LSB Industries Inc (LXU) 2010 Q3 法說會逐字稿

Greetings and welcome to LSB Industries, Inc. Third Quarter Conference Call. At this time, all participants are currently in a listen-only mode. A question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS.) As a reminder, this conference is being recorded.

And now I will turn the call over to Carol Oden. Thank you, Ms. Oden. You may begin.

Thank you, Scott. Again, we would like to welcome you to the LSB Industries, Inc. Third Quarter 2010 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, our 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 4, 2010, and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay. 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 the conference call over to Mr. Jack Golsen.

Thank you. Good afternoon.

Thanks for joining our conference call this afternoon. Today we released the results of our third quarter. The third-quarter results were better than the third quarter 2009, although they are still not yet up to our potential.

Despite this improvement, 9 months' earnings in 2010 remain below 2009, primarily due to the costs associated with starting our Pryor, Oklahoma chemical plant. However, we think that Pryor is now in a position to contribute to future earnings.

In this conference call, Barry and Tony will discuss the current climate control and chemical business and our financial results in more detail.

I believe that we are still moving in the right direction in both of our businesses, although not quickly enough to satisfy us. The big picture is that the overall economic activity in our businesses during the first 9 months of this year has slightly improved.

In our climate control business, commercial construction in our markets has recently shown a slight improvement. Although residential construction is again lower than prior years, we continue to increase sales of our geothermal products over the past periods in the face of the declining residential market.

Recently in our chemical operations, product demand and pricing have been good, especially in the agricultural markets we serve, and the agricultural market is projected to be strong in the coming year.

The primary reformer rebuild in our Pryor plant, which was damaged by fire, was completed at the end of the third quarter. Today production of anhydrous ammonia is strong and on target. The nitric acid and urea plants are positioned to produce UAN to meet customer orders.

We have some [late] news. Our climate control business is beginning modification and repurposing of an existing facility to house our modular geothermal chiller manufacturing operations. This facility will build recently-developed high-efficiency modular air cool chillers in addition to hydronic geothermal chillers.

Another item that is positive. We have recently concluded a three-year labor contract with the second Union at our Eldorado, Arkansas plant. This plant has two separate unions and we previously announced that we have concluded a contract with the first union.

Also, we have reached agreement with the union at our Cherokee, Alabama plant which is subject to confirmation by the bargaining group.

Now for the details of the third quarter, I will turn this call over to Tony Shelby. At the end of our review, we will open this conference call to questions. Thank you.

Thanks, Jack.

As reported in our earnings announcement this afternoon, the financial results for the third quarter of 2010 compared to the third quarter of 2009 included sales, $138.9 million, compared to $127.8 million; operating income, $8.5 million, compared to $4.3 million; net income, $3.8 million, compared to $1.1 million; the diluted earnings per share, $0.17, compared to $0.05; and EBITDA -- chemical, $4.4 million versus negative $500,000, climate control, $10.9 million versus $11.8 million, and consolidated EBITDA, $12.9 million versus $8.5 million. For the trailing 12 months, consolidated EBITDA was $46 million.

The following comments are all related to the third quarter.

Under sales, Climate Control sales were $64.5 million, or 4.3% below 2009. However, the product order intake was $67 million during the quarter, compared to $49 million in the 2009 quarter. Chemical sales were $72.6 million, or 21.5% higher than 2009. The increase was primarily a result of stronger customer demand for industrial and mining products and an increase of selling prices due in part to higher raw material input costs. Agricultural product sales in tons were lower than the prior year due to a number of unusual events, including the effects of dry weather conditions in certain key markets, low beginning inventories of UAN, extended plant maintenance activities referred to as turnarounds. However, looking forward, agricultural supply and demand fundamentals are very favorable for nitrogen fertilizer producers and farmers alike.

Operating income. As mentioned, consolidated operating income for the third quarter increased from $4.3 million in 2009 to $8.5 million in 2010, or an increase of $4.2 million. Climate Control's operating income for the quarter was $10.1 million, or 15.7% of sales, compared to $10.9 million, or 16.2% of sales in 2009. The $830,000 reduction in operating income was the result of lower sales volume and, to a lesser extent, higher raw material costs offset by a decrease in certain operating expenses.

Chemicals operating income for the quarter was $1.2 million, compared to a loss of $3.3 million in 2009, a $4.5 million improvement. Chemicals gross profit increased from $5.7 million to $5.9 million but declined from 9.5% of sales to 8.1%. The lower margin as a percent of sales was primarily attributable to the lower mix of agricultural products shipped to total sales.

Below the gross profit line, Chemicals 2010 operating income benefited from a reduction of Pryor operating costs from $6.1 million in 2009 to $4.9 million in 2010, and from insurance recoveries of $3.1 million included in Other Income.

Focusing on Pryor. During the third quarter, the Pryor facility was down while the ammonia plant gas reformed was being rebuilt. As a result of the plant being down during the entire quarter, in the absence of any production, the overhead costs -- overhead and other costs of $6.2 million were expensed as incurred. Planned maintenance turnaround costs of $1.3 million were charged to cost of sales, and the remaining $4.9 million were below the gross profit line, classified primarily as SG&A. The rebuild was completed by the end of September at a cost of approximately $7 million. The rebuilt costs were capitalized as property plant equipment. We estimate that our property damage insurance claim will be approximately $8 million for the repair and other costs, subject to a $1 million deductible. Included in Other Income is $2.8 million resulting from the initial insurance advance against the property damage insurance claim. Any additional insurance proceeds resulting from the property damage claim represents a gain contingency and will be recognized as Other Income if and when realized. Barry will complete the discussion of the Pryor facility operations during the review of Chemicals results.

