LSB Industries Inc (LXU) 2009 Q3 法說會逐字稿

Good day, everyone, and welcome to the LSB Industries, Incorporated third quarter 2009 conference call. At this time, I would like to inform you that this conference is being recorded and that all participants are currently in a listen-only mode. I will now turn the conference over to Carol Oden. Please go ahead, Ms. Oden.

Again, we would like to welcome you to the LSB Industries, Inc. third quarter 2009 conference call. Today, LSB's management participants are Jack Golsen, Chairman and Chief Executive Officer, Barry Golsen, President and Chief Operating Officer, and Tony Shelby, the 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. 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, November 5th, 2009, and therefore you are advised that time sensitive information may no longer be accurate at the time of any reply.

After the Q&A, I will have some important comments and disclaimers about forward-looking statements and our references to EBITDA. We suggest that you stay on the call long enough to hear them.

Now, I will turn this conference call over to our Chairman, Mr. Jack Golsen.

Thanks, Carol. I want to thank you all for joining our third quarter 2009 conference call. Today, Tony Shelby will review our financial results in detail and Barry Golsen will review our operations with you. After these reviews, we will be available to answer your questions.

Today we issued a press release announcing our results for the third quarter and filed our 10-Q, both of which you can access over the Internet. Excluding the startup costs of our Pryor plant which we incurred during the third quarter, both our chemical and climate control businesses reported quarter-over-quarter operating income improvements.

Our chemical business reported a decrease in sales in the third quarter of 2009 primarily due to lower cost commodity raw materials that resulted in lower unit selling prices and reduced volume of our mining products.

Our climate control business also reported lower sales, principally of our heat pump and hydronic fan coil products.

Overall, we reported a decrease in net income compared to last year's third quarter. Despite lower sales, our chemical business, excluding the Pryor startup costs, and our climate control business both achieved greater operating income than in the third quarter of 2008. However, this was offset by a $7.1 million startup cost at the Pryor, Oklahoma chemical facility.

Earnings per share were $0.05 fully diluted, compared to $0.18 last year. Tony will give you more details about these results. For the first nine months, fully diluted earnings per share this year were $0.95 compared to last year's $1.40.

Looking at the general economic situation, we have not seen a recovery of the economy as it relates to our businesses. In our climate control business, credit for potential customers who need credit for projects that use our products is still scarce. And it is now generally believed by the industry that the commercial construction sector will lag the rest of the economy.

Despite the present economic situation, we remain enthusiastic about our geothermal heating and cooling products. We are continuing to put heavy emphasis on this part of our business. Although we have seen some initial positive effects from the tax benefit provisions for geothermal heat pumps which are part of the federal economic stimulus package, generally these have been offset by the effects of the recession.

We now believe that the recovery in residential construction will happen earlier than recovery in the commercial sector. And when that happens, our geothermal heat pump product sales should benefit.

We continue to invest in the growth of our entire climate control business. And Barry will go into detail about this aggressive program.

In our chemical business on a national basis, the level of activity of our large industrial customers who purchase our products remains lower than it was last year. We are in the process of starting the plant at Pryor, Oklahoma, which will produce urea, ammonium nitrate fertilizer, which you know as UAN, and anhydrous ammonia.

Although we are experiencing some unexpected delays and associated cost overruns, we currently expect to start up the Pryor facility during December, barring any further interruptions. We believe that the Pryor facility will be a valuable asset for LSB after it is complete and operating.

The long-term outlook is good for grain and crop production and for the fertilizers required to support them, including UAN. Recent low prices of UAN are firming. We expect -- we estimate that our all-in cost to refurbish Pryor will only be a fraction of the cost to construct a plant with comparable capacities.

We have the liquidity and available credit for our present needs and our planned long-term growth. At September 30th, we had $70.2 million in cash on hand and time deposits, plus our $50 million working capital credit line. The near term economic climate is challenging for us, but we remain optimistic about our prospects for long-term growth and profitability.

On September 16th, we announced that we filed a Universal Shelf Registration with the SEC. This registration gives us the ability to offer to sell up $200 million of various securities including common stock, preferred stock, debt, warrants, units, or a combination of these securities.

Since then, we have been asked several times if we are considering a transaction. At present, we have no specific transaction in mind. But, we determined that, given the current market environment, having a shelf registration in place would provide greater flexibility if we identify any strategic opportunities that require capital.

Finally, you may be interested to know that in August, LSB was listed as number 34 on Fortune magazine's list of fastest growing companies. In October, we were also named one of America's best small companies by Forbes magazine and listed as number 41. We take pride in this recognition during one of the most difficult economic times in recent history. We share this recognition with the entire LSB team.

I will now turn this call over to Tony for the financial review.

Thanks, Jack, and good afternoon.

We made our earnings announcement shortly after the market closed this afternoon. The financial results for the third quarter 2009 compared to the third quarter of '08 included sales of $127.8 million compared to $210.9 million, operating income of $4.3 million compared to $8.7 million, net income of $1.1 million compared to $4.2 million, diluted earnings per share of $0.05 versus $0.18, and consolidated EBITDA of $8.5 million compared to $12.8 million last year.

Our consolidated operating results during the third quarter included $7.1 million of expenses related to the startup of our previously idled Pryor, Oklahoma chemical facility compared to costs of only $425,000 the same period during 2008. I'll cover this in more depth later.

