LSB Industries Inc (LXU) 2008 Q2 法說會逐字稿

Good day, everyone, and welcome to LSB Industries second quarter 2008 conference call. At this time, I would like to inform you this conference is being recorded and that all participants are currently in a listen-only mode. I will now turn the call over to Ms. [Eldon]. Please go ahead, ma'am.

Welcome to the LSB Industries conference call. Today, LSB's management participants are Jack Golsen, Chairman and Chief Executive Officer, Barry Golsen, President, and Tony Shelby, Chief Financial Officer. This conference call is being broadcast live over the internet and is also being recorded. An archive of the webcast will be available shortly after the call on our website at www.lsb-okc.com, and will be accessible for one month. After comments by management, a question and answer session will be held. Instructions for asking questions will be provided at that time. Information reported on this call speaks only as of today, August 6th, 2008, and therefore you are advised that (inaudible) information may no longer be accurate as of the time of any replay. Comments today may contain certain forward-looking statements. All statements other than statements of historical fact are forward-looking statements.

Statements that include the words expect, intend, plan, believe, project, anticipate, estimate and similar statements of the future of a forward-looking nature identify forward-looking statements, including but not limited to: Starting up our Pryor Oklahoma Chemical plant, attaining a long-term off-take agreement for the production of the Pryor plant; production plans at the Pryor plant -- we are in a strong position to finance operations, as well as growth opportunities; Capital Expenditures for extensions; optimism about the long range potential for our geothermal products; demand for our assets of ammonium nitrate; emphasized cost reduction while developing product and customer mix that will allow us to operate our Chemical plants at full rate; 2008 outlook for commercial construction; prospects for growing the Climate Control business; and outlook for a strong ag market. The term EBITDA as used in this presentation is net income plus interest expense, depreciation, amortization, income taxes and certain non-cash charges, unless otherwise described. EBITDA is not a measurement of financial performance under GAAP and should not be considered as an alternative to GAAP measurements. We will post on our website a reconciliation of GAAP with any EBITDA numbers discussed during this conference call.

You should not rely on forward-looking statements, because actual events or results may differ materially than those indicated by these forward-looking statements as a result of a number important of factors. These factors include but are not limited to: A decline in general economic conditions; interest rate changes; competitive pressures; cost to activate the Pryor plant; changes in working capital; price of our common stock; and uncertainties discussed under the heading "Special Note Regarding Quarterly Statements" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2007, the Form 10-Q for the quarter ended March 31, 2008 and the reports we file from time to time with the Securities and Exchange Commission. We do not intend to take and undertake no duty to update the information contained in this press release. Now I'll turn the conference call over to Mr. Jack Golsen, (inaudible).

Thank you, Carol. Good afternoon, everybody, and welcome to LSB's second quarter 2008 conference call. Thanks for joining our conference call today. Today, Tony Shelby, our Chief Financial Officer and Executive Vice President, will go over our overall results and the pertinent numbers of our Climate Control and Chemical businesses. Then, Barry Golsen, our President and Chief Operating Officer, will discuss both the Climate Control and Chemical Companies' Operations. When they have completed their statements, Tony, Barry and I will be available to answer questions. Today, we reported this year's second quarter fully diluted after-tax earnings of $0.75 per share. This compares to last year's second quarter diluted earnings per share of $0.58. For the first six months of 2008, we reported income of $1.21 per share compared to $0.87 per share last year. Please keep in mind that in 2007, we benefited from our net operating tax loss, where this year we are reporting fully taxed earnings. Also included in 2008's second quarter results is a 7.6 million income from proceeds of a lawsuit. During the second quarter of 2008, our Company was named by Business Week as Number 38 on the list of the 50 Hottest Growth Companies. Business Week stated that starting from a base of 10,000 publicly traded companies, this rating considers return on invested capital, one and three year sales growth, one year earnings growth, latest 12 month profit, and current market values. This is the second consecutive year that we were recognized by Business Week in this group of companies. We've announced that we were considering the feasibility of starting the Pryor Oklahoma Chemical plant, which produces anhydrous ammonia and urea ammonium nitrate, which you may know as UAM.