Below the consolidated operating line, interest expense was $1.9 million for the third quarter of 2010, compared to $2.2 million for 2009. Included in interest expense are charged of $400,000 in the 2010 quarter and $700,000 in the 2009 quarter, both attributable to the mark-to-market adjustments in 2010 and 2009 of our LIBOR interest rate swap and the floating rate to a fixed rate that runs into 2012 -- into the year of 2012. Our fixed rate swap fixes LIBOR at approximately 3.4%, compared to a current market below 0.5%. Current LIBOR market is less than 0.5%.

The tax provision for the third quarter was $2.9 million, or 43% of pre-tax income. The tax provision for the 9 months ended September 30, 2010, was 43.4% of pre-tax income and included the impact of the increased domestic manufacturer's deduction, the advanced energy credits and the additional income tax provision related to the non-deductible expenses in prior years.

Capital expenditures. During the quarter, we had total capital expenditures of $17.2 million, including $720,000 for the Climate Control business and $16 million for the Chemical business, which included $11 million from the Pryor plant. At September 30, we had committed and planned capital expenditures of $11.4 million. Chemical plant spending was $9.1 million, including $4.8 million for Pryor, and Climate Control was $2.3 million.

Focusing on liquidity and capital resources. Cash provided by operations for the third quarter of 2010 was $10.2 million, which included net income of $3.8 million, depreciation of $4.3 million and seasonal changes in the current assets and liabilities. After capital expenditures of $15.3 million, proceeds from property insurance of $3.6 million and various other items, cash and short-term investments decreased $3.8 million for the quarter.

At September 30, our cash on hand totaled $51.4 million and short-term investments totaled $10 million. Our borrowing availability under our $50-million working capital revolver was $49.2 million.

At September 30, 2010, our long-term debt, including the current portion, was $101 million and stockholder's equity was $161 million. The ratio of long-term-debt-to-stockholders' equity was approximately 0.63 to 1.

Based upon our present financial position and our outlook we have adequate working capital to finance ongoing operations as well as organic growth opportunities.

During this extended period of uncertainty in the global economy, we've intentionally maintained a significant liquidity position. We're focused on our long-term debt maturities due in 2012 and are developing a capital plan to address those obligations as well as our growth opportunities.

That will conclude the financial review, and Barry will cover operational highlights and the outlook for the company.

Thanks, Tony.

Today I'll discuss the Climate Control business first. As Tony mentioned, our total Climate Control business sales during the third quarter of 2010 were lower than the third quarter of last year by 4.3%. Sales to commercial and institutional customers were 73% of our total business during the third quarter and were down 12% from the third quarter of 2009. Sales of products used in single-family residences, all geothermal heat pumps, were the remaining 27% of our third-quarter sales and were up 25% from the same period last year.

Focusing on major product lines, total heat pump sales -- both commercial and residential -- were up 6%, fan coil sales were down 15% and sales of other products and services were down 25%.

Total new product orders during the third quarter were $67.5 million, a 37% increase compared to the third quarter of 2009. New orders of products for commercial and institutional applications were up 51% compared to the same quarter last year, while new orders for our geothermal heat pumps that are used in single-family residences were up 7%.

Year to date, as of September 30, new orders for commercial and institutional applications were up 20% and new orders for residential geothermal heat pumps were up 27% over the same period last year.

At September 30, we had a backlog of product orders of $54.8 million, up from $48.2 million at June 30 and (inaudible) at September 30, 2009.

October 2010 new product orders totaled $19.4 million, up 3% over October of 2009. And our backlog at the end of the month was $53.5 million, compared to $40.3 million at the same time last year.

We are encouraged to see our overall new order bookings and backlog increase. Whereas we can't predict what will actually happen in the future, our current sense is that the commercial sectors we serve have passed the low point in construction activity. Forecasting data I will cover later supports this.

As of the end of the third quarter, we continued to maintain leading market shares for geothermal and water source heat pumps and for hydronic fan coils.

Our gross profit during the third quarter of 2010 was $23 million, or 35.6% of sales, down from $24.7 million, or 36.7% of sales, in the same period in 2009. The reduction in gross profit was primarily the result of lower sales and increased material costs. You'll note that we had an improvement in gross profit as a percentage of sales -- 35.6% in the third quarter as compared to 31.5% in the second quarter of this year. This was primarily related to gains realized on our commodity hedging contracts, favorable product mix and physical inventory adjustments, as well as better absorption on labor and overhead due to volume increases.

Our Climate Control segment operating profit during the third quarter of 2010 was $10.1 million, compared to $10.9 million in the 2009 quarter. The decline was primarily the result of the lower gross profit that I just discussed.

Looking to the future, what's the construction outlook? One source -- the latest McGraw-Hill Construction Research & Analytics Construction Market Forecasting Service -- forecasts that new contract awards in 2010 -- that is, for the full year -- of this year -- will be approximately 7% lower than 2009 awards were for the specific building types that accounted for most of our commercial business and accounted for approximately 64% of our total Climate Control business sales in 2009.

