain salaried and hourlyemployees. Benefits are based on a pay formula. The Company uses September 30 as its measurementdate. The defined benefit plans’ assets consist principally of equity securities and corporate andgovernment debt securities. The Company also has certain non-qualified pension plans coveringexecutives, which are unfunded. The Company accrues pension costs based upon annual independentactuarial valuations for each plan and funds these costs in accordance with statutoryrequirements.The components of net periodic pension expense follow:             (in thousands) **2006**  2005  2004  Service cost $2,991  $2,976  $2,731 Interest cost  24,926   23,550   15,669 Expected return on plan assets  (24,224)  (21,575)  (12,280)Amortization of prior service cost  (36)  (28)  21 Amortization of actuarial loss  5,636   5,632   4,889 Amortization of net assets  —   —   49 Termination charge  492   1,165   —  Pension expense $9,785  $11,720  $11,079  The Company has defined benefit plans in the U.S., Canada and the U.K. The Company administers itsplans to comply with the laws set forth by each country’s regulators.
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The following table reconciles, by geographic location, the plans’ funded status to amountsincluded in the Consolidated Statements of Financial Position at December 31, 2006:                 (in thousands) **U.S.**  **Canada**  **U.K.**  **Total**  **Change in Projected Benefit Obligation Present Value**                Projected benefit obligation—beginning of year $267,100  $38,637  $148,774  $454,511 Service cost  1,976   1,015   —   2,991 Interest cost  14,972   2,058   7,896   24,926 Actuarial (gain) loss  (8,247)  3,109   23,575   18,437 Termination charge  —   —   492   492 Foreign currency exchange rate changes  —   36   22,563   22,599 Benefits paid  (15,204)  (905)  (3,686)  (19,795) Projected benefit obligation—end of year  260,597   43,950   199,614   504,161  **Change in Plan Assets**                Fair value plan assets—beginning of year  180,574   31,042   103,691   315,307 Actual return on plan assets  18,239   2,415   8,565   29,219 Foreign currency exchange rate changes  —   15   15,047   15,062 Employer contribution  7,683   3,373   4,030   15,086 Participants’ contributions  171   —   —   171 Benefits paid  (15,204)  (905)  (3,686)  (19,795) Fair value plan assets—end of year  191,463   35,940   127,647   355,050  **Funded Status**  (69,134)  (8,010)  (71,967)  (149,111)Unrecognized net actuarial loss  35,058   11,006   61,817   107,881 Unrecognized prior service cost  (319)  —   —   (319) **Accrued benefit cost** $(34,395) $2,996  $(10,150) $(41,549) 
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The following table reconciles, by geographic location, the plans’ funded status to amountsincluded in the Consolidated Statements of Financial Position at December 31, 2005:                 (in thousands) **U.S.**  **Canada**  **U.K.**  **Total**  **Change in Projected Benefit Obligation Present Value**                Projected benefit obligation—beginning of year $253,932  $29,149  $144,988  $428,069 Service cost  2,078   898   —   2,976 Interest cost  14,196   1,854   7,499   23,549 Actuarial (gain) loss  10,506   6,008   12,753   29,267 Termination charge  —   —   1,165   1,165 Foreign currency exchange rate changes  —   1,460   (16,142)  (14,682)Benefits paid  (13,612)  (732)  (1,489)  (15,833) Projected benefit obligation—end of year  267,100   38,637   148,774   454,511  **Change in Plan Assets**                Fair value plan assets—beginning of year  162,415   25,443   101,287   289,145 Actual return on plan assets  16,332   3,008   10,497   29,837 Foreign currency exchange rate changes  —   1,173   (11,263)  (10,090)Employer contribution  15,439   2,150   4,659   22,248 Benefits paid  (13,612)  (732)  (1,489)  (15,833) Fair value plan assets—end of year  180,574   31,042   103,691   315,307  **Funded Status**  (86,526)  (7,595)  (45,083)  (139,204)Unrecognized net actuarial loss  49,288   8,859   35,705   93,852 Unrecognized prior service cost  (355)  —   —   (355)Contributions  170   —   —   170  **Accrued benefit cost** $(37,423) $1,264  $(9,378) $(45,537) The amount recognized in the balance sheet for the plans described above are as follows:         (in thousands) **2006**  2005  Accrued benefit cost $41,549  $46,974 Accumulated other comprehensive loss  73,123   55,934 Deferred tax asset  34,439   27,279 Funding subsequent to valuation  (1,709)  (1,625) Amount recognized  147,402   128,562 Less: current portion  (12,958)  (8,326) Pension liabilities $134,444  $120,236  The accumulated benefit obligation for the Company’s pension plans was $493.4 million and $444.2million at December 31, 2006 and 2005, respectively. The projected benefit obligation for theCompany’s pension plans was $504.2 million and $454.5 million at December 31, 2006 and 2005,respectively. The Company’s fair value of plan assets for the pension plans with an accumulatedbenefit obligation in excess of plan assets was $138.5 million and $128.9 million at December 31, 2006 and2005, respectively.