Without the Pryor startup expenses in both periods, LSB would have reported a $2.2 million increase in operating income for the third quarter. Year-to-date results through September of '09 -- 30 of '09 compared to the same period in '08 included sales of $416.5 million compared to $569.4 million, operating income of $38.2 million compared to $57.3 million, net income of $21.5 million compared to $33 million, diluted earnings per share of $0.95 versus $1.40, and consolidated EBITDA of $52.5 million compared to $69.2 million.

LSB's consolidated EBITDA for the trailing 12 months at September 30th, '09 was $64.2 million compared to $84.4 million at September 30th, 2008. Operating income for the first nine months of '09 included startup expenses associated with the Pryor facility of $12.3 million, including a $1 million embedded loss.

In the same period last year, expenses associated with maintaining the Pryor facility were $1.3 million. Also included in the 2009 pretax income is a gain of $1.8 million from the extinguishment of debt as a result of acquiring $10.1 million of our 2007 debentures at a discount to place value.

Focusing on the third quarter, on a consolidated basis sales were down from $210.9 million to $127.8 million. Climate control sales were $67.4 million, or 19% lower, primarily due to lower demand in our key markets for heat pumps and hydronic fan coils.

Chemical sales were $59.7 million, or 52% lower, due to reductions in our mining product tons shipped and lower sales prices for all of our products, partially offset by a modest increase in agricultural and industrial product tons shipped.

Operating income for the third quarter was $4.3 million compared to $8.7 million, a decrease of $4.4 million. Our climate control business reported lower sales, but reported a $1.1 million improvement over the third quarter in operating income of $10.9 million.

The chemical business, on the other hand, as a result of the significant startup expenses are Pryor, recorded a $3.3 million operating loss compared to $1.9 million operating last year, a swing of $5.2 million.

In addition to the startup costs at Pryor, there are other items in the third quarter results of both years that require explanation for a full understanding of chemical's results of operations and the comparability to the prior year third quarter. During the third quarter of '09, gross profit on fertilizer sales were $6.5 million less than the third quarter of '08, reflecting the general decline in fertilizer demand and margins as compared to the much more robust supply-demand environment last year.

During the third quarter of 2009, losses from natural gas contracts were $850,000 compared to losses of $7.3 million in the same period last year, a reduction of hedging losses of approximately $6.5 million. Also in the third quarter, operating income was favorably affected by improvement in plant efficiencies.

These pretax items are also described in our earnings announcement and 10-Q. You'll also notice in our earnings release that our effective income tax rate for the third quarter of 2009 was approximately 55%. This rate includes our effective rate of approximately 39% for federal and state, plus an additional provision in the quarter relating to adjustments that are reconciling the completed 2008 federal income tax return to the 2008 estimated tax provision, and an adjustment for the impact of the limitation on the domestic manufacturers' deduction.

Focusing on liquidity and capital resources, the third quarter cash flow from operations was $12.9 million. Included in the operating cash flow were increases of accounts receivable of $3.9 million, reductions of inventories and supplies of $2 million, and reductions of accounts payable and accrued liabilities of $4.3 million. After cash capital expenditures of $9.8 million, term borrowings of $6 million and other items, the net cash flow was $7.2 million.

At September 30, our cash on hand, as Jack indicated, was $60.2 million plus $10 million in CDs for a total of $70.2 million. Our borrowing availability under our $50 million working capital revolver was $49.2 million. Our current liquidity and capital resources reflect a sound financial position.

At September 30, our long-term debt, including the current portion, was $103.5 million, and stockholders equity was $153.2 million. Long-term debt to stockholders' equity was approximately 0.68 to 1. Based upon our present financial position and our outlook, we have adequate working capital to advance the ongoing operations as well as organic growth opportunities.

Year-to-date through September the 30th, we had capital expenditures of $23.5 million, including $5 million for our climate control business and $18.3 million for our chemical business, which includes $6.5 million for the Pryor plant. At September 30, we had committed capital expenditures of $7.2 million, including $1.9 million in our climate control business and $5.3 million in our chemical business, which includes $2.2 million for the Pryor facility.

Back to Pryor. In the second quarter -- I said earlier that we'd discuss Pryor further. In the second quarter 2009 conference call and 10-Q, we indicated that the Pryor facility would probably be producing UAN in September and that the remaining startup costs were estimated to be approximately $4 million, barring unforeseen delays.

On October the 9th, we announced that we had encountered delays in the startup of the Pryor facilities. Those delays were caused by extended vendor lead times to refurbish certain piece of major equipment that we had not contemplated refurbishing. Due to the delayed startup, the expenses for the third quarter increased to $7.1 million.

The costs, including variable costs such as natural gas -- these costs included variable costs such as natural gas and electricity consumed during frequent starts and stops as we work towards a successful startup, and also include an embedded loss of $1 million on Pryor's firm sales commitments at September 30th, 2009. This embedded loss is our current estimate based on numerous factors and includes the effect of higher natural gas costs, and the costs in excess of committed selling prices for those tons that we expect to acquire on the open market to make up for the shortfall in Pryor facility production.

We now expect to be in production by the end of December, barring any further unforeseen delays. Because we don't know exactly how long it will take to start the Pryor facility, we are unable to accurately project the remaining startup cost. However, the monthly expense factor, excluding variable costs, is approximately $1.6 million.