McGraw-Hill also forecasts that this will be followed by year-over-year increases of approximately 8%, 25% and 35% in 2011, '12 and '13, respectively, for these building types in the aggregate.

Keep in mind that contract awards occur several months before we actually receive orders for and ship the products we produce. During 2009, construction contract awards for the primary commercial sectors we serve declined approximately 38%. In addition, it should be noted that although commercial orders are up 20% year to date, our sales levels are 19% below those of 2009 year to date. This disparity is due to the beginning backlog carried forward at the start of each year. In 2009, beginning backlog for commercial products was $58.8 million, whereas in 2010, beginning backlog was only $28.8 million.

We also track the Architectural Billings Index, which is an indicator of future commercial and institutional construction activity 9 to 12 months in the future. The ABI increased to 50.4 in September. This is the first time the index has nudged above 50, the point that indicates expansion, since January of 2008.

Based on all the information we have available, we believe that there will be a gradual recovery in commercial construction and we intend to participate in that as it occurs. In the meantime, we're continuing to do those things that we believe will make us stronger and more competitive.

Moving on to residential geothermal heat pumps -- or GHPs -- on a more positive note, single-family residential new construction contract awards are currently forecast by McGraw-Hill to increase 6% this year. This is, however, a decrease from the 22% expected gain I reported a quarter ago, reflecting the mid-year stall in residential construction. Total new housing starts for single-family houses are forecast by McGraw-Hill to be 590,000 units in 2010. McGraw-Hill also forecasts increases of 27% in 2011, 56% in 2012 and 40% in 2013. To meet this demand, we have significantly increased our GHP sales and marketing efforts.

These projected increases by McGraw-Hill do seem large, but it should be noted that even with these projected increases, the single-family residential market will still not return to the 2005 level of 1.6 million new homes built.

As discussed earlier, our sales of residential GHPs were up approximately 25% in the third quarter of 2010 compared to the third quarter of 2009, while new orders were up 7% compared to last year's third quarter. Year to date, as of September 30, our residential GHP new orders were up 27% over the same period in 2009. We believe that a combination of our intensified sales and marketing efforts, the 30% federal income tax credit for GHPs, increased home construction and the trend toward more energy-efficient construction has had a positive impact on GHP sales and new orders for us.

We have also seen a recent trend toward more use of GHP systems in replacement applications, which now approaches half of our residential heat pump sales.

Returning to the total Climate Control business, despite the fact that our current commercial sales are soft, we're optimistic about the future. Throughout this downturn, we've continued to do the things that we believe will build this business for the long term. We believe these will put us in a strong competitive position as the market rebounds. We also believe there is a long-term trend toward energy-efficient and green construction, and we're positioned with the right products to take advantage of this trend.

Turning to our Chemical business, as Tony reported, for the third quarter of 2010, total sales of our chemical products were $72.6 million, compared to $59.7 million in 2009. The increase in our Chemical business sales was primarily due to increased demand for our mining products and an increase in selling prices of all products, partially driven by higher raw material input costs.

Sales of our industrial and mining products were a combined $54.1 million, while sales of our ag products were $18.5 million. Typically, agricultural sales are lower in the third quarter than the first two quarters due to seasonality. This year, ag sales were also impacted by hot and dry weather in certain markets that we serve and an extended plant maintenance turnaround at our Cherokee facility.

Gross profit and operating income were both improved as compared to the third quarter of 2009 for all the reasons that Tony pointed out earlier.

Focusing on the agricultural part of our Chemical business, as I just mentioned, during the third quarter, ag product sales were $18.5 million, or 9% lower than the third quarter of 2009. Total ag products shipped were 30% lower than 2009 -- excuse me. Total ag product tons shipped were 30% lower than 2009. Dollar sales did not decline as much as tons shipped due to higher sales prices for our ag products.

During the third quarter, our shipped tonnage of UAN fertilizer, which came primarily from our Cherokee, Alabama plant, was approximately 37% lower than in the third quarter of 2009. Decreased volumes were partially offset by increased sales prices, and therefore, revenues decreased 24%. Lower tonnage (inaudible) in the current third quarter was due to the plant turnaround in 2010 and lower inventory on hand at the beginning of the 2010 third quarter.

Turning to ag-grade ammonium nitrate, or AN, our third quarter 2010 revenues were lower than the third quarter of 2009 by 24%, as a result of a 36% decrease in tons shipped. However, during the third quarter of 2010, the published sales prices for AN was approximately $60 per ton higher than one year earlier. The significant decrease in our agricultural AN product sales volume in the third quarter was due to hot, dry weather conditions in the markets we serve.

The current outlook, according to most market indicators, including reports in Green Markets, Fertilizer Week and other industry publications, points to positive supply and demand fundamentals for the type of fertilizer products we produce and sell for both the short and long term. Recent reductions in grand production estimates have increased grain prices. Strong grain values should be favorable to increased fertilizer demand and prices.

Again, demand from the markets we serve is strong and we're optimistic about the near term. We also remain bullish about the long-term demand for the agricultural products we produce.