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The assumptions used to determine the actuarial present value of benefit obligations and pensionexpense during each of the years ended December 31 were as follows:               **2006**  2005  2004  Weighted average discount rate  5.5%  5.4%  5.7%Long-term per annum compensation increase  3.3%  3.3%  3.5%Long-term return on plan assets  7.6%  7.7%  7.7% The Company employs a total return investment approach whereby a mix of equities and fixed incomeinvestments are used to maximize the long-term return of plan assets for a prudent level of risk.The intent of this strategy is to minimize plan expenses by outperforming plan liabilities overthe long run. Risk tolerance is established through careful consideration of plan liabilities,plan funded status, and the Company’s corporate financial condition. The investment portfoliocontains a diversified blend of equity and fixed income investments. Derivatives may be used togain market exposure in an efficient and timely manner; however, derivatives may not be used toleverage the portfolio beyond the market value of the underlying investments. Investment risk ismeasured and monitored on an ongoing basis through annual liability measurements, periodicasset/liability studies, and quarterly investment portfolio reviews.The Company selects a long-term rate of return of each of its plans individually. The Companyconsults with each of its three actuaries, as well as each of the fund’s money managers. Theexpected long-term rate of return is based on the portfolio as a whole and not on the sum of thereturns on individual asset categories. While historical returns are taken into consideration,current market trends such as inflation and current equity and fixed income returns are also takeninto consideration.The percentage of the Fair Market Value of the total plan assets for each major asset category ofthe plan’s assets is as follows:           September 30,   **2006**  2005  **Asset Allocation**        Equities  58.3%  56.4%Bonds  18.4%  14.2%Cash equivalents  23.3%  29.4%    100.0%  100.0% The Company expects to contribute $20.4 million to its pension plans in 2007.The expected benefits to be paid from the pension plan are as follows:     (in thousands) Payments  **Estimated Future Benefit Payments**    2007 $17,902 2008  18,474 2009  19,052 2010  19,850 2011  21,280 2012-2016  126,515 
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The amounts in accumulated other comprehensive income that have not yet been recognized ascomponents of pension expense at December 31, 2006, and the expected amortization of these amountsas components of net periodic benefit cost for the year ended December 31, 2007 are:Components of accumulated other comprehensive income:     (in thousands)     Net actuarial loss $107,881 Net prior service cost (credit)  (319)Net transition obligation (asset)  —    $107,562  Expected amortization during 2007:     (in thousands)     Amortization of net transition obligation $— Amortization of prior service cost  (37)Amortization of net losses  6,066    $6,029  The Company also sponsors defined contribution savings plans covering most full-time employees.Contributions made by participating employees are matched based on a specified percentage ofemployee contributions. The cost of the Company’s contributions to these plans totaled $5.3million in 2006, $4.8 million in 2005 and $1.5 million in 2004.**17. Post-Retirement Benefits**The Company provides health care benefits for certain U.S. employees who retired on or beforeJanuary 1, 2002. Participant contributions and co-payments are subject to escalation. The planpays a stated percentage of most medical expenses reduced for any deductible and payments made bygovernment programs. The plan is unfunded.
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The following table indicates the components of the post-retirement medical benefits obligationincluded in the Company’s Consolidated Statements of Financial Position at December 31:         (in thousands) **2006**  2005  **Change in Benefit Obligation**        Projected benefit obligation—beginning of year $4,202  $4,171 Service cost  11   12 Interest cost  228   230 Participants’ contributions  202   222 Actuarial (gain) loss  1,737   346 Foreign currency exchange rate changes  —   28 Benefits paid  (916)  (807) Projected benefit obligation—end of year  5,464   4,202  **Change in Plan Assets**        Fair value plan assets—beginning of year  —   — Employer contribution  715   585 Participants’ contributions  202   222 Benefits paid  (917)  (807) Fair value plan assets—end of year  —   —  **Funded Status**  (5,464)  (4,202)Unrecognized net actuarial gain  1,655   (220)Unrecognized prior service cost  761   982 Employer contribution  179   138  Accrued benefit cost $(2,869) $(3,302) Net periodic post-retirement medical benefit (income) expense consisted of the followingcomponents:             (in thousands) **2006**  2005  2004  Service cost $11  $12  $11 Interest cost  226   230   172 Amortization of prior service cost  77   44   (43)Amortization of actuarial gain  —   (13)  (45) Post-retirement medical benefit expense $314  $273  $95  The projected benefit obligation (PBO) and accumulated benefit obligation (ABO) at December 31,2006 was $5.5 million. The PBO and ABO at December 31, 2005 was $4.2 million.The Company limits its future obligation for post-retirement medical benefits by capping at 5% theannual rate of increase in the cost of claims it assumes under the plan. The weighted averagediscount rate used in determining the accumulated post-retirement medical benefit obligation was5.98% in 2006, 5.63% in 2005 and 5.83% in 2004. The assumed annual health care cost trend rate was5% in 2006, 2005 and 2004. The impact on the benefit obligation of a 1% increase in the assumedhealth care cost trend rate would be approximately $0.6 million while a 1% decline in the ratewould decrease the benefit obligation by approximately $0.5 million.In December 2003, the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (theAct) was signed into law. The Act introduced a prescription drug benefit under Medicare Part D anda federal subsidy to sponsors of retirement health care plans that provide a benefit that is atleast actuarially equivalent to Medicare Part D. The subsidy is based on approximately 28% of anindividual
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beneficiary’s annual prescription drug costs between $250 and $5,000. The effects of the subsidywere factored into the 2005 annual year-end valuation. The reduction in the benefit obligationattributable topast service cost was approximately $0.8 million and has been reflected as an actuarial gain.Future benefit payments expected to be paid for post-retirement medical benefits are as follows:Estimated future benefit payments     (in thousands) Payments  2007 $513 2008  505 2009  535 2010  523 2011  555 2012-2016  2,997 The amounts in accumulated other comprehensive income that have not yet been recognized ascomponents of retiree medical expense at December 31, 2006, and the expected amortization of theseamounts as components of net periodic benefit cost for the year ended December 31, 2007 are:Components of accumulated other comprehensive income:     (in thousands)     Net actuarial loss $1,655 Net prior service cost (credit)  761 Net transition obligation (asset)  —    $2,416  Expected amortization during 2007:     (in thousands)     Amortization of net transition obligation $— Amortization of prior service cost  69 Amortization of net losses  88    $157  **18. Accumulated Other Comprehensive Income (Loss)**Accumulated other comprehensive income (loss) refers to revenues, expenses, gains and lossesthat under accounting principles generally accepted in the United States are recorded as anelement of shareholders’ equity but are excluded from net income. Terra’s accumulated othercomprehensive income (loss) is comprised of (a) adjustments that result from translation ofTerra’s foreign entity financial statements from their functional currencies to United Statesdollars, (b) adjustments that result from translation of intercompany foreign currencytransactions that are of a long-term investment nature (that is, settlement is not planned oranticipated in the foreseeable future) between entities that are consolidated in Terra’s financialstatements, (c) the offset to the fair value of derivative assets and liabilities (that qualify ashedged relationships) recorded on the balance sheet, and (d) minimum pension liabilityadjustments.