After deducting the $12.3 million for Pryor in 2009, our chemical year-to-date operating income was $15.5 million compared to $34.5 million on a comparable basis last year.

That concludes our financial review. Barry will cover operational highlights 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 third quarter of 2009 were lower than the same period last year by 19%. Total heat pump sales were down 23%, fan coil sales were down 43%, and sales of our other products and services were up 64%.

Sales of our fan coil products have been the most severely impacted by the recession and the decline in construction of both lodging and multifamily residential sectors, which historically have been an important part of fan coil sales. In 2008, they accounted for 62% of the sales of our fan coil product line. These two sectors have been among the hardest hit.

According to McGraw-Hill, since 2006, which represented a high point for both lodging and multifamily, through their forecast for this year, 2009, the value of construction contracts awarded in these sectors have declined or will decline 66% and 74% respectively, with most of this decline occurring in 2009. Together, this represents an industrywide loss of over $61 billion of annual contract awards.

So, I'm going into this much detail on these two sectors to explain the fall off in sales in our fan coil business.

New product orders during the third quarter were $49.1 million, a 51% decrease compared to the third quarter of 2008, and approximately 10% lower than both the first and second quarters of 2009. The quarter-over-quarter decrease was caused by the generally weak economy's impact on construction activity and the fact that the third quarter of 2008 was our highest booking quarter in history, with a 53% increase over the 2007 third quarter, and an increase for our residential geothermal heat pumps of over 2.5 times the 2007 quarter.

At September 30th, we had a backlog of product orders of $39.4 million, down from $49.5 million at June 30th, 2009, and $85.8 million at September 30th, 2008. During October, our new product orders totaled $18.8 million compared to $28 million a year ago in October.

As of the end of the third quarter of 2009, we continue to maintain leading market shares for geothermal and water source heat pumps and for hydronic fan coils. Our gross margin during the third quarter of 2009 was 36.7%, up from 29.9% for the same period in 2008. The increase in gross margin was due primarily to improved gross margin in our heat pump products caused by higher selling prices and lower material cost, partially offset by lower factory overhead absorption as a result of lower unit sales volume.

In addition, we had efficiency improvements in our coil manufacturing operation. And our engineering and construction services business recognized gains of $1.1 million related to customer change orders and project performance improvements.

Finally, in the third quarter of 2009, we had a gain of approximately $400,000 on copper future contracts compared to a loss of $500,000 in the third quarter of 2008.

While we benefitted from higher selling prices and lower raw material costs through the third quarter, competitive pressures are strong. Some raw material costs have risen -- most raw material costs have risen. We also expect that our level of factory overhead absorption will be less in the near term with anticipated lower sales volume and fewer units produced. Considering these factors, we do not believe we will be able to sustain the same gross profit percentage in the near term.

We are regularly asked what is the outlook for construction, both commercial and residential, and how do you think it will impact your climate control business? One independent resource that we refer to is McGraw-Hill's Construction Research and Analytics Construction Market Forecasting Service. This is published quarterly. Its fourth quarter sneak peek was just published two weeks ago, and it forecast further deterioration in 2009 in the commercial construction market since the report published the prior quarter.

McGraw-Hill's current outlook is that contract awards for the specific commercial building types that accounted for approximately 70% of our climate control business sales in 2008 in the aggregate will decrease by approximately 38% in 2009. This will be followed, according to McGraw-Hill, by a flat year in 2010, and year-over-year increases of 18%, 27%, and 25% in 2011, '12, and '13 respectively. Despite an aggregate flat forecast for these sectors next year in 2010, some of these sectors are expected to continue to decline before they actually turn the corner and begin to recover.

Residential construction is also forecast to have a 22% decline this year, although this is somewhat less severe than the 32% decline forecast a year ago. McGraw-Hill is -- excuse me, a quarter ago. McGraw-Hill is forecasting that single-family residential construction will increase by 32% in 2010. In other words, that the residential construction market has already hit bottom and will improve significantly in 2010.

In addition to the McGraw-Hill forecast, we also look at the Architectural Billings Index, which is an indicator of future commercial and institutional construction activity nine to 12 months in the future. In February, the ABI reached an all-time low since the inception of the index in 1995 of 33.3. Since that time, the index has bounced around from month-to-month, and in September, it was 43.1. It has now been 21 months since the index has reported a score above 50, which indicates growth.

On the other hand, the American Institute of Architects September Index of Inquiries Into New Projects had a score of 59.1. And that's the highest score that that index has had in two years.

Direct input from our sales force is that there is a pipeline of commercial and institutional construction activity in various planning and design phases, but that there is also a hesitancy by developers to proceed with new projects. And some projects have been put on hold and some of them cancelled.

Previously, we've reported on the American Recovery and Reinvestment Act. The rate at which federal projects funded by this stimulus have progressed is much slower than we had previously anticipated. It's not possible to predict the speed at which these projects will actually move forward, but we do expect more stimulus activity in 2010 than we've seen in 2009.

As I mentioned earlier, our overall level of new order bookings has been substantially lower than the third quarter of last year. Year-to-date through October, new orders are running 35% the same period in 2008. And we really don't know of anything at this time that will change this in the near term with regard to the commercial and institutional part of our business. The backlogs we're carrying are substantially lower than in the recent past, and our shipments and sales in the near term will be dependent on new order bookings.

Considering all of these inputs, we believe that sales in the fourth quarter of 2009 and also into the first half of 2010 will be lower than the same periods a year earlier.