I will update you on the status of that at this time. Previously, we told you that we're looking for a long term off-take agreement for the entire plant production of the Pryor plant. We have identified several potential strategic industry customers who have indicated an interest in reaching an agreement with us. We are close to receiving our environmental permits to restart the plant. We've been told by the regulators that we should expect to receive the permits by early October of this year. Meanwhile, we have been mobilizing for the plant start up by ordering certain equipment that will be required for the start up. If for any reason we decide not to start the plant, this equipment can be used in our other plants. We'd like to make it clear that until we have an acceptable off-take agreement for sale of the product with one of the interested prospects, there is no assurance we will start the plant. Our initial plan is to manufacture 325,000 tons of UAM and an additional 50,000 tons of anhydrous ammonia with as little downside risk to the Company as possible. We do not know yet precisely how long it will take to bring the plant to this rate of production, as we must complete a turnaround on the plant and training of personnel. Our estimate is 6 to 12 months if everything goes smoothly. That's my news today, and now I'll turn you over to Tony Shelby.

Thank you, Jack. We made our earnings announcement approximately one hour ago, reporting diluted earnings per share, as Jack indicated, of $0.75 for the second quarter of 2008 versus $0.58 in the 2007 second quarter, and in the past 30 minutes or so, we did file our 10-Q. The details for the second quarter 2008 compared to the second quarter of 2007 were: Sales rose 26% to $198 million; operating income was 29.3 million as compared to 15.2 million, a 93% increase; net income attributable to common stock was 17.9 million compared to $13 million, an increase of 4.9 million or 38%. Arriving at net income, the provisions for income taxes in 2008 were 10.7 million, which had the effect of reducing earnings per share by $0.43. The income tax provision for 2007 was only 188,000. The minimal provision for income tax in 2007 was a result of existing NOL carry forwards into 2007 reducing the taxable income. In 2008, we had lower net operating cost carry forwards into the year.

During 2008, we will accrue and pay income taxes at regular corporate tax rates. Income taxes -- these income taxes are fairly complex and we'll explain our 10-K and also address in the 10-Q that we just filed. Diluted earnings per share were $0.75, up 29% from the $0.58 last year. Consolidated EBITDA was 33.1 million compared to 18.5 million in 2007, a 79% increase. The results for the second quarter 2008 include as other operating income the collection of a litigation judgment against Ingersoll-Rand Company of $7.6 million. which after-taxes was approximately 4.7 million. This is reflected in the consolidated results that we just discussed and also in the Chemical business results to be discussed later. As you will recall from earlier calls, this award was for damages and business interruption our Chemical business experienced in 2004 and 2005 as a result of the failure of equipment rebuilt by Ingersoll-Rand. Year-to-date, through June 30, 2008 as compared to the same period in 2007, sales were 358.5 million, an 18% increase. Net income applicable to common stock was 28.5 million compared to 18.6 million, an increase of 9.9 million or 53%. Provisions for income taxes in 2008 were 17.4 million as compared to only 532,000 in 2007. The explanation of this significant increase in tax provision for the year-to-date is the same as I just explained for the second quarter.

Diluted earnings per share were $1.21, up 39% from $0.87 last year. Consolidated EBITDA was 56.3 million compared to 35.4 million in 2007, a 59% increase. Excluding the litigation judgment, EBITDA was 48.7 or an increase of 13.3 million or 47%. LSB's trading 12 month EBITDA at 6-30-08 was 94.6 million compared to 54.8 million for the trailing 12 months at June 30, '07. Over the past two years, we have substantially improved our balance sheet and liquidity. Our liquidity and capital resources reflect a sound financial position. At June 30, 2008 our long term debt, including the current portion, was 121.6 million and stockholders equity was 123.1 million. In other words, long term debt to stockholders equity was approximately 1 to 1. At June 30, 2008, we had cash on hand of $48 million plus borrowing availability on our working capital revolver of another $49 million. We are in a very strong position to finance ongoing operations as well as growth opportunities available to the Company.

During the three months ended June 30, 2008, net cash provided by operations was $10.3 million. This net cash provided by operations included increases in accounts receivable and inventory of 12.9 and 6.4. Due to sales increases and seasonal inventory requirements, the receivables inventory are both up due to the increase in sales and the inventory requirements to meet the seasonal needs. Net cash used during the quarter of 4.2 million include 9.9 million of capital expenditures and other items, offset by the cash received from the litigation judgment. Both Climate Control and Chemical performed well in the 2008 second quarter reporting improved operating income and cash flow. Climate Control sales of 80.6 million were 8% higher, as operating income increased 23% to 11.9 million and EBITDA increased 21% to 12.6 million compared to 10.4 million at last year's second quarter. Chemical reported sales of 113.5 million compared to 79.4 million, a 43% increase. Chemicals operating income increased 158% to $20.5 million, as EBITDA increased 123% to 22.9 million. Excluding the income from the litigation judgment, the Chemical business operating income increased 63%, and EBITDA increased 50%.