The price of anhydrous ammonia, the raw material feedstock for our El Dorado facility, as quoted at the Tampa price point, averaged $386 per metric ton during the third quarter, compared to $267 in the third quarter of 2009. Today's Tampa price is quoted at $452 per metric ton.

During the first nine months of 2010, anhydrous ammonia increased in cost while natural gas costs declined, resulting in a competitive cost disadvantage for agricultural ag-grade AN produced from purchased ammonia at our El Dorado facility, compared to competitors who produce ammonia from natural gas. Conversely, our Pryor and Cherokee operations are benefiting from low gas costs, resulting in low costs to produce ammonia and other products.

Turning to our industrial chemical products, during the third quarter, our industrial product sales were $30.2 million, up 14% quarter over quarter. However, tons shipped were only up 5%. The increase in revenue per ton was due to the pass-through of higher cost of anhydrous ammonia, the raw material for the El Dorado and Baytown plants. We believe that in the long run, there will be steady requirements for our industrial assets, and we're seeing increased demand as the economy improves.

During the third quarter, our mining product sales were $23.8 million, up 83% compared to 2009's third quarter. Tons shipped were up 72%. Increased tons shipped were due to increased demand for coal and other mining services as economic conditions improved.

For the remainder of 2010, we anticipate modest increased demand from certain of our large industrial customers and from our mining customers, tempered by the usual year-end and seasonal fall-off in the mining sector.

Most of our chemical business' industrial and mining sales are pursuant to cost-plus pricing arrangements, with our customers assuming the raw material cost fluctuation risk with eliminating much of the risk of a disconnect between raw material costs and the market prices for our products. During the first nine months of 2010, approximately 72% of our industrial mining products were sold pursuant to agreements that either have 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 our industrial products.

Now turning to and focusing on the Pryor facility, we know that many of you are following this closely, so I'll try to give you a thorough and detailed update.

We reported to you last quarter that we had a fire in the primary ammonia reformer on June 18 and there would be an approximate 90-day delay while the reformer was being rebuilt. The rebuild was completed on schedule and we also used that delay period to perform a previously-scheduled plant maintenance turnaround. We restarted production of ammonia on September 30, experienced a few delays in mid-October and resumed production on October 27. We're currently producing ammonia. The nitric acid and urea plants will be activated to produce UAN in proper sequence. We are currently selling ammonia to be used as fertilizer during the fall agricultural season.

Our primary rationale for reopening Pryor was the change in the nitrogen fertilizer industry in the United States over the past several years, coupled with the long-term favorable outlook for fertilizer products. Today we believe those reasons are still valid and the long-term outlook is even stronger. We believe that Pryor is a valuable asset that will contribute to earnings for many years to come. We're enthusiastic about our relationship with Coke Chemical on this project, which should facilitate the growth of this business for LSB.

Summing up, all our chemical plants are experiencing good, steady demand. The demand for industrial and mining products has increased and the outlook for ag products demand is strong.

Before closing, I would like to mention that Tony and I will be presenting at the Baird Clean Technology Conference in San Francisco on November 30. We would hope to meet some of you there. Also, since this is the last conference call before the holidays and new year, we want to extend our good wishes for a happy holiday season and happy new year to all of you.

I'll now take your questions.

Thank you. Ladies and gentlemen, we will now be conducting a question-and-answer session. (OPERATOR INSTRUCTIONS.) Our first question is coming from the line of Mr. Dan Mannes with Avondale Partners. Your line is now open. You may proceed with your question.

Hello, Dan.

Good afternoon, everybody.

Did you change your last name, Dan?

Not on purpose. A couple quick follow-ups here. If we can just talk about Pryor. Your commentary as it relates to the UAN and the nitric acid plants. I guess I'm just trying to understand. Is that different than it's been before? The commentary about being positioned -- I guess the question is is it -- are they actually running at this point or at this point you're just going to sell ammonia and maybe start them up a little bit later into the spring? If you could just kind of give us a little bit more explanation there.

Well, as we said, we're starting them up in the proper sequence and we're -- first activated the ammonia plant and we're running the ammonia plant. In the next few weeks, we'll be activating those plants.

And you've gone through this process before. Is that fair or has the ammonia plant never run at this level?

No no. We have, during this whole extended start-up process, run each of these plants successfully. It's just that during this start-up sequence, this is the sequence that they're using in the operation. So we're confident that these are going to start up and run fine as we start them up in the proper sequence.

And did you do a turnaround on them as well while --

Yes we did. We did complete rebuilds on them. Yes we did.

Okay. And then just briefly, to the extent there are problems with that start-up, ammonia margins look pretty healthy. Would you be able to cover fixed overhead just running the ammonia plants and selling ammonia --

Yes.

And be profitable?

Yes.

Good. Okay. Briefly, on the existing business for the third quarter, I guess I was a little bit surprised by the light level of ag sales. You guys usually do a turnaround on Cherokee every year. I guess I'd forgotten it was 3 versus 4. But was there anything else going on? Did you end the quarter with a lot of inventory of ag chemicals? I guess the number's just a lot lower than I would have thought, especially given the perception of demand out there.