Because it's an area of interest to many of you, I'd like to discuss our residential geothermal heat pump sales. As you're all aware, there have been steep declines in residential construction for the past three years. McGraw-Hill's current revised forecast is for a decline of 22%, as I discussed before, in overall residential construction in 2009. And this brings the cumulative decline to 70% since the peak in 2005.

Through the second quarter of this year, new order bookings and sales of our geothermal heat pumps to the single-family residential market bucked this trend, as was the case through 2007 and 2008. Year-to-date through June 30th, new orders for GHPs were slightly ahead of the first half of 2008, and sales were up 36%. However, in the third quarter, new order bookings of our residential geothermal heat pumps declined 44%, and our sales of these products also declined 25% as compared to the third quarter of 2008.

Please keep in mind that the bar was set exceptionally high last year. During last year's third quarter, we experienced a sales increase of over 2.5 times the 2007 third quarter. Looking back, another factor that contributes to the year-over-year third quarter bookings decline this year is that during the 2008 third quarter, many of our distributors were in a stocking up mode, anticipating an increase of sales and dealing with much longer factory lead times than we have today.

This was not the case in the 2009 third quarter. Year-to-date through September 30th, our new orders for our geothermal heat pump residential geothermal heat pump product were down 22%, and sales were up 16% as compared to the first nine months of 2008. Also, through September 30th, residential geothermal heat pump sales were approximately 21% of our total climate control business sales.

While we believe that the 30% tax credit and other incentives enacted in February will have a positive impact on this business, so far this impact seems to have been offset by the recession. We believe that even though residential geothermal heat pump sales have not been impacted to the same degree as conventional heating and cooling systems, the recession is having a dampening effect on growth in this market as well.

Looking beyond the current slowdown, we're confident in the growth potential of geothermal sales into the huge residential heating and cooling market. There were approximately 5.8 million standard heating and cooling systems shipped in the United States in 2008, and 3.8 million shipped year-to-date through September, according to Air Conditioning, Heating, and Refrigeration Institute statistics.

As you can see, there's tremendous potential for geothermal heat pump sales to grow as the residential recovery occurs and the trend toward green, sustainable construction continues. To that end, we've substantially intensified our efforts in marketing programs for geothermal products, and will continue to do so. You might have noticed ads we are running in many national publications and on the Internet. Also, we have recently launched a consumer-targeted website for our geothermal products. Investing in the future, we have prepared our manufacturing facilities to handle this increased volume.

During the third quarter, we also executed an OEM supply agreement with Rheem Manufacturing Company to supply our geothermal heat pumps to the Rheem and Ruud distribution network in the United States and Canada. Rheem is in the process of rolling this out to their distribution network with a full new product launch. We expect this to have a positive effect on sales of our geothermal heat pumps in 2010 and future years.

Before I leave our climate control business, I'd like to tell you about something that we're -- that occurred recently that we're very proud of. We were recently informed that the Central Oklahoma Habitat for Humanity's Hope Crossing development will soon receive the United States Green Building Council's LEED for Homes Outstanding Affordable Project award. Last week, Hope Crossing was also recognized by Developer magazine as a Sustainable Community of the Year.

All of the homes in Hope Crossing have heating and cooling provided by LSB's ultrahigh efficiency ClimateMaster Tranquility geothermal heat pumps. ClimateMaster has partnered with Habitat for Humanity in the concept, design, and construction of this award winning green development.

Turning to our chemical business, as Tony reported, sales of our chemical products were down 52% from the third quarter of 2008. The reduction in sales was caused by a combination of lower shipments to our mining customers and, more significantly, the steep decline in commodity prices which resulted in much lower cost and selling prices for our products.

Gross profit for the third quarter 2009 was $5.7 million, or 9.5% of sales, including $1 million of losses on Pryor firm sales commitments that Tony mentioned before, compared to a gross profit of $5.3 million, or 4.3% of sales, in 2008. The increased margin as a percent of sales was due in large part of the significant reduction of natural gas hedge losses in 2009, the pass through of raw material costs to certain customers, which had the effect of increasing margin percentages as feedstock costs decreased, along with the other items Tony discussed in his financial review.

Operating income, on the other hand, declined from $1.9 million in 2008 to a loss of $3.3 million, primarily as a result of startup costs at the Pryor facility of $7.1 million, expensed in 2009, compared to costs of $425,000 at Pryor in that quarter of 2008.

Focusing on the agricultural part of our chemical business, during the third quarter, Ag product sales were $20.3 million, 53% lower than the third quarter of 2008. Both urea, ammonium nitrate -- and ammonium nitrate sales were down. I will explain what happened with each of these products separately, but first the published market prices I will refer to are indicators of the regional market pricing at Southern Plains' price point for our products, but are not necessarily our exact netback sales prices. Also, prices I refer to are approximate and not exact.

During the third quarter, higher demand for UAN, urea ammonium nitrate, resulted in higher tons shipped. However, much lower market prices per ton resulted in lower sales and lower margins. Our shipped tonnage of UAN fertilizer, which we produce at our Cherokee, Alabama facility, was 18% higher than in the third quarter of 2008. However, our revenues from these sales decreased 56%.