In order to -- this is a point I wanted to make before we got off of Chemical. In order to secure our margins on forward sales commitments in the Chemical business, we've entered gas hedges; and as everybody knows, recent extreme volatility in the natural gas prices has created wide swings in the mark-to-market value of natural gas hedges. At June 30, 2008, gas prices were high and our natural gas hedges included unrealized gains of approximately $700,000. At July 31, the futures market for our hedges -- they extend out through 2009 -- resulted in unrealized non-cash markdown to market of approximately $5.4 million due to the significant drop in the gas prices in July 2008. This unrealized gain or loss -- the unrealized gain or loss to be recorded for the third quarter 2008 will depend on the market price of natural gas at September 30, 2008, as compared to the price at June 30, 2008. Therefore, we are unable to predict the impact these hedges will have on the third quarter and future quarters. It should be clearly noted that these are not speculative hedges. These hedges economically secure the profit margin of significant orders for our Chemical business so that the ultimate profit to be realized is known at the time the customer orders are accepted, as indeed realized at the time of physical transactions occur.

The interim mark-to-market accounting does result in volatility in our financial statements; however, the unrealized gains or losses are non-cash items. Capital expenditures for the quarter include $3.6 million for Climate Control and $6.2 million for Chemical. Year to date, capital expenditures for Climate Control and Chemical were 5.1 million and $9.8 million, respectively. Our current committment for the remainder of 2008 is $12 million, including 4.7 million for production equipment in Climate Control and 7.3 million for process improvements in Chemical. In addition, we're considering other expenditures for expansion opportunities in Chemical, including but not limited to the activation of the Pryor Oklahoma facility. That concludes the financial review. Barry will cover the operational highlights in the second quarter and the outlook for the Company.

Thanks, Tony. First, let's discuss the Climate Control business. As Tony mentioned, our Climate Control business sales during the second quarter were higher than the same period last year by 8%. Heat pump sales were up 8%, fan coil sales were up 10%, and our other sales were up 6%. As discussed on the last conference call, bookings during the fourth quarter of 2007 were lower than expected and this contributed to lower shipments during the first quarter this year; however, bookings in Q1 rebounded strongly and this helped boost shipments in Q2. Also, during Q1 and Q2 of 2007, our sales were unusually high because we were working down the excessive backlogs we had at that time, particularly in our heat pump operation. Despite these high sales levels last year in Q2, sales this year were still higher. This was due to increased order level in the first quarter, price increases, sales mix, and increased fan coil unit shipments.

New orders during the second quarter were 75.6 million, a 16% year-over-year increase, and the highest order bookings quarter in the history of our Climate Control business. We ended the quarter with a backlog of product orders of 63.3 million, up from 54.5 million at year-end. I'm glad to report that as of the end of the second quarter, we continued to maintain leading market shares for geothermal and water source heat pumps and for hydraulic fan coils. Our gross profit during the second quarter this year was 32.2%. as contrasted to 29.4% for the same period last year. The increase in gross profit was due to the fact that price increases we have implemented last year had taken effect during the second quarter of this, year offset by new material price increases; and I'd like to note that whereas in the first quarter, the increase in gross profit was to a certain extent a result of copper hedging gains, there were no copper hedging gains in the second quarter, so that was a pure gross profit without any hedging activity.

With regard to raw materials -- copper, steel and aluminum -- since our last conference call, we've continued to incur increases. As you know, commodities are close to all-time highs. Historically, we've been able to pass through material price increases, although sometimes, there's been a delay in realizing the effect of these increases on the bottom line due to committed pricing in the backlogs in place at the time price increases are announced. A key question that we discussed during the last conference call remains, how will our Climate Control business be affected by the slowdown that our economy is undergoing -- specifically, what is the outlook for construction, both commercial and residential? The vast majority of our Climate Control business sales are to commercial and institutional new construction renovation and replacement. In 2007, commercial and institutional sales accounted for 89% of total Climate Control business sales. About 83% of those commercial sales -- or 74% of total Climate Control business sales -- were used in the following type of structures: Offices, hotels, educational facilities, healthcare and retirement facilities, manufacturing and process plants, apartments, and condominiums. McGraw Hill's current outlook, as reported in the 2008 Fall Edition of their Construction Market Forecasting Service, is that contract awards for those building types that I just mentioned in the aggregate will decrease by 1.7% in 2008 and will decrease again by 4.5% in 2009, followed by increases of 4.3% and 10.2% in 2010 and 2011, respectively. These numbers represent an upward revision for 2008 since the last conference call, but a slightly downward revision for the out years.