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  The components of accumulated other comprehensive income (loss), net of tax, for the yearsended December 31, 2006 and 2005 are:                   Foreign     Pension and    Currency     Post-retirement    Translation Fair Value of Benefit  (in thousands) Adjustment Derivatives Liabilities Total Balance December 31, 2004 $14,287  $(19,307) $(50,974) $(55,994)Change in foreign currency translation adjustment  (23,387)  —   —   (23,387)Reclassification to earnings  —   3,059   —   3,059 Change in fair value of derivatives  —   11,139   —   11,139 Change in minimum pension liabilities  —   —   (4,960)  (4,960) Balance December 31, 2005  (9,100)  (5,109)  (55,934)  (70,143) Change in foreign currency translation adjustment  33,618   —   —   33,618 Reclassification to earnings  —   31,693   —   31,693 Change in fair value of derivatives  —   (38,420)  —   (38,420)Change in pension and post-retirementbenefit liabilities  —   —   (11,850)  (11,850)Adoption of SFAS 158  —   —   (8,637)  (8,637) Balance December 31, 2006 $24,518  $(11,836) $(76,421) $(63,739) **19.** **Income Taxes**   Components of the income tax provision (benefit) applicable to continuing operations are as follows:             (in thousands) **2006**  2005  2004  Current:            Federal $719  $—  $— Foreign  4,351   679   1,058 State  400   —   —     5,470   679   1,058  Deferred:            Federal  6,417   4,196   2,570 Foreign  (2,710)  9,102   (8,628)State  70   240   —     3,777   13,538   (6,058) Total income tax provision (benefit) $9,247  $14,217  $(5,000) 
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The following table reconciles the income tax provision (benefit) per the Consolidated Statementsof Operations to the federal statutory provision:             (in thousands) **2006**  2005  2004  Income (loss) from continuingoperations before taxes:            Domestic $6,570  $560  $(7,516)Foreign  6,890   35,744   70,112     13,460   36,304   62,596  Statutory income tax provision (benefit):            Domestic  2,432   196   (2,631)Foreign  2,841   11,057   21,934     5,273   11,253   19,303              Reduction to foreign tax assessmentsand reserves  —   —   (27,877)Foreign exchange gain (loss)  3,553   (1,302)  1,548 Debt repayment losses  —   7,807   — Warrant fair value gain  —   (3,278)  — Valuation reserve  (367)  964   2,460 Other  788   (1,227)  (434) Income tax provision (benefit) $9,247  $14,217  $(5,000) The tax effect of net operating loss (NOL), tax credit carryforwards and significant temporarydifferences between reported and taxable earnings that gave rise to net deferred tax assets(liabilities) were as follows:         (in thousands) **2006**  2005  Current deferred tax asset        Accrued liabilities $8,323  $1,944 Inventory valuation  (685)  (1,019)Unsettled derivative losses  (3,521)  1,341  Net current deferred tax asset  4,117   2,266  Non-current deferred tax liability        Depreciation  (185,044)  (188,977)Investments in partnership  (7,352)  (7,235)Investment in affiliates  (34,537)  (37,589)Intangible asset  (2,089)  (2,785)Unfunded employee benefits  9,111   13,117 Discontinued business costs  8,202   8,257 Valuation allowance  (61,361)  (61,728)NOL, capital loss and tax credit carryforwards  166,386   180,548 Accumulated other comprehensive income  42,592   30,141 Other  241   253  Net noncurrent deferred tax liability  (63,851)  (65,998) Net deferred tax liability $(59,734) $(63,732) The Company’s NOL’s were established in tax years 2000-2005. These NOL’s, if unused, will begin toexpire in 2020.