The published sales price per ton during the third quarter of 2009 averaged approximately $155 per ton as compared to $475 per ton a year ago. Despite slightly higher tons shipped than year ago, sales during the third quarter continued to be impacted by the reluctance of our customers to commit to purchases following the sudden collapse of pricing of UAN and other commodities in 2008. Currently, the published prices for UAN at Southern Plains are approximately $165 per ton, while the NYMEX natural gas price for delivery in December is approximately $4.85 per MMBtu.

Looking forward, we expect that the pricing and margins for UAN will continue to be weak in the fourth quarter compared to last year and that there will be a resurgence of demand in spring 2010 due to the current outlook for favorable grain supply and demand fundamentals. This should result in better margins. Sales volume in the fourth quarter in early spring will depend to some degree on to what extent the downstream fertilizer distribution channels begin to restock.

Turing to Ag grade ammonium nitrate, or AN, produced at our Eldorado, Arkansas plant, our third quarter 2009 revenues were lower than third quarter 2008 by 53%, reflecting both lower tons shipped and lower sales prices per ton in 2009. Tons shipped were down 13% from the third quarter of 2008 as a result of current market conditions in the distribution channel. In other words, dealers and distributors are reluctant to restock before the actual spring demand kicks in.

During the third quarter of 2009, the published sales price for AN averaged $253 per ton compared to $500 per ton in the same quarter of 2008. Current published prices of AN are $255 per ton.

The price of anhydrous ammonia, the raw material feedstock for our Eldorado facility as quoted at the Tampa price point, escalated significantly during the first nine months of 2008. Since that time, ammonia prices have tumbled. During the third quarter of 2009, the published price averaged $270 per metric ton. Today's Tampa price is higher at $355 per metric ton.

Fortunately, the price of both the feedstocks we use, anhydrous ammonia at Eldorado and natural gas at Cherokee, have declined along with the selling prices of our products. Also, remember that approximately one-half of our chemical business sales are to customers who accept the cost of ammonia or natural gas as a pass through as part of our selling arrangement with them.

The industry consensus regarding the long term global demand for grain in general and corn and wheat specifically is favorable. Short term, because of the delayed harvest and the delayed fall fertilizer application, most industry sources are predicting a strong 2010 spring fertilizer application.

Turning to our industrial chemical products, during the third quarter our industrial acid sales were $26.5 million, down 45% quarter-over-quarter. However, tons shipped were up 3.5%. We're experiencing the soft demand we predicted in previous conference calls as well as lower sales prices per ton. This is due to the general slowdown in the construction and industrial markets which use these products.

We believe that in the long run, there will be steady demand for our industrial acids. But, until the general economy begins to rebound, our industrial chemical volume will probably remain at about current levels.

During the third quarter, our mining product sales were $13 million, down 62% quarter-over-quarter. Tons shipped were down 54%. The disproportionate reduction of sales dollars versus ton was due primarily to lower costs of natural gas and anhydrous ammonia, which are pass through costs for our mining product customers.

There was a decline of 21,000 tons of industrial grade ammonium nitrate, all of which is sold under a multiyear supply agreement. The agreement does provide for minimum volumes.

Demand for our mining products is down generally as a result of a reduced demand for coal.

Most of our chemical business industrial and mining sales are pursuant to cost-plus pricing arrangements with our customers assuming the feedstock cost and fluctuation risk. This eliminates much of the risk of disconnect between raw material cost and the market prices of our products.

Also, during the first nine months of 2009, approximately 75% of our industrial and mining products were sold pursuant to agreements that have either minimum purchase requirements or a fixed total contract profit irrespective of volume taken by our customer. To that extent, we are somewhat insulated from a potential downturn in demand for industrial products.

We announced during the third quarter that our Cherokee Nitrogen Company subsidiary signed a long-term supply agreement with Yara North America, Inc. to supply diesel exhaust fluid, or DEF. The US Environmental Protection Agency has enacted emissions standards for diesel engines which will become effective in 2010. These standards require that nitrogen oxide, or NOx, emissions be further reduced from diesel engines starting with new heavy-duty vehicles. DEF is used in selective catalytic reduction, or SCR technology, as an exhaust additive to accomplish NOx reduction.

At this time, SCR technology is the method that a vast majority of vehicle manufacturers have chosen to meet the new standards. With SCR technology, approximately two gallons of DEF are required for every 100 gallons of diesel fuel consumed.

We believe that eventually this will be a huge market as old vehicles that are not subject to the new regulations are phased out and the current inventory of rolling stock is replaced with new vehicles. It's anticipated that Cherokee will begin production of our trademark named EarthPure DES in January 2010 to be marketed by Yara under the Yara brand name Air1.

Summing up, our climate control business sales and incoming orders were down as compared to the third quarter of 2008, but income was up. Generally, short-term indicators are negative for commercial construction. Shipments of our residential geothermal products that had, until the third quarter, bucked the downward trend of both the general residential construction and the market slide for conventional residential heating and cooling systems have also been impacted by the recession. New orders for these products during the third quarter were lower than the third quarter of last year's record breaking third quarter level. Sales driven by geothermal incentives seem to be dampened by the recession at present. And so far, the rate of stimulus spending is much lower than we had anticipated.

On a positive note, there are indications that the residential construction market has bottomed out and will turn around in 2010. We believe that our prospects for growing all of LSB's climate control businesses over the long haul, and particularly our geothermal heat pumps, are very good. We continue to invest in the growth of these businesses.