Turning to single family residential construction, it's again stating the obvious to describe the dismal situation that this market is in. The current McGraw Hill forecast is for a 32.8% decline in 2008, following a cumulative decline of almost 40% over 2006 and 2007. It's important to focus on the fact that in 2007, our sales hit the single family residential market, which for us is all geothermal heat pumps, represented only 11% of total Climate Control business sales and only 5.4% of total LSB sales. In other words, we don't have a huge exposure in that market at this time. The in the last conference call, I reported that during the first quarter, our residential geothermal sales were down 12 % from the level in Q1 2007 and that some of that decline was due to the comparison to high shipments in Q1 of 2007 when we were reducing our backlogs and lead time. I'm very glad to report that during the second quarter, our residential geothermal shipments increased 50% over shipments during the second quarter of 2007. Furthermore, during the second quarter, our bookings of new orders for residential geothermal products increased113% over the second quarter of 2007. Year-to-date, as of 6-30, our residential geothermal bookings are up 82% over the first half of last year. We believe that our geothermal products are an important part of the solution to environmental and energy issues facing our country, and we remain very optimistic about the long range growth potential for these products.

Turning to our Chemical business, as both Jack and Tony reported, this business got off to a great start in the first quarter, and this trend continued into the second quarter. During the second quarter, total sales of our Chemical products were up 43% over the same period last year. Industrial assets were up 85%. Agricultural products were up 17%, and mining products were up 43%. The improved performance in quarterly results were driven by substantially higher sales prices for our fertilizer products, increased UAN tons shipped and better pricing for our mining products and industrial assets. Gross profits and operating income were also significantly higher. As has been well-documented by numerous trade publications and the national press, global grain stocks -- including corn and wheat -- are at historic low levels and are driving the demand for nitrogen fertilizers. These favorable supply demand fundamentals were the catalyst for significantly higher fertilizer selling prices and better margins in 2007, and this trend has continued into the first half of 2008. The dramatic improvement in profits in the second quarter over last year's second quarter results were driven primarily by the high demand for our agricultural products, principally UAN -- urea ammonium nitrate.

During the second quarter, our shipped tonnage of UAN was 31% higher than the second quarter of 2007, while our revenues from these sales increased 114%. The published sales price per ton during the second quarter of 2008 ranged from $355 to $430 per ton, up from a range of 260 to $295 a ton a year ago. At the same time, the cost of natural gas, the primary feedstock for producing UAN at our Cherokee facility, increased from a range of $6.89 to $8 per MMBtu in the second quarter of last year compared to a range of $9.35 to $12.93 this year. Currently, the spot market natural gas price is approximately $8.75 without transportation costs, and the 12 month strip which changes daily was quoted today at approximately $9.25 per MMBtu. All of the supply demand fundamentals continued to be in our favor during the second quarter; however, there was delayed start to the ag season in areas supplied by our El Dorado, Arkansas plant, caused by cool and wet weather conditions which continued throughout the entire first crop season. Also, less fertilizer was used for forage areas to graze cattle due to the poor conditions in the cattle market.

These factors depressed demand for fertilizer, principally ammonium nitrate produced at our El Dorado facility. During the second quarter of 2008, we sold 29% fewer tons of AN than in the second quarter of 2007; however, our revenues for this product were down only 10%, reflecting the increased sales price per ton. The price of anhydrous ammonia, the raw material feedstock for our El Dorado facility, has escalated significantly since the beginning of the year. After being relatively stable through 2007, it increased from an average of in the mid-400s per metric ton in January to a current price of $745 per metric ton. This current high cost of imported ammonia increases the cost of nitrogen products produced at our El Dorado plant; however, the majority of El Dorado sales are to customers who accept the cost of ammonia as a passthrough, so we have a natural hedge built in on those products. Market data indicates continued strong demand for nitrogen fertilizers due to the need for increased demand for grain. We also believe that there will be steady demand for both our industrial assets and our industrial grade ammonium nitrate used for surface mining.