Dan, we broke this down into several elements, but the primary focus here was the fact that we had a tremendous third quarter in 2009 because we had some consolidated shipments that went out. This year, we began the third quarter with a very light inventory at Cherokee. We did a turnaround. So whereas in the past, we would have shipped significantly more UAN in the third quarter than we did, we had limited availability and we down for turnaround. And then on the ammonium nitrate side -- on the agricultural-grade ammonium nitrate side, we just had weak demand for that particular product due to weather conditions, but it's certainly not indicative of what we expect going forward on the ag side.

But it's more indicative of just the aggregate amount of volume you have available, just given what your sales were in the second quarter.

This is sort of one of those perfect storms that came together. We had limited product available and down time and so it had -- it's not really reflective of the demand for product.

Got it. Real quick. The margin structure on Q3, and Barry, you talked about the sequential uptick. I know you guys don't give guidance on margins, but there has been a lot of volatility on margin this year -- anywhere from now low 30's all the way back up to mid. I guess I'm just trying to figure out what's a sustainable level going forward and I guess --

I know I've said this before and I'll say this again. We still think of the Climate Control business as being in the low 30's -- 30, 31, generally speaking, in the kind of markets that we're in, at least right now. And we had some unusual things in the third quarter, which I outlined. And I wouldn't -- I'm not giving you guidance, but I certainly wouldn't count on this level of GP going forward.

And then on the -- for the chemical side, I point out for you sequentially that our ag sales in the second quarter of 2010 were in the $50 million range and only $19 million in the second -- in the third quarter, so that was really the main difference in gross profit percentages quarter over quarter sequentially.

Okay. Real quick. I didn't get a full view on your Q, but it did look like you'd upped some of your hedging for natural gas. Can you give us any color -- given how attractive pricing is for ag chemicals, are you preselling at this point for delivery next year?

No. As a matter of fact, we have laid back a little bit on preselling because we've expected prices to go up, which they have, so we've done a limited amount of preselling.

And -- okay. And then just one last question. I think, Jack, you had mentioned some updated news about maybe changing over one of your climate sites. Could you give a little bit more color? Is this a new product line you guys are getting into?

It's not a new product line. We have been -- we have developed a geothermal -- modular geothermal chiller that's been very successful in the marketplace, and it got to the point where it needs its own plant. We were manufacturing in some of our other facilities. And this section will make those chillers and it will also make air-cooler modular chillers. So to really do it and do it right, we set up -- we're setting up this additional facility. Barry, do you have anything to add to that?

Yes. It's a dedicated facility and all the expertise will be focused and dedicated on this kind of product as opposed to being mixed in with other products, so we just feel it'll operate more efficiently. And I -- this is not entirely new. I mentioned this in the last conference (inaudible). We're just updating you on it. The fact that we're actually kicking off the refurbishment of that plant and the repurposing of it.

And the geothermal modular chiller -- that's primarily a commercial product?

Yes.

Got it. Thanks again, guys.

Sure, Dan.

Thank you. Ladies and gentlemen, our next question is coming from the line of Mr. Eric Stine with Northland Capital. Your line is now open. You may proceed with your question.

Hello, Eric.

Hi. Thanks, guys, for taking my call. This is actually Thomas filling in for Eric. Can you hear me?

Yes we can.

Just two quick questions. Can you provide an update on the distribution agreement with [Ream Rudd]?

An update in what way? Well, we have the distribution agreement. It's in place and they're proceeding to sell the produce and we're proceeding to supply them with product. As to any specifics such as quantities, we don't disclose that.

Okay.

They're an OEM customer.

They're an OEM customer. Yes.

Gotcha. Okay. Second question. Can you provide kind of a -- I guess directionally where the agricultural segment could go in 4Q, and is the outcome in 4Q due to seasonality or a recovery due to low 3Q levels?

I didn't hear the last part of it.

Is it -- is the direction going to be considerably higher based upon the low third-quarter volume?

Correct.

We're expecting a reasonably strong fourth quarter in ag products because this is the time of year where they use a lot of ammonia. That's the first thing they use. And after that, they use UAN. And after that, they use (inaudible) nitrate -- ammonium nitrate.

So I think if you look at all the information written in the trade publications, you'll see that there should be a very strong demand for all three of those products that Jack mentioned.

Sometimes the weather is such that they can't put down ammonia because it's too wet and so they go -- they wait and they go to UAN. And in those cases, the volumes of UAN are greater if they have not applied straight ammonia. You understand what I'm saying?

Yes. (Inaudible) my question.

Okay. Great.

Alright. Thank you.

Thank you.

Our next question is coming from the line of Mr. Joe Mondillo with Sidoti & Company. Your line is now open. You may proceed with your question.

Good afternoon, guys.

Hi, Joe.

First I wanted to talk about the Pryor facility a little bit. I was wondering if you would care to comment on sort of an outlook or guidance on what that plant can contribute to your top line/bottom line, given full capacity -- running at full capacity -- and maybe flat pricing.

We can't obviously give guidance, but in our previous releases and disclosures, we've disclosed that we plan to produce 325,000 tons of UAN and have a minimum of 35,000 tons of excess ammonia to sell. And so if you look at gas prices now in the (inaudible)-plus range and UAN prices in the $300-plus range, there's a significantly better spread that exists today than there has been in the last 18 months. So you've got really good spreads right now, but we can't really forecast. You know there's about 14 (inaudible) of gas in a ton of UAN.