Turning to chemical, third quarter sales were down, profits from our chemical business, not including the Pryor startup expenses, were actually higher than the same period in 2008. But, we had startup losses at the Pryor facility.

Much of the market volatility we experienced last year seems to have stabilized for the time being. But, market prices of all of our products are substantially lower than they were a year ago. We believe the long-term outlook for our Ag market is good because the continuing demand for farm crops should be strong.

The demand for our industrial chemical products has declined due to the weak economic conditions. However, we're insulated from this downturn to a certain extent because of the nature of our cost-plus and minimal tag or fixed profit sales arrangements.

The Pryor plant is expected to start up soon. However, until the plant is producing, the startup expenses will reduce the chemical businesses earnings.

We're entering the DES market with our EarthPure DES product in 2010.

Thanks for listening. And we will now start our Q&A session.

(Operator instructions.) Our first question is from the line of Eric Stine with Northland Securities.

Hi, everyone. Thanks for taking my questions.

Hi, Eric.

I was wondering if you could just discuss the -- I believe you got a small grant as part of the recent geothermal stimulus grants for a demonstration project. Could you just provide some details on that?

Yes. Okay. There were over 300 million, I think it was something like $370 million approximate dollars that were granted by the DOE for geothermal projects, geothermal demonstration projects. Of that -- well, the vast majority of it had to do with deep geothermal, and power generation with deep geothermal. But, approximately $62 million of those grants, which consisted of 37 different grants, were for geothermal heating and cooling projects.

We received a $233,000 grant that is for the development of modeling software to model the benefits and savings of geothermal. And by the way, that's the first step in the sales process. The customer that's thinking about using geothermal, usually what he'll do is he'll contact a salesperson and they'll use some kind of modeling software.

So, we're looking at improved, updated, newer, better modeling software. And we will match that with an equal amount of money. And all of the grants, by the way, or most of the grants will be matched with -- by the receiver of the grant with their own money to fulfill the obligation or the mission under the grant.

In addition to that small grant that we got, the Geothermal Heat Pump Consortium got a $1 million grant to develop installation standards, which we think is a very good thing for the industry. And most of the rest of the $62 million, I think about $53 million worth approximately, were for actual demonstration projects. And these will be projects where someone's going to do an installation. It'll be like a regular commercial installation or some type of installation, like a regular building that gets done. It'll be monitored. It'll be tracked, etc.

But, it's basically going to result in about -- over $100 million of construction projects that will use geothermal. And we expect that our equipment will be used on some of those projects. Is that clear enough?

Yes, that's very helpful. I appreciate that. Just switching gears to the chemical side, could you just give us an update on the Bryan facility as far as how the rebuilding process has gone, and also shifting around some distribution?

We are in the process of designing the rebuild, and we plan to rebuild because that's a good market for us. It's offseason right now, so there's not a lot of shipping that's going on. But, we do have the capability to service that market from our other locations.

Okay. Appreciate that. And then just lastly, could you just touch on the SG&A, the $3.1 million in one-time? I mean, how should we think about that line going forward? Should we think about it kind of returning to where you were in the second quarter?

Which one is it you're referring to?

Just the SG&A. I know you had the $3.1 million kind of one-time expenses in there related to Pryor. How should we think about SG&A going forward as far as a level? Whatever you can provide there would be helpful.

Well, the third quarter includes $7.1 million from the Pryor startup costs, 7.1 less the -- $6 million, actually, $1 million was up in cost of sales. The embedded launch was up in cost of sales. So, you had $6.1 million in SG&A from the -- in the third quarter to the prior. And the majority of -- the SG&A, we're continuing to carefully watch that and to make cuts where we can. But, you do have a certain extent of that that is variable with sales.

So, it'd be more consistent with prior years in terms of a percent of sales. But, as Barry indicated in the climate control review, we do have some fairly aggressive spending going on in terms of marketing on the geothermal side. So, that'll be a -- that's an -- that will be an increase going forward for a short period of time.

Okay. So, we should see an increase over time, but maybe a downtick from the third quarter?

We will -- well, we can't really forecast what it -- the amount of SG&A that will be there for the Pryor startup. We're running $1.6 million a month, as we indicated. And when we get started in production, that'll become -- that'll start to be covered by production.

However, I think the trends that you've seen over the past sequential quarters is pretty indicative except for the fact that we are trying to make efficiency improvements where we can.

Okay. That's helpful. Thank you very much.

Thank you, Eric.

Your next question is from the line of Dan Mannes with Avondale Partners.

Afternoon, everybody.

Hi, Dan.

A couple follow up questions here. First, the partnering with Rheem. Is that going to be similar to the arrangement you have with Carrier, number one? And number two, does that only relate to geothermal, or does that relate to some of your other products?

It only relates to geothermal. And I'd say yes, it would be similar to the Carrier arrangement.

And there's no real issue there? I mean, you have basically exclusive right to sort of let -- private label your product to other distributors?

Yes, we do.

And then lastly, what about -- and this sort of goes to a second question. What does this entail in terms of training dealers on installations? Because that's one concern we're starting to hear is, given this product is selling a lot better than conventional HVAC on the residential side, there's some concern that sort of people are coming out of the woodwork and maybe don't have the same skill sets and experience with a more complicated installation.

One of the reasons why we're really heartened to see that there was a $1 million grant given to develop actually a installation -- a certification program, although we do have our own certification program that we use with our dealers. We believe some of our competitors do as well. Having an industrywide certification program will certainly help.