Our Chemical business will continue to focus on growing our non-seasonal industrial customer base with an emphasis on customers who accept the risk inherent with raw material cost fluctuations. This is currently 60 to 65% of our Chemical sales. At the same time, we will maintain a strong presence in the seasonal agricultural sector, which is 35 to 40% of our sales. We have the ability to reallocate portions of our capacity to fertilizer when the markets indicate favorable volumes and margins. Other key parts of our strategy are to emphasize cost reductions while we develop a product and customer mix that will allow us to operate our plants at full rates, lowering the fixed cost of each unit of production. Turning to general corporate matters, since our last conference call, both Roth Capital and Canaccord Adams have initiated coverage of LSB. Along with Avondale Partners, Sterne Agee & Leach, and Jesup & Lemont, we now have five analysts covering the Company. Next Tuesday on August 12th, Tony and I will be presenting at the Canaccord Adams Annual Global Growth Conference in Boston. We hope to see some of you there.

Summing up, the second quarter for our Climate Control sales rebounded and the year-over-year bottom line improved. New orders were very strong during the second quarter, continuing the trend from the first quarter. The current outlook for 2008 commercial construction is slightly higher than a quarter ago; however, we will be challenged by increasing raw material costs. We are particularly glad to see strong shipments in new orders for our geothermal products. We are very excited about the prospects for growing all of LSB's Climate Control business, and particularly those geothermal products, over the long term. Chemical sales and profits were up significantly as a result of a booming agricultural market. The outlook for a strong ag market to continue for some time is good according to industry consensus. Our industrial Chemical businesses remain steady and profitable as well. Very good results in the second quarter were further enhanced by the 7.6 million litigation judgment we received. Finally, we should make a decision whether to proceed with the start up of the Pryor plant subject to receiving the required permits soon. We'll now take your questions.

(OPERATOR INSTRUCTIONS) Our first question will come from the line of Eric Glover with Canaccord Adams.

Congratulations on the quarter.

Thanks, Eric, how are you?

Good, thanks. First, I'm curious about the strength you mentioned in the residential side of your Climate Control business. And can you talk about what's driving the sales growth there and whether you think you may be actually gaining share in that area?

Well, we know that for several years, consistently we've gained share in that area. We're to date, I don't really like to look at quarterly numbers too close because they're not very reliable, but we know that that's been the trend the last several years. As to what's driving it, we've always felt that there were different industry drivers for this particular product than the unitary air-conditioning at large. Unitary air-conditioning at large is just driven by the size of the market -- whatever -- as the market goes up and down that goes up and down. We all know that that residential market is down in general, but the drivers for this market are energy concerns, energy cost concerns, energy security concerns, environmental issues, and we think -- we feel that it's a perfect storm right now of all of these things that make this the right product for the time, and apparently that's reflected in the results so far this year.

Okay, thanks. I was wondering if you could also review again the sequential drop in operating margin in the Chemical products business, excluding the gain from litigation.

Sequential drop --

Yes, I have your Chemical products operating margin at 13.3% in the first quarter going to 11.4% including the gain in the second quarter.

Hold on a second. You got 11.3% if you take out the judgment?

Yes. All right, we can come back to that. Could you comment on the level for SG&A going forward? It was up to 22 million from 18.4 in the first quarter, and what's sort of a good range for that in the third quarter?

Well, that's a reflection of the increased sales. A lot of that is commissions. I think the bulk of that would be commission.

Yes, it would. Talking about -- I didn't hear the very tail end, I missed the question.

Want to repeat the question, please?

Yes, I was asking about the SG&A expense in the quarter, which was up to 22 million from 18.4 in the first quarter and what we could expect in the third quarter either as a percentage --

The percentage increase.

Right.

The increase of sales.

Eric, back to your other question, what did you get for a gross profit and operating income percentage for --

11.4 excluding the gain.

We got 20.5 million operating income in the three-month period of June 30 '08.

Okay.

And you take 7.5 -- 6.5 out of that, and it's 11.3%.

Okay.

And I take the 7 million, 936 last year and divide it by 79,422 I get 10%.

Right. No, I'm talking about -- yes, okay. All those add up. I was talking about the sequential decline in operating margins.

Well, what do you mean, from the prior quarter?

Yes, from Q1 08 to Q2 08.

Well, you have probably gas prices catching up and ammonia prices caching up to the sales price. As we've gone through the second quarter, you've seen a significant increase, as Barry mentioned, in the anhydrous ammonia cost and then you've seen gas prices go up. Now it's very interesting. Gas prices were very low during the winter -- $8 or $9 -- they went up in June to $13, and late May and early June, they're back down to $9, so you have some volatility there in your raw material input cost that will affect quarter to quarter. As Barry said, even in this business too, there's a certain amount of lumpiness in your quarter to quarter because you don't have that exact parallel between your input cost and your sales price.