And the other thing is I'll point out that that spread that Tony's talking about, in the basic economics of producing a ton of UAN, are significantly better than they were when we made the decision to pull the trigger and reactive this plant. So we're feeling good about the outlook there.

There's one more thing that has contributed somewhat to our protracted start-up, and that's that we're going to be able to produce more ammonia than we originally projected and we'll have more excess ammonia to sell in the market, in addition to the 325,000 tons of UAN. We thought we were going to have 35,000 tons of ammonia. We're going to have substantially more than that to sell.

Okay.

So that also contributes to the better overall economics for the plant.

Okay. Could you address -- excluding the Pryor, how is your gross margin on the chemical side of the business tracked from the second quarter to the third quarter?

The gross profit was substantially less in the third quarter than the second quarter. Was that your question?

Yes. Excluding Pryor.

The reason is exactly what I told Dan Mannes a while ago, that in the second quarter, we had $50 million worth of agricultural sales and in the third quarter, only $18 million, and agricultural product is our most profitable because it is sold at market versus a formula basis. So that's really the primary difference.

Okay. I'm sorry. I sort of heard that or -- okay. I guess in terms of the operating income line then, excluding Pryor, it seems like it's been sort of stable over the last couple quarters. Why has that been?

What part of our business are you referring to?

The chemical operating income line.

Rephrase the question. I'm sorry.

On an operating income line in the chemical business, the margin has been somewhat stable, excluding Pryor. Given the trends in gross -- why is that? What's going on there?

As Barry indicated, we got 70% of our business more or less is contractual -- 72% of the non-agricultural business is contractual. So we have a -- the advantage of being able to pass through our cost on most of these contractual business, which tends to level out your margin. And then the plus or minus -- the major variation comes from the level of your agricultural sales and the market conditions at the time you ship it. So the stability in the operating margin is chemical is primarily a result of the fact that we got a heavy percent of contractual industrial business.

But shouldn't that --

In -- I'd like to add to that to make it clearer. In the future, that percentage is going to drop, not the volume but the percentage, because as we sell product from Pryor, that right now will be agricultural product. And so the mix, next time we're talking to you, probably will not be the same percentage.

That's right.

It'll be substantially less. It might be like 60/40 or something like that. Whatever it turns out to be, it'll be less. The volume will be higher but the percentage of ag will be higher and the percentage of industrial will be lower.

I thought, in terms of the third quarter, though, the margin was light because of a lighter agricultural. Isn't that sort of --

That's exactly right.

That's right.

So what you're saying is, in the fourth quarter when we get more agriculture, the margins are going to be lighter? That seems sort of contradictory.

No no.

No no no. The third quarter this year gross profit was down some because we had a very low mix of agricultural products, which tends to be more profitable.

Right. Okay. And then Jack was saying, as we get Pryor online, which is more agricultural, it should be more profitable, margins should be up, right?

Well, the -- right now, you're in a very good market for nitrogen fertilizer, which we produce, and as long as that continues, you should -- it should be favorable to the overall (inaudible).

They've done everything today. It's not something you have to watch every day.

Okay. Okay. I guess just to follow up -- just to comment on Tony's answer to my original question, your gross margins are being reflected in the lower ag volume. However, the operating income line does still seem to be stable and your answer sort of had to do with contractual agreements with the cost/cost-plus on the industrial and mining, but shouldn't that -- that should be reflected in the gross margin.

That's true.

So I guess there must be something in the operating income line that's sort of stabilizing that.

Well, what's happened is we've charged a lot of the costs for Pryor to the operations.

Do you recall the fact that we are taking the fire costs down into SG&A?

Yes. I'm excluding that. Alright. I'll follow up. I guess the other question I had was how much of a benefit on the Climate Control is from the hedging that you've had that propped up those margins so much?

On -- say that again. On Climate Control?

How much was there -- no, I don't know right off the top of my head. Tony, do you have that number for the third quarter? What the benefit was (inaudible) --

Yes. We can come back. We'll get that number and get it to you.

Okay. And then I guess my last question just had to do with the tax rate. I don't know if you addressed that. I might have missed that.

The tax rate is 43% and a normal tax rate would be closer to 40%, but as we've mentioned in our footnotes, we had some adjustment -- catch-up adjustments on non-deductible expenses that took our tax rates higher this year. So you had a --

Okay.

You have a 43% tax rate --

That's a one-time phenomenon.

If you have a (inaudible) 30% tax rate, which more normalized would be 40%.

Okay. That'll do it for me then. Thanks.

Thanks. We'll follow up on your question about the hedging gain.

Okay. Great. Thanks.

It wasn't substantial.

Thank you. (OPERATOR INSTRUCTIONS.) Our next question is coming from the line of Mr. Brian Cramer with Roth Capital Partners. Your line is now open. You may proceed with your question.

Hello, Brian.

Good afternoon. Okay. A couple of things that haven't been touched on yet. The operating expenses. Obviously, Pryor has made up a proportion of that of the last few quarters, the last year, year and a half. 6.1 in this most recent quarter. How do you see that, I think, in the fourth quarter? And then --

I believe it was -- I believe we said it was 4.7, 4.8.

Go ahead and (inaudible) your question and we'll come back to it.

Okay. Yes. I just wanted to understand. Looking forward, obviously that's a big difference. You're looking at $20 million or less on a go-forward basis if you pull Pryor out of it. And what should we expect in terms of any additional expenses in the fourth quarter related to Pryor?