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  During 1996, after receiving a favorable ruling from Revenue Canada, Terra refreshed its tax basisin plants and equipment at its Canadian subsidiary by entering into a transaction with a Canadiansubsidiary of Anglo American plc, resulting in a deferred tax asset. In 2000, Revenue Canadachallenged the refreshed amount of this tax basis, and Terra established a reserve against thepreviously recorded tax asset. Terra contested Revenue Canada’s position and realized a reductionto the tax assessment during 2003 with a final settlement during 2004. In connection with the taxassessment reductions, final settlement of the issues and new company structure opportunities,Terra eliminated tax reserves of $27.9 million in 2004. **20.** **Industry Segment Data**   Terra operates in two principal industry segments—Nitrogen Products and Methanol. TheNitrogen Products business produces and distributes ammonia, urea, nitrogen solutions, ammoniumnitrate and other nitrogen products to agricultural and industrial users. The Methanol businessmanufactures and, prior to 2004, distributed methanol, which is principally used as a raw materialin the production of a variety of chemical derivatives and in the production of methyl tertiarybutyl ether (MTBE), an oxygenate and octane enhancer for gasoline. Management evaluatesperformance based on operating earnings of each segment. Terra does not allocate interest, incometaxes or infrequent items to the business segments. Included in Other are general corporateactivities not attributable to a specific industry segment.
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The following summarizes additional information about Terra’s industry segments:                   Nitrogen          (in thousands) Products  Methanol  Other  Total  **2006**                Revenues $1,793,759  $34,955  $8,008  $1,836,722 Operating income (loss)  63,275   4,952   (1,947)  66,280 Total assets  1,377,471   98,916   96,326   1,572,713 Depreciation and amortization  74,031   13,386   20,652   108,069 Capital expenditures  50,626   2   228   50,856 Equity earnings  17,013   —   —   17,013 Equity investments  164,099   —   —   164,099 Minority interest in losses  11,286   —   —   11,286                   2005                Revenues $1,899,236  $31,347  $8,482  $1,939,065 Operating income (loss)  131,474   (14,089)  (3,689)  113,696 Total assets  1,298,289   102,811   122,525   1,523,625 Depreciation and amortization  90,638   10,993   8,711   110,342 Capital expenditures  29,967   59   794   30,820 Equity earnings  21,415   —   —   21,415 Equity investments  183,884   —   —   183,884 Minority interest in earnings  13,667   —   —   13,667                   2004                Revenues $1,320,142  $186,823  $2,145  $1,509,110 Operating income (loss)  138,745   1,479   (5,478)  134,746 Total assets  1,440,103   122,273   123,132   1,685,508 Depreciation and amortization  76,175   13,019   13,036   102,230 Capital expenditures  17,038   53   1,381   18,472 Equity earnings  442   —   —   442 Equity investments  215,939   —   —   215,939 Minority interest in earnings  11,207   —   —   11,207  
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  The following summarizes geographic information about Terra:                           Revenues  Long-lived Assets (in thousands) **2006**  2005  2004  **2006**  2005  2004  United States $1,397,994  $1,464,375  $1,061,261  $663,994  $512,572  $570,031 Canada  63,902   55,641   61,395   49,637   55,625   51,036 United Kingdom  374,826   419,049   386,454   238,577   219,045   257,520    $1,836,722  $1,939,065  $1,509,110  $952,208  $787,242  $878,587  **21.** **Agreements of Limited Partnerships**   *Terra Nitrogen Company L.P. (TNCLP)*   Terra owns a 1% General Partnership interest and 75.3% of the Common Units of TNCLP at December31, 2006. Terra consolidates TNCLP results with the publicly held TNCLP Common Units reflected inTerra’s financial statements as a minority interest.   In accordance with the TNCLP limited partnership agreement, quarterly distributions to unitholdersand Terra are made in an amount equal to 100% of its available cash, as defined in the partnershipagreement. The General Partner receives a combined minimum 2% of total cash distributions, and asan incentive, the general partner’s participation increases if cash distributions exceed specifiedtarget levels.   If at any time less than 25% of the issued and outstanding units are held by non-affiliates of theGeneral Partner, TNCLP may call, or assign to the General Partner or its affiliates, its right toacquire all such outstanding units held by non-affiliated persons with at least 30 but not morethan 60 days’ notice of its decision to purchase the outstanding units. The purchase price perunit will be the greater of (1) the average of any previous twenty trading days’ closing prices asof the date five days before the purchase is announced and (2) the highest price paid by theGeneral Partner or any of its affiliates for any unit within the 90 days preceding the date thepurchase is announced. **22.** **Subsequent Events**   In February 2007, the Company repaid its $200.0 million, 12.875% due 2008 and $131.3 million,11.50% due 2010 bonds that were outstanding at December 31, 2006. The repayment proceeds wereobtained from a new $330.0 million, 7.0% unsecured note with a maturity date of 2017. The Companyincurred costs related to bond tender premiums and transaction fees of approximately $40 millionthat will be recorded as an earnings charge in the first quarter of 2007. In connection with thebond refinancing, the Company’s revolving bank credit facility was extended until February 2012.   During the 2006 fourth quarter, the Company entered into a Memorandum of Understanding with KemiraGrowHow Oyj to create a joint venture to operate the fertilizer and associated process chemicalbusinesses of both companies in the U.K. The Memorandum of Understanding is a non-legally bindingagreement and is subject to approval by the U.K. competition authorities, negotiation ofdefinitive documents and lender consent. During the 2007 first quarter, the U.K. Office of FairTrading referred the proposed joint venture to the Competition Commission. **23.** **Guarantor Subsidiaries**   The Parent files a consolidated United States federal income tax return. Beginning in 1995,the Parent adopted the tax sharing agreements, under which all domestic operating subsidiariesprovide for and remit income taxes to the Parent based on their pretax accounting income, adjustedfor permanent differences between pretax accounting income and taxable income. The tax sharingagreements allocated
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  the benefits of operating losses and temporary differences between financial reporting and taxbasis income to the Parent.   Condensed consolidating financial information regarding the Parent, TCAPI, the GuarantorSubsidiaries and subsidiaries of the Parent that are not guarantors of the Senior Secured Notes(see Note 7) for December 31, 2006, 2005 and 2004 are presented below for purposes of complyingwith the reporting requirements of the Guarantor Subsidiaries. The guarantees of the GuarantorSubsidiaries are full and unconditional. The Subsidiary issuer and the Guarantor Subsidiariesguarantees are joint and several with the Parent.   Guarantor subsidiaries include subsidiaries that own the Woodward, Oklahoma; Port Neal, Iowa;Yazoo City, Mississippi and Beaumont, Texas plants as well as the corporate headquarters facilityin Sioux City, Iowa. All guarantor subsidiaries are wholly owned by the Parent. All other companyfacilities are owned by non-guarantor subsidiaries.