Okay, very good. Thank you.

Sorry, the reason we were a little bit hesitant before, we misunderstood your question the first time you asked it. We thought you were asking year over year. We missed the sequential part.

Okay, sorry about that.

And the second question you had was?

Oh, the operating cost?

Yes, SG&A. I'm just trying to get a sense of should we be looking at like a 22 million level of a sustainable type of thing or should we be dropping back down a couple million based on that?

Well, first of all, we don't forecast what those costs are going to be. But the primary movement in our operating cost has been the variable costs, which go up and down with the sales volume.

You have two factors. You got sales volume, you got commissions and you have freight.

And you've got other variable sales expenses. Warranty costs, things like that. But the primary movement has been in those variable cost, and they tend to fluctuate with the sales volume. They fluctuate with the sales volume more in the Climate Control business than they do in the Chemical business.

Okay. Thank you.

Thank you.

Our next question will come from the line of Richard Nelson with Jesup & Lamont.

Good afternoon, fellas. Remarkably good quarter. Congratulations.

Thank you.

I have a couple questions. One, first to Tony. I think you commented on it but I didn't quite get the full gist. Your tax rate was a fair amount lower. If you could elaborate on that? And the second question I had would be for Barry. When you commented on the McGraw Hill outlook for 2008, as there being a prospective decline of 1.2%, yet your backlogs obviously, as you've stated, are the highest ever. Are you actually gaining some considerable market share, if you could elaborate on that?

Let me answer that question first. It's hard to say -- it's hard to directly correlate McGraw Hill's numbers with our shipments and -- or backlog our shipments in any one quarter, because McGraw Hill's numbers are contract awards, and there is a time lag between contract awards and when projects are completed that can be anywhere from a year to four years, sometimes even longer. And our products shipped, some types during the cycle, usually in the latter half of the cycle; and so depending on the duration of the project, our products ship at different times. So we don't look at the McGraw Hill data as being specifically indicative of what's going to happen in terms of our shipments next year or in any particular period. We look at it as a -- somewhat of an indicator of the trend of what's going on in construction. So I think you're comparing apples and oranges if you try to draw a direct correlation, and so you can't necessarily draw a share pick up correlation from that.

Okay. Rick, on your tax question, would you repeat the tax question?

Yes. Your tax rate came down a fair amount in the second quarter and I was just wondering, is that a level that we can expect going forward or might it inch back up?

Well, I can't remember if we put 37.5% for the quarter or year-to-date.

It was 532,000 --

(inaudible) Rick, it's going to vary somewhat based on the way the year unfolds and what kind of timing differences you have and tax differences you have. The other thing I can tell you is that we attempt to get the year-to-date number close to the average rate for the year.

Okay.

And you've got accelerated depreciation this year on capital expenditures which is -- no, you don't? You do?

Yes, you have to accelerate it.

Yes.

So we attempt to get the average rate year-to-date number close to what we anticipate for the year.

Okay, well, I'll get back in queue, but thanks a lot and again, very, very good performance.

Thank you, Rick.

Our next question will come from the line of Brian Shore with Avondale Partners.

Good afternoon, guys. Great quarter.

Hi, Brian, how are you?

Good. Quick question for you you on the Climate Control side. Are you seeing a mix -- or a shift in the mix -- between retrofit and new construction? Or are you still seeing good interest on new construction, even with the declining market?

We haven't seen a meaningful mix change at this point in time.

Okay, great. And you mentioned in the release and then earlier on the call, the hedging that you guys have done on the Climate Control side in terms of raw materials. Should we expect that sort of, I guess, hedging going forward? Or is there --

Well, we have a very active hedging function here at the Company, but we are not out there speculating. What we're trying to do is to look at our backlogs, look at what we think raw materials are going to do -- in some cases we're trying to specifically cover backlogs, in other cases we're trying to lock in on a cost of a specific commodity that we feel is a good cost for the balance of the year or for whatever period we're hedged in. And so our hedging function really depends on how volatile we think raw materials are going to be.

Okay.

I don't think you can look at what's happened with our hedging in the first quarter or the second quarter and draw any kind of conclusion from that or any kind of specific pattern from that.

Okay.

What we really did is we fixed -- in the copper hedge that you're talking about, for the period of time that we hedged we fixed the price of copper so we knew what it was costing us, so we didn't care what the market did after that.