Now let's narrow the question. Are you talking about below the gross profit line?

Yes.

Okay. The -- let me just quote you the numbers for Pryor first. Year to date, we've got $13 million below the line and $11 million last year. For the third quarter, we've got $4.6 million versus $6.1 million last year. And those numbers should go away if we're successful in covering all of our costs in the fourth quarter and subsequent periods. They should be included in cost of sales, lined up offsetting the sales volume.

Okay.

In other words -- let's say it in plain English. In plain English, we've been expensing the costs of Pryor without production. Now that we're going to -- we're getting production, they should absorb their own overhead and contribute a profit.

Right. Now when you hit full production or the point, will you announce that during the quarter? How are you going to approach that?

It'll be in our fourth-quarter SEC filing.

Okay.

Because right now, we've already made the announcement that we're running ammonia at a sustained rate so -- and that we'll pick up UAN and nitric acid in the proper sequence, so I don't think there's an announcement necessary.

It'll be handled like all our other chemical operations.

Okay.

Included in our fourth quarter --

I would like to just interject and come back here. On answering a question that was asked by the previous caller, during the three months during the quarter -- the last quarter, we had approximately a $500,000 gain on futures contracts in the Climate Control business. Q3 of '09. And based on reported sales of $64.5 million, that's less than 1%. That's like less than -- it's like eight-tenths of 1% impact. So I hope that answers the previous question.

He asked you about 210.

That's what I'm -- I'm talking about 210.

You said it was 29.

I meant to say 210. Excuse me. Okay. (Inaudible) do you have another question?

Yes. I might have missed it during the remarks -- the prepared remarks -- but what was the UAN? Did you give the UAN -- that it was an average price during the quarter or the current spot price?

I don't think we disclosed that, and as I mentioned before, UAN sales weren't that extensive. But right now, the price is in the $300 range.

Okay.

$300 a ton.

Yes. Thank you.

It depends on the part of the country --

Based on Green Markets, Southern Plains, during the third quarter, there was a range of pricing. It was increasing. And it increased from $215 to $285. It was in that range. It's higher now. But that's published prices.

Sure. Great. Thank you. Now on the Climate Control side, I think, in going through the Q quickly, although residential was up for the first 9 months pretty nicely, I think this quarter it was only up 6% year over year. Is there something going on there? Is it timing? What -- how should we look at that?

Well, we know that there was kind of a mid-year stall in new construction. It's pretty much well-publicized. We know that new construction did not increase as much as we expected it to this year -- as anybody expected it to. We know that we're dealing with a lot of reticence out there in the current economic conditions for people to spend money. This is -- geothermal is our residential product. It's a high-end product. There's less financing available out there in the world today than there was a few years ago for things like home equity loans. So basically, we do have the advantage right now of the 30% tax credit which will extend until the end of 2016. So as the recovery occurs, we feel that we'll be getting a significant benefit from that, but we just feel that there are some headwinds out there and they've impacted us in the third quarter.

Well, that's -- they've impacted all geothermal, haven't they?

I'm getting there.

Okay.

Okay. In fact, our view is, from the data that we have available to us, the overall market for geothermal products in unit shipments is off year to date approximately 5% from last year, whereas our sales are up.

7%.

Yes. Our sales are up in unit sales, I believe -- let me look and make sure I've got the right number here. 11%.

Okay.

So -- 11%. So we've actually gained market share this year.

Right. Okay.

So that's our view of the picture.

Sure. Thank you. And one other on Pryor. Did I hear also in the prepared remarks related to CapEx that there's expected CapEx on Pryor in the fourth quarter?

Yes you did.

Okay. I'm assuming that's related to the other parts as you sort those out?

Part of that is the rebuild cost has not been paid yet.

Gotcha. Gotcha. Okay. That's it. Thanks.

Sure.

And it does not include the recoveries from insurance.

Ladies and gentlemen, our next question is coming from the line of Mr. David Kaizer with Robotti & Company. Your line is now open. You may proceed with your question.

Good morning, David.

How's it going, guys?

Good. How are you?

Great. So part of my question was just answered about the -- just wanted you to go over the numbers with the geothermal heat pumps and it is evident that you gained market share. I just wanted to confirm that.

We believe we did, yes.

And then in terms of the split, you said it's closer to 50/50 in terms of new homes and retrofit?

I'd say it's approaching -- I said it was approaching 50%. We don't have the exact number because we actually can't obtain that from our distribution, but we know that, a few years ago, as a rule of thumb, we used to say 30 -- about roughly a third retrofit and mostly new construction, and we're seeing it approach 50% today.

Okay. And do you think that trend can continue or do you think once new homes start to pick up that it returns or it's something in between?

I really don't know. I can't really prognosticate on that.

Okay.

I really don't know.

And then just -- you focus on Pryor a lot and you mentioned that -- I just want to confirm it -- the $13 million was spent on Pryor this year?

CapEx?

No no no. I'm sorry. Was expensed, excuse me. Is that right or do I have that wrong?

That's right.

Okay. So --

Let me clarify that. That's how much we have below the line as SG&A expense.

That's what I'm referring to, yes.

They had some sales and cost of sales and some pro rata costs (inaudible), but we're referring to below the gross profit line.