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Condensed Consolidating Statement of Financial Position for the Year Ended December 31, 2006:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Assets**                        Cash, cash equivalents andrestricted cash $1  $100,736  $—  $78,282  $(2) $179,017 Accounts receivable, net  —   —   75,466   123,325   —   198,791 Inventories  —   —   84,924   117,958   8,135   211,017 Other current assets  3,166   1,319   12,918   18,355   (4,078)  31,680  Total current assets  3,167   102,055   173,308   337,920   4,055   620,505  Property, plant andequipment, net  —   —   381,987   338,912   (2)  720,897 Equity investments  —   —   10,710   153,389   —   164,099 Deferred plant turnaroundcosts, intangible andother assets  (1,839)  7,582   22,117   39,351   1   67,212 Investments in and advancesto (from) affiliates  758,377   347,478   1,622,696   422,436   (3,150,987)  —  Total Assets $759,705  $457,115  $2,210,818  $1,292,008  $(3,146,933) $1,572,713  **Liabilities**                        Debt due within one year $—  $—  $1  $—  $(1) $— Accounts payable  109   —   63,634   92,750   —   156,493 Accrued and otherliabilities  28,119   5,927   61,781   62,354   (5,227)  152,954  Total current liabilities  28,228   5,927   125,416   155,104   (5,228)  309,447  Long-term debt and capitalLease obligations  —   331,300   —   —   —   331,300 Deferred income taxes  22,214   —   —   43,848   (2,211)  63,851 Pension and other liabilities  166,032   —   7,386   1,212   2   174,632 Minority interest  —   18,501   76,186   —   —   94,687  Total liabilities andminority interest  216,474   355,728   208,988   200,164   (7,437)  973,917                           Preferred stock  115,800   —   —   —   —   115,800                          **Stockholders’ equity**                        Common stock  144,975   —   73   49,709   (49,781)  144,976 Paid in capital  693,895   150,218   2,007,811   1,246,129   (3,404,157)  693,896 Accumulated othercomprehensive incomeincome (loss) andunearned compensation  (92,187)  —   6,373   30,828   (8,753)  (63,739)Retrained earnings (deficit)  (319,252)  (48,831)  (12,427)  (234,822)  323,195   (292,137) Total stockholders’ equity  427,431   101,387   2,001,830   1,091,844   (3,139,496)  482,996  Total liabilities andstockholders’ equity $759,705  $457,115  $2,210,818  $1,292,008  $(3,146,933) $1,572,713  
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Condensed Consolidating Statement of Operations for the Year Ended December 31, 2006:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Revenues**                        Revenues $—  $—  $859,454  $969,261  $(1) $1,828,714 Other income, net  —   —   5,795   2,213   —   8,008  Total revenues  —   —   865,249   971,474   (1)  1,836,722  **Cost and Expense**                        Cost of sales  —   —   882,352   901,940   (52,070)  1,732,222 Selling, general andadministrative expenses  2,358   (8,142)  (7,601)  16,549   52,069   55,233 Equity in the (earnings) lossof subsidiaries  29,853   (184,740)  (91,993)  (46,002)  275,869   (17,013) Total cost and expenses  32,211   (192,882)  782,758   872,487   275,868   1,770,442  Income (loss) from operations  (32,211)  192,882   82,491   98,987   (275,869)  66,280 Interest income  —   (167)  7,004   (1,267)  887   6,457 Interest expense  (1,860)  (42,320)  (8)  1,610   (5,413)  (47,991) Income (loss) before taxand minority interests  (34,071)  150,395   89,487   99,330   (280,395)  24,746 Income tax benefit (provision)  (7,607)  —   —   (1,642)  2   (9,247)Minority interest  —   (2,178)  (9,108)  —   —              (11,286) **Net Income (Loss)** $(41,678) $148,217  $80,379  $97,688  $(280,393) $4,213  
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Condensed Consolidating Statement of Cash Flows for the Year Ended December 31, 2006:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Operating Activities**                        Net income (loss) $(41,678) $148,217  $80,379  $97,688  $(280,393) $4,213 Depreciation and amortization  —   2,928   45,789   35,154   31,076   114,947 Non-cash loss on derivatives  —   —   589   344   —   933 Deferred taxes  —   —   —   3,777   —   3,777 Minority interest in earnings(loss)  —   452   10,838   —   (4)  11,286 Equity earnings in excess ofprofit distributions  (29,853)  184,740   91,993   46,002   (283,680)  9,202 Amortization of unearnedcompensation  7,010   —   —   —   —   7,010 Change in operating assetsand liabilities  33,137   (73,758)  (33,997)  31,657   50,853   7,892  **Net Cash Flows fromOperating Activities**  (31,384)  262,579   195,591   214,622   (482,148)  159,260  **Investing Activities**                        Purchase of property,plant and equipment  —   —   (29,115)  (21,741)  —   (50,856)Plant turnaround costs  —   —   (13,755)  (21,526)  —   (35,281)Distributions received fromunconsolidated affiliates  —   —   —   9,660   —   9,660 Proceeds from the sale ofproperty, plantand equipment  —   —   16,400   2,700   —   19,100 Restricted cash  —   —   8,595   —   —   8,595  **Net Cash Flows fromInvesting Activities**  —   —   (17,875)  (30,907)  —   (48,782) **Financing Activities**                        Payments underborrowing arrangements  —   —   (25)  (12)  —   (37)Proceeds from exercise ofstock options  363   —   —   —   —   363 Tax benefit of unvested stock  1,255   —   —   —   —   1,255 Change in investments andadvances from (to)affiliates  53,652   (173,351)  (236,202)  (126,256)  482,157   — Preferred share dividends paid  (5,100)  —   —   —   —   (5,100)Repurchases of TRA stock  (18,786)  —   —   —   (10)  (18,796)Changes in overdraftprotection arrangements  —   —   —   11,443   —   11,443 Distributions to minorityinterests  —   —   (8,861)  —   —   (8,861) **Net Cash Flows fromFinancing Activities**  31,384   (173,351)  (245,088)  (114,825)  482,147   (19,733) 