Sure. I guess I was just looking at margins -- gross margin in the quarter was strong. I wanted to make sure that we weren't going to see any sort of compression in the back half of the year beyond just because you guys are hedging well.

No, we're not taking a hedging risk. What we're doing is we're covering specific usage.

Excuse me. I think you were asking a slightly different question. I think what you were asking is, did we have a hedging gain in the second quarter that was not going to repeat in the back half of the year. Is that what you're asking?

Well, yes, I just wanted to make sure that you guys, I guess are -- that we're not going to see any sort of margin compression because you hedged well in the first half and that may not continue, but I think you answered my question.

Okay, good.

Just quick on the Chemical side, are you guys -- I guess what's the outlook for contracting now, I guess particularly on the fertilizer side? Are you contracting any business now for later in the year and early next year to try and lock in where prices are to take advantage of them, or is that difficult to do with prices where they are?

Well, we have done quite a bit of pre-selling and that's where the gas hedges originate that I mentioned. It's not a significant part of our business. We have locked in some; but for the most part, we expect -- we haven't sold a significant part of our capacity, committed pricing or volumes to long term.

Okay.

Well, let me add to that. You've got a natural hedge built into the way our contracts are with our customers and about 60% of our production.

Right. Sure, and I guess my question --

I know, I know.

Okay.

So in the ag part, if we go -- if someone wants to buy some product today for delivery in November or December, and we look at today's price of gas and we price it based on that, and if they're willing to pay that then we lock in that gas.

Okay.

But assuming your question goes to what level of pre-selling we've done, it's not a significant part of our capacity.

Okay, great. And then you guys mentioned earlier in the call you have the ability to shift production based on where market pricing is versus some of your cost plus production. Have you guys done any of that to take advantage of where pricing is and do you see yourself --

We do that to a certain extent, but yet our policy is to be loyal to and to service the needs of all of our industrial customers, both our industrial asset customers and our industrial AN customers; and don't forget, a good portion of our industrial assets made an appointment that's dedicated specifically to that, so that product that's made in Baytown, we do not shift that.

Sure.

But so we have the ability to do it but not to the detriment of any of those other customers.

I got you, great. And then just lastly, on Pryor, I know there's several, I guess, steps that need to occur. Is securing an off-take buyer a must in terms of whether you do decide or decide not to start it up?

That's been our plan so far.

Okay.

If conditions change and we thought that we didn't have a buyer and we thought that the market was good then we would -- we may be reconsidering, but right now, our whole premise has been that we want to have it filled out before we start the plan.

Okay, and is cost still what you'd said previously -- estimated cost, I think 15 to 20?

Yes.

Okay, great. Well, wonderful quarter guys. Thanks for the insight.

Thanks, Brian.

Our next question will come from the line of Rick [Haas] with Roth Capital Partners.

How's it going?

Hi, Rick.

A lot of good questions so far. I think one confusion that I have is concerning your bookings versus your backlog for geothermal; and to me, you have bookings for the quarter, okay, that's your orders for the quarter, your backlog for geothermal. I mean, what's the book-to-bill in the geothermal? Is it three months?

What's the what?

Book-to-bill.

By the time you book it to the time you deliver it.

Oh. Well --

I guess I'm just looking for an overall backlog number if you have one.

Our overall backlog number for our Climate Control business?

Correct.

Well, our overall backlog we said was 60-- let's see.

That was just geothermal, right? 63.3?

No, no. We had -- it was 63.3 or 4 depending on the way you round it, million at 630. That's for our total Climate Control business, as far as product orders. That does not include contracting business done for our [Tristone] subsidiary.

Okay. Okay, I may have misread it in the press release then. Okay, and then considering the commercial Climate Control orders, how much of that has come from -- if you have a feeling -- you probably don't have an exact number, but I guess a guess on how much of that has come from construction projects that have started, say more than a year ago or two years ago, somewhere around there?

You know what? If I told you, I would be taking a guess. I don't have any specific numbers on that in front of me or that I can cite to you.

Okay, and then as far as the gross margins concerning the ag product, are we looking at something consistent with the industry?

Repeat that, please?

Gross margin in the ag sales?

I think, Rick, you have to separate the ammonium nitrate that we produced in our Arkansas plant for the UA that we produce in the Cherokee plant for the natural gas. The UAN is a much stronger gross profit product, and we're pretty much following industry trends there. The ammonium nitrate is a much smaller market, and we're producing that from anhydrous ammonia so the margins there are a little more compressed than they are on the UAN side.