So just taking a broader picture and not worrying about like next quarter, you have to be very optimistic about the future, that you've grown geothermal heat pumps in a tough environment, the commercial markets are starting to pick up so the Climate Control business has -- seems like it's poised for growth. And in the meantime, Pryor's kind of behind you and if you were to add back what you spent on Pryor this past year, you would have had a nice year in a very tough environment. So I kind of answered the question for you, but you have to be very confident in what's coming in the future.

We feel confident. Yes we do.

Alright. I appreciate it. Most of my questions were answered so I just wanted to touch base and --

Alright. Thanks a lot.

Thanks a lot.

Thank you guys.

Thank you. Our next question is coming from the line of Mr. Michael Coleman with Sterne, Agee. Your line is now open. You may proceed with your question.

Hi, Michael.

Hi, Mike.

Hi. Good afternoon. You hit on what I was going to ask about, so thanks and talk to you later.

Sure, Mike.

Thank you. Our next question is coming from the line of Mr. Dan Mazur with Harvest Capital. Your line is now open. You may proceed with your question.

Good afternoon, guys.

Hi, Dan.

Hi, Dan.

Just a few quick ones. Just with the agreement with Coke, do you get the published prices on UAN? Is it just as simple as taking the $325 times 300, assuming full capacity or full production?

Well, we do pay a marketing fee to Coke so you'd have to net that out from the sales price -- from whatever the market price is.

Then, also remember or realize that we haven't really pulled the trigger on that yet since we haven't really started shipping under that agreement.

Right.

It's up but nothing to speak of.

Okay. And then do you have an estimate for just what above the 35 million ammonia that you think you could produce?

You mean the 35,000 tons per year?

30,000. Yes the (inaudible) more than 35,000 tons?

60,000 to 90,000 tons.

Now that's in aggregate. That's not above the 30.

Right.

That's in aggregate.

Okay. And then is there a good way to think about the production costs at Pryor on a cost-per-ton -- maybe something you -- is there a rule of thumb or maybe what Cherokee's run --

Well, if you're talking about UAN, we can't really -- we haven't run the plant yet so we don't have any definitive numbers. So we just -- just from industry statistics. Some plants run better conversion than others, but if you use 14.4 (inaudible) of gas at whatever gas prices, you could look at the futures or the current, and then add $70 or $80 conversion and you're -- you'd have a pretty good feel for it. We can't project $70 or $80. It could be less; it could be more. We'll see after we run.

Okay. Well, that's better than I expected so -- okay. That's helpful. Thanks, guys.

Sure, Dan.

Thank you. Our next question is coming from the line of Mr. Jay Petschek with Corsair Capital. Your line is now open. You may proceed with your question.

Hi, Jay. How are you?

Hi, Jay. How's it going?

Hi, guys. Good. I just wanted one question. You may have answered it. I may have missed it. But just going back to Pryor, you mentioned some production figures and I get confused as to whether those are the numbers on ammonia and urea and have to do with the contracts we've had in place already or that is the sole production capacity of Pryor.

Okay. Let me clarify it for you. Our contract calls for 325,000 tons a year of UAN. Alright?

Right.

And to do that and fulfill that, based on our original projections that we made, running the ammonia plant at the turned-down rate, we had about 35,000 excess tons of ammonia that we could sell on the market.

Right.

So based on what we now know and are running at -- the rate we're running at -- assuming that we continue to run at this rate -- we will have between 60,000 and 90,000 tons of ammonia per year to put on the market, over what's required for the 325,000 tons of UAN.

Right.

(Inaudible) contract --

I was just going to repeat it to make sure I -- it's doubly clear.

(Inaudible) contract to produce 325,000 UAN and then we'll have, over and above that, revenue stream 60,000 to 90,000 tons of ammonia to sell at the open market.

Right.

That's correct.

You've got it.

Okay. And does the plant capacity -- can it take on other things above that, because you talked about turned-down capacity, so is there a way to expand or is that full capacity for Pryor to fulfill the UAN contract and then you have 60,000 to 90,000 tons to sell on the open market and that's it.

Well, there's facilities there that we have no plans to activate yet. We want to see the profit coming in from the plant that's on the table now before we think about starting up additional plants that are on the site.

And to do that, it's sort of a similar start-up deal (inaudible).

To do that, we have to spend money. We have extra UAN -- we have extra acid plants and we have additional ammonia plants and we have additional urea plants. But we haven't got to what the costs would be to activate those. We want to make a profit on this plant, show what it can do and have some history with it before we attempt to activate the rest of them.

So kind of summing up, we have no plans at this time to activate any further other part of this plant.

Yes.

And I assume you did the easiest one first.

Not necessarily, no. We did the largest ones first (inaudible).

Okay. Thank you.

Sure.

Our next question is coming from the line of Mr. [Revis] Lewis, a private investor. Your line is now open. You may proceed with your question.

Thank you very much. Are you interested at all in selling your company (inaudible) in that regard?

Excuse me. We can't hear you. There must be static on the line.

Are you interested in selling the company?

Excuse me. We can't -- there's static on the line. We can't hear you. Would you --

Can Scott tell us what he's selling?

It's very hard to make out, Mr. Lewis.

Are you interested in selling your company?

Are we interested in selling the company?

Yes.