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Condensed Consolidating Statement of Cash Flows for the Year Ended December 31, 2006(continued):                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Effect of Foreign ExchangeRate on Cash**  —   —   —   1,906   —   1,906  **Increase (Decrease) in Cashand Cash Equivalents**  —   89,228   (67,372)  70,796   (1)  92,651  **Cash and Cash Equivalentsat Beginning of Year**  1   11,508   67,372   7,486   (1)  86,366  **Cash and Cash Equivalentsat End of Year** **$**1  $100,736  $—  $78,282  $(2) $179,017  
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Condensed Consolidating Statement of Financial Position for the Year Ended December 31, 2005:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Assets**                        Cash, cash equivalents andrestricted cash $1  $11,508  $75,967  $7,486  $(1) $94,961 Accounts receivable, net  —   1,563   54,486   150,357   1   206,407 Inventories  —   —   60,350   119,061   10,903   190,314 Other current assets  9,198   12,704   9,720   22,763   193   54,578  Total current assets  9,199   25,775   200,523   299,667   11,096   546,260  Property, plant andequipment, net  —   —   275,223   458,313   —   733,536 Equity investments  —   —   —   183,884   —   183,884 Deferred plant turnaroundcosts, intangible andother assets  —   10,861   7,299   42,139   (354)  59,945 Investments in and advancesto (from) affiliates  747,233   536,937   1,358,920   618,155   (3,261,245)  —  Total Assets $756,432  $573,573  $1,841,965  $1,602,158  $(3,250,503) $1,523,625  **Liabilities**                        Debt due within one year $—  $—  $26  $12  $—  $38 Accounts payable  210   —   48,501   77,152   —   125,863 Accrued and otherliabilities  3,119   92,984   54,855   63,670   (76,719)  137,909  Total current liabilities  3,329   92,984   103,382   140,834   (76,719)  263,810  Long-term debt and capitalLease obligations  —   331,300   —   —   —   331,300 Deferred income taxes  —   —   —   70,088   (4,090)  65,998 Pension and other liabilities  148,793   —   11,173   1,591   (1)  161,556 Minority interest  —   18,049   74,209   —   —   92,258  Total liabilities andminority interest  152,122   442,333   188,764   212,513   (80,810)  914,922                           Preferred stock  115,800   —   —   —   —   115,800                          **Stockholders’ equity**                        Common stock  146,994   —   73   49,709   (49,782)  146,994 Paid in capital  712,671   150,218   1,741,688   1,473,065   (3,364,971)  712,671 Accumulated othercomprehensive incomeincome (loss) andunearned compensation  (63,728)  —   —   5,232   (17,016)  (75,512)Retrained earnings (deficit)  (307,427)  (18,978)  (88,560)  (138,361)  262,076   (291,250) Total stockholders’ equity  488,510   131,240   1,653,201   1,389,645   (3,169,693)  492,903  Total liabilities andstockholders’ equity $756,432  $573,573  $1,841,965  $1,602,158  $(3,250,503) $1,523,625  
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Condensed Consolidating Statement of Operations for the Year Ended December 31, 2005:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Revenues**                        Revenues $—  $—  $576,993  $1,353,589  $1  $1,930,583 Other income, net  —   —   7,189   1,293   —   8,482  Total revenues  —   —   584,182   1,354,882   1   1,939,065  **Cost and Expense**                        Cost of sales  —   3,510   603,372   1,242,991   (49,637)  1,800,236 Selling, general andadministrative expenses  2,817   (8,183)  (4,425)  6,848   49,491   46,548 Equity in the (earnings) lossof subsidiaries  40,800   (209,743)  (89,609)  (79,915)  317,052   (21,415) Total cost and expenses  43,617   (214,416)  509,338   1,169,924   316,906   1,825,369  Income (loss) from operations  (43,617)  214,416   74,844   184,958   (316,905)  113,696 Interest income  —   2,049   5,291   (612)  1,358   8,086 Interest expense  (1,860)  (44,843)  (16)  (6,758)  (1)  (53,478)Loss on early retirementof debt  —   —   —   (27,193)  —   (27,193)Change in fair valueof warrant liability  8,860   —   —   —   —   8,860  Income (loss) before taxand minority interests  (36,617)  171,622   80,119   150,395   (315,548)  49,971 Income tax benefit (provision)  (4,435)  —   —   (9,782)  —   (14,217)Minority interest  —   (2,679)  (10,989)  —   1   (13,667) **Net Income (Loss)** $(41,052) $168,943  $69,130  $140,613  $(315,547) $22,087  