Okay, and then based on off-take agreements that you seen in the marketplace thus far, how do those typically work from a -- I guess from a structural standpoint?

There are no standard agreements. Whatever agreement we come to will not be standard. It will be a special customized agreement depending on the relationship we establish with a perspective off-take customer partner.

If you have a off-take partner that has the transportation equipment and upstream storage and distribution, then that's the profile of the off-take partner, and then the UAN has a strong margin, as Barry clearly documented in the marketplace today, so you'd be -- there would be some splitting of that on some basis. Beyond that , there is nothing standard that we're aware of.

Okay. So it would be -- obviously compared to margins in the market in the broad market, if you were saddled up with an off-take partner, then your margins would be lower to some degree?

That's correct, because we wouldn't be bringing the transportation equipment or the distribution system. They would have costs to offset some of that.

Okay. Okay. I think that's it. Thanks a lot.

Sure.

(OPERATOR INSTRUCTIONS). Our next question will come from the line of Cliff Borden with CIBC.

Hi, guys. Great quarter. We appreciate the extra color on the geothermal that we're getting. I guess my first question is on the -- actually on the Chemical. So as I understand it -- and correct me if I'm wrong -- you basically hedged natural gas only against pre-serve fertilizer products?

We're having trouble understanding you. We're getting a bad connection here, Cliff. Could you speak a little slower and perhaps get a little farther away from your mouthpiece?

The audio is a little bit garbled.

Is it? Okay, I'll try again then. Basically on the Chemical side, on the hedges that you have on the natural gas, is that only against pre-sold fertilizer product ?

Yes.

It's pre-sold and our firm pricing commitments over time. Same thing essentially, so we're locking in margins.

Okay, so it's against pre-sold product, so there's no risk on that.

Right.

Essentially. Now, in terms of the Fall application season, how is that looking at this point? Do you have any feel for that?

No, we really don't. It's a little bit early. We've had 95 degree weather in the Southwest so I don't think a lot of people are -- not much activity right now.

Okay. Well, it's 70 degrees here. On the geothermal side -- on the geothermal side on institutional, have you seen any growth in that area?

In what area?

Institutional.

What do you mean by institutional? Just --

No, commercial side of the geothermal business.

Oh, the commercial side. Yes, that's an area that, you know, has been steadily growing over the last several years. It continues to grow, but we've had much bigger growth this year in the residential side than commercial in general.

Okay. On the Canadian market, do you have any comments there? Have you see any pick up in growth in that area?

That's a very, very strong market for us.

Okay. Anything internationally?

Pardon?

Internationally.

Anything international? I lost them. I'll call you later, guys. I can't really hear you myself. Thanks.

Our next question will come from the line of Steve Conway with [RS] Research.

Hi, guys. Like everybody else has said, congratulations on a nice quarter.

Thank you.

I've got a question for you -- you made a mention of it in your statements and then there's one line item in the press release regarding litigation judgments, and this leads up to my question here and that was, in some prior filings that I've read, there was a mention or there have been a couple of mentions of a couple of lawsuits that you've been involved with, one involving the University of Kansas and another one involving J-Hawk Group, and it wasn't clear from the filings whether they had been settled or not. It kind of described what was going on there -- but one of them apparently is covered by the insurance, and --

Steve, those are fairly de minimus in terms of the amount, but they have not been settled.

Well, one of them has verbally. One of them has verbally. It says so in the 10-Q. One of them has been verbally settled and is supposedly preparing the documentation to settle, and that's with the University of Kansas.

And they're fairly small amounts?

Yes, that was $200,000, which we believe is covered by insurance.

Okay, and then the one with J-Hawk? I'm sorry -- and then the one with J-Hawk?

J-Hawk had a verbal settlement, but if you'll read the 10-Q, they have not followed through on the verbal agreement yet.

Steve, you're looking at the press release -- Jack is telling you what's in the 10-Q, which is on file, you'll pick that up.

Yes, yes.

That's right. Okay. And then to your press release from today, you said you got a judgment of 7.6 million -- that has got nothing to do with what we just talked about?

No. That's separate. That was against Ingersoll-Rand.

Okay, very good. Okay, thanks very much.

Steve, what's your Company?

It's RS Research.

Who?

RS.

And there are no further questions at this time. I will now turn the conference back to management.

Thank you very much. We'll see you all next quarter.

Ladies and gentlemen, this concludes our conference call for today. Thank you all for participating and have a nice day. All parties may now disconnect.