And your question was what's the extent of the training going to be. I mean, it's going to be the same kind of training that we currently give ClimateMaster installing contractors.

I guess does that imply, then, have you been seeing an increase in prospective dealers during the last couple months?

Well, they're just rolling out the -- they're in the process of rolling out this program. So, there's a process that involves announcing that you're going to have a product, maybe showing the product at your annual product show that most of these companies have, going around and having regional shows, having regional training, getting catalogs out, etc., etc. It takes a couple quarters to really get a project -- a product launched.

Dan, are you concerned that there are people drifting in from other areas of the HVAC industry that may not be totally qualified?

Yes. I mean, from a distribution standpoint, it's great to have more distributors. But, from a long-term perspective, you'd like to make sure that the installations that occur in the best possible way and don't leave bad feelings by the buyers for a fairly expensive piece of equipment.

Well, I think we have the same concerns. And that's why we have significantly increased and beefed up our training capability in the last 12 months at ClimateMaster. I can't tell you exactly what everybody else in the industry has done. But, we have increased the number of training sessions that we have and the number of trainers that we have. We have a train the trainer program. Instead of doing them mostly at the factory, we're going around the country and doing them as well.

So, we're trying to address this with all the things that most air conditioning companies do as they grow.

Got it. Switching topics real quick onto the commercial side, you mentioned McGraw-Hill was sort of indicating for your major end markets maybe a flattish 2010 versus '09. And you were saying that sort of your internal sales force sees a pretty full pipeline of potential projects in the future. Do you have any -- does that include potentially the impact of some of these stimulus projects, especially on government buildings, schools, etc.? Or, is that excluding that potential impact?

You mean the McGraw-Hill numbers?

And the viewpoint from your sales force as well.

Well, our sales force is looking at everything they see. And they don't distinguish between whether it's a stimulus package or whether it's something else. So -- and I think McGraw-Hill, to a certain extent, takes that into consideration as well. So, I would say that the flattish year probably takes that into consideration.

Got it. And then, just the last question I have, your other HVAC segment, I assume this is the modular chillers and the custom air handlers. It looked like that was up pretty materially year-over-year. And maybe I missed this in your prepared comments, but did anything unique happen there, or was that just sort of a --?

Most of the growth year-over-year in that sector was due to our contracting business, which does geothermal installations, by the way.

It's commercial, generally?

Yes. Well, institutional or commercial.

Got it. And then, that's something that --.

Although it depends what you count military. They've done several large military installations. Those are essentially large numbers of residential installations. But, instead of doing them one at a time, they might do them several hundred at a time.

It would be multifamily except they're detached homes, right?

Yes, exactly.

Got it. Well, thanks for the color.

Sure. Thanks, Dan.

(Operator instructions.) Your next question is from the line of Brian Kremer with Roth Capital Partners.

Good afternoon, guys.

Hi, Brian.

Hi. On the climate control side, obviously you were facing a very tough comp year-over-year. Oil prices were really high last year. So -- but, I didn't hear anything about sequential, quarter-over-quarter, Q1 to 2 and then 2 to 3 in terms of the heat pump -- I'm sorry, the ground source heat pumps. What does that look like?

Well, let me see. I've got that information in front of me. Just hold on a second. I certainly don't want to throw out any numbers off the cuff without making them correct.

From a -- as far as residential sales, our -- we were down about 1% in the third quarter from the second quarter. And I don't have the other information in front of me, but I can just give you a percentage off the top of my head.

Okay.

I could calculate it. Hold on a second. The second quarter was -- let's see.

While he's doing that, Eric, I will mention that we do have sequential order information in our 10-Q.

Is it there?

Well, it's not necessarily on GHP, but on total orders.

Right, right. Yes, I was just -- because obviously others are --.

The second quarter was down about 9% from the first quarter. I do not have fourth quarter of last year numbers in front of me. Wait, yes I do.

All right. That's good. That gives me the -- so, basically you were flat sequentially this quarter?

Yes.

So, going into the fourth quarter, I'd assume it's -- typically fourth and first quarters are a little slower just because installations are more difficult as well, right?

You can say that. Generally speaking, that's usually a trend.

Yes. Okay. I think I'm reading this correctly, looking at the last couple Qs. And then, I guess it just worked out this way, but it seems pretty consistent that the ground source heat pumps have been making up 21% mix almost every quarter.

Making what?

Up a 21% mix of the climate control business?

I think it's just a coincidence. They're running 20% to 21% right now.

Okay. And then --.

I think last year that was around 19% for the year.

Okay. I just thought it'd be going up faster since it seemed like it was 21% in the first quarter and it's still 21% now, while the rest of that seems to be coming down. But -- so, okay. The -- let's see, two others. The -- on the chemical side, fall applications, do you expect to see any uptick in volume due to later -- now in the last month or so, what's the outlook there?

No, we -- we're looking forward -- more forward to the spring UAN season. Right now, the delayed harvest is affecting ammonia sales, and that's not a big part of our agricultural offering. So, the fall -- the delayed harvest is going to determine, to a certain extent, how much ammonia gets applied. And the less ammonia that gets applied, the stronger the demand for UAN is going to be for the rest of the year and in 2010.

Right. Okay. Great. Then, last question. Strategic opportunities you mentioned related to the shelf that you have filed. What are those? I mean, what -- in your view right now, what is a strategic opportunity?