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Condensed Consolidating Statement of Cash Flows for the Year Ended December 31, 2005:                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  **Operating Activities**                        Net income (loss) $(41,052) $168,943  $69,130  $140,613  $(315,547) $22,087 Non-cash loss on earlyretirement of debt  —   —   —   22,543   —   22,543 Change in fair valueof warrant liability  (8,860)  —   —   —   —   (8,860)Depreciation and amortization  —   —   43,506   64,838   7,241   115,585 Non-cash loss on derivatives  —   —   4,091   —   —   4,091 Deferred taxes  13,538   —   —   (5,400)  5,400   13,538 Minority interest in earnings(loss)  —   2,679   10,989   —   (1)  13,667 Equity earnings in excess ofprofit distributions  40,800   (209,743)  —   (79,915)  241,917   (6,941)Amortization of unearnedcompensation  2,431   —   —   —   —   2,431 Term loan discount accretion  —   —   —   1,773   —   1,773 Change in operating assetsand liabilities  11,211   147,075   (56,723)  (107,064)  (163,538)  (169,039) **Net Cash Flows fromOperating Activities**  18,068   108,954   70,993   37,388   (224,528)  10,875  **Investing Activities**                        Purchase of property,plant and equipment  —   —   (3,331)  (27,489)  —   (30,820)Plant turnaround costs  —   —   —   (22,331)  —   (22,331)Distributions received fromunconsolidated affiliates  —   —   —   31,901   —   31,901 Proceeds from the sale ofproperty, plantand equipment  168   —   —   7,392   —   7,560 Restricted cash  —   —   (8,595)  —   —   (8,595) **Net Cash Flows fromInvesting Activities**  168   —   (11,926)  (10,527)  —   (22,285) **Financing Activities**                        Payments underborrowing arrangements  —   —   (104)  (125,063)  —   (125,167)Proceeds from exercise ofstock options  142   —   —   —   —   142 Stock issuance  —   —   (9,190)  —   9,190   — Change in investments andadvances from (to)affiliates  (12,428)  (299,473)  —   239,000   72,901   — Preferred share dividends paid  (5,950)  —   —   (133,875)  133,875   (5,950)
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Condensed Consolidating Statement of Cash Flows for the Year Ended December 31, 2005(continued):                                   Guarantor  Non-Guarantor         Parent  TCAPI  Subsidiaries  Subsidiaries  Eliminations  Consolidated  Distributions to minorityinterests  —   (2,664)  (10,944)  —   1   (13,607) **Net Cash Flows fromFinancing Activities**  (18,236)  (302,137)  (20,238)  (19,938)  215,967   (144,582) **Effect of Foreign ExchangeRate on Cash**  —   —   —   —   8,560   8,560  **Increase (Decrease) in Cashand Cash Equivalents**  —   (193,183)  38,829   6,923   (1)  (147,432) **Cash and Cash Equivalentsat Beginning of Year**  1   204,691   28,543   563   —   233,798  **Cash and Cash Equivalentsat End of Year** **$**1  $11,508  $67,372  $7,486  $(1) $86,366  
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Condensed Consolidating Statement of Operations for the Year Ended December 31, 2004:                                   Guarantor Non-Guarantor    (in thousands) Parent TCAPI Subsidiaries Subsidiaries Eliminations Consolidated **Revenues**                        Revenues $—  $—  $535,977  $961,472  $9,516  $1,506,965 Other income, net  —   —   10,972   689   (9,516)  2,145  Total revenues  —   —   546,949   962,161   —   1,509,110  **Cost and Expense**                        Cost of sales  —   —   504,037   848,825   (4,785)  1,348,077 Selling, general andadministrative expenses  3,780   (9,823)  30,173   11,294   8,766   44,190 Product claim costs  —   —   —   (17,903)  —   (17,903)Equity in the (earnings)loss of subsidiaries  (45,792)  (97,064)  (74,338)  (442)  217,636   —  Total cost and expenses  (42,012)  (106,887)  459,872   841,774   221,617   1,374,364  Income (loss) fromoperations  42,012   106,887   87,077   120,387   (221,617)  134,746 Interest income  1   1,856   4,261   1,838   (4,649)  3,307 Interest expense  (3,077)  (49,643)  (29)  (5,172)  4,787   (53,134)Loss on early retirementof debt  —   (11,116)  —   —   —   (11.116) Income (loss) beforeincome taxes andminority interest  38,936   47,984   91,309   117,053   (221,479)  73,803 Income tax benefit (provision)  28,660   —   —   (23,660)  —   5,000 Minority interest  —   (2,192)  (9,015)  —   —   (11,207) **Net Income** $67,596  $45,792  $82,294  $93,393  $(221,479) $67,596  
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Condensed Consolidating Statement of Cash Flows for the Year Ended December 31, 2004:                                   Guarantor Non-Guarantor    (in thousands) Parent TCAPI Subsidiaries Subsidiaries Eliminations Consolidated **OperatingActivities**                        Net income (loss) $67,596  $45,792  $82,294  $93,393  $(221,479) $67,596 Adjustments to reconcile netloss to net cash flows fromoperating activities:                        Loss on early retirementof debt  —   2,985   —   —   —   2,985 Depreciation andamortization  —   4,086   47,676   50,468   —   102,230 Deferred income taxes  (49,601)  —   —   46,362   (2,819)  (6,058)Minority interest in earnings  —   2,192   9,015   —   —   11,207 Equity in earnings (loss)of subsidiaries  45,792   97,064   74,338   442   (217,636)  — Unearned compensation  1,205   —   —   —   —   1,205 Change in operating assetsand liabilities  55,980   (29,562)  48,867   (10,533)  (18,571)  46,181 Claim cost recovery  —   —   —   (12,874)  —   (12,874) **Net Cash Flows fromOperating Activities**  120,972   122,557   262,190   167,258   (460,505)  212,472  **Investing Activities**                        Purchase of property,plant and equipment  —   —   (4,250)  (14,222)  —   (18,472)Plant turnaround costs  —   —   (12,103)  (16,775)  —   (28,878)Acquisitions, net of cashreceived  175,250   —   —   (229,418)  —   (54,168) **Net Cash Flows fromInvesting Activities**  175,250   —   (16,353)  (260,415)  —   (101,518) **Financing Activities**                        Principal payments onlong-term debt  —   (70,700)  (95)  (59)  —   (70,854)Stock issuance  116,247   —   —   —   —   116,247 Deferred financing costs  —   (2,598)  —   —   —   (2,598)Distributions to minorityinterests  —   (1,575)  (6,497)  —   —   (8,072)Change in investments andadvances from (to)affiliates  (412,468)  82,376   (216,441)  86,815   459,718   —  **Net Cash Flows fromFinancing Activities**  (296,221)  7,503   (223,033)  86,756   459,718   34,723  **Effect of Foreign ExchangeRate on Cash**  —   —   —   —   787   787  **Increase (Decrease) in Cashand Short-term Investments**  1   130,060   22,804   (6,401)  —   146,464  **Cash and Short-term Investmentsat Beginning of Year**  —   74,631   5,739   6,964   —   87,334  **Cash and Short-termInvestments at End of Year** $1  $204,691  $28,543  $563  $—  $233,798  
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**24. Quarterly Financial Data (Unaudited)**                 (in thousands, except per-share data) March 31 June 30 Sept 30 Dec 31 **2006**                Total revenues $398,920  $523,520  $464,781  $449,501 Operating income (loss) $(28,166) $26,224  $29,388  $38,834 Net income (loss) $(23,991) $6,257  $10,341  $11,606 Per Share:                Basic income (loss) per share $(0.27) $0.05  $0.10  $0.11 Diluted income (loss) per share $(0.27) $0.05  $0.10  $0.11                  2005                Total revenues $450,012  $489,993  $485,694  $513,366 Operating income (loss) $30,823  $69,761  $31,977  $(18,865)Net income (loss) $4,431  $21,702  $11,086  $(15,132)Per Share:                Basic income (loss) per share $0.03  $0.22  $0.10  $(0.17)Diluted income (loss) per share $0.03  $0.20  $0.10  $(0.17)
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**Report of Independent Registered Public Accounting Firm**To the Board of Directors and Stockholders of Terra Industries Inc.:We have audited the accompanying consolidated statements of financial position of Terra IndustriesInc. and subsidiaries (“Terra”) as of December 31, 2006 and 2005, and the related consolidatedstatements of operations, cash flows and changes in stockholders’ equity for each of the threeyears in the period ended December 31, 2006. Our audits also included the consolidated financialstatement schedule listed in the Index as Item 15. These financial statements and the financialstatement schedule are the responsibility of Terra’s management. Our responsibility is to expressan 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 AccountingOversight Board (United States). Those standards require that we plan and perform the audit toobtain reasonable assurance about whether the financial statements are free of materialmisstatement. An audit includes examining, on a test basis, evidence supporting the amounts anddisclosures in the financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well as evaluating the overallfinancial statement presentation. We believe that our audits provide a reasonable basis for ouropinion.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, 2006 and 2005,and the results of their operations and their cash flows for each of the three years in the periodended December 31, 2006, in conformity with accounting principles generally accepted in the UnitedStates of America. Also, in our opinion, such consolidated financial statement schedule, whenconsidered in relation to the basic consolidated financial statements taken as a whole, presentsfairly, in all material respects, the information set forth therein.As discussed in Note 1 to the consolidated financial statements, in 2006 the Company adoptedStatement of Financial Accounting Standard No. 158, *Employers’ Accounting for Defined BenefitPension and Other Postretirement Plans*relating to the recognition and related disclosureprovisions effective December 31, 2006.We have also audited, in accordance with the standards of the Public Company Accounting OversightBoard (United States), the effectiveness of Terra’s internal control over financial reporting asof December 31, 2006, based on the criteria established in *Internal Control  —  IntegratedFramework*issued by the Committee of Sponsoring Organizations of the Treadway Commission and ourreport dated March 12, 2007 expressed an unqualified opinion on management’s assessment of theeffectiveness of Terra’s internal control over financial reporting and an unqualified opinion onthe effectiveness of Terra’s internal control over financial reporting.