We said we had absolutely no specific transactions in mind.

Oh, no, I understand. I understand. But, I'm -- I mean, would you, at this point, view the climate control side more appealing, or is really just you won't know it until you see it?

At this point, we really hate to prognosticate on what might or might not happen in the future. It's hypothetical.

Okay. That's it. Thanks.

Okay. Thanks.

Your next question is from the line of Michael Coleman with Sterne, Agee.

Yes, good afternoon.

Hi, Michael.

Hi, Mike.

Hey, back to the other HVAC and the military institutional. A couple of things. One, is that business represented in your backlog?

No.

Okay.

It's not represented in our -- we're very careful to refer to our backlog as product backlog. And the reason we don't include it in that backlog is because it would be misleading. Because, for example, we could book a project today that's a $15 million project, but it might not be a project that we're going to deliver for -- it might be installed over a two-year period. And generally speaking, with our product backlog we usually make the comment that it's going to all shift within a year.

So, because of the lumpiness of that business, we feel it would be maybe misleading to try to throw that backlog in.

Okay. I understand. As part of the stimulus, the Corps of Engineers has $4.6 billion, a large piece of it in the civil works construction. So, given the kind of thrust within the Corps of Engineers for modernization of the various housing for the military, what's the visibility for that segment? Is this is a one-time quarter, or do you see continued growth within that segment?

Well, in general, we see continued growth in any of the government segments relating to retrofit, if they include energy upgrades. And that seems to be the emphasis of the government.

But, that's just a general trend. And I wouldn't necessarily try to relate to specifically to our business, because as you know, we do not forecast.

Yes, I know you don't forecast. But, okay. The -- all right, that's fine.

If your question is are we aware of it and then are our people aware of it, the answer is yes.

Oh, that's great.

It's something that we focus on all the time.

Great. Then, wanted to ask you related to your thermal, but a different channel. In terms of homebuilders, have you been working with homebuilders in terms of making a geothermal heat pump optional on new construction? Where are you with that?

Well, we have a pretty extensive sales force of geothermal, not only out in the field but also in the factory. In the field, they tend to work more with local and regional builders. Although at the factory, we try to cover the large national builders and the larger regional builders.

And so, we have many different initiatives and approaches that we use, depending on what the builder would like to do and what he think works in his market. But, I'd really rather not talk about any of those specifics because it's -- we're talking about customers and leads and generating business. And we consider that information really highly proprietary, and not the kind of information we really want our competitors to have.

Sure. And just wanted to make sure I heard a comment earlier. On the Rheem distribution agreement, that's not an exclusive? You could perhaps have another agreement with another HVAC residential player at some point in the future?

You heard correctly.

Okay, great. And just one more, if I may. On the DEF, how many solutions on this DEF are there in the marketplace that you're aware of?

What do you mean?

How many suppliers?

Well, yes. Besides yours, is there three or four? Is there --?

The only other one that we know of that's manufacturing a product is Terra.

Okay.

That's in the -- we're talking about in the United States.

Domestic.

In North America.

In Europe, about 80% of the business Terra is getting is handled by Yara.

I see. Okay. Sounds good. Thank you.

Sure.

Thank you.

Thanks, Michael.

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

Okay. Well, that -- thanks for listening in. And I urge you to stay on the line and to listen to Carol, who will now make comments on our forward-looking statements.

Thanks again for listening today. The comments today contain certain forward-looking statements.

All statements other than statements of historical facts are forward-looking statements. Statements that include the words "expect," "intend," "plan," "believe," "project," "anticipate," "estimate" and similar statements of a future or forward-looking nature identify forward-looking statements including, but not limited to, the Pryor facility will startup in December, 2009 and will be a valuable asset after it is complete at a fraction of the cost to construct a plant with comparable capacity, we have almost completed the Pryor facility reactivation, the long term outlook for grain and crop production and fertilizer, pricing and margins for UAN will be weak in the fourth quarter of 2009, and there will be a resurgence of demand in 2010, that this should result in better margins, much of our chemical product market volatility has stabilized, the monthly expense factor at the Pryor facility, in the long run there will be a steady demand of our industrial assets, and our industrial chemical volumes will probably remain at current levels, the DEF market will eventually be huge, and we will begin production of DEF in January, 2010, we have adequate working capital to finance ongoing operations and organic growth, our level of factory overhead absorption will be less in the near term, we will not be able to sustain the same gross profit percentage in the near term, there will be more stimulus projects in 2010, there is a tremendous potential in geothermal heat pump sales to grow, sales in the fourth quarter and first half of 2010 will be lower than earlier periods, the OEM supply agreement with Rheem will have a positive affect in 2010 and future years.

You should not rely on forward-looking statements because actual events or results may differ materially from those indicated by these forward-looking statements as a result of a number of important factors. We incorporate the risks and uncertainties discussed under the heading Special Note Regarding Forward-Looking Statements in our annual report on Form 10-K for the fiscal year ending December 31, 2008, and our Form 10-Q for the quarter ended March 31st, 2009, June 30th, 2009, and September 30th, 2009, and the reports we file from time to time with the Securities and Exchange Commission.

We undertake no duty to update the information contained in this conference call. 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 measurement. We will have -- we will post on our website reconciliation to GAAP of any EBITDA numbers discussed during this conference call.

Thank you. That ends our conference call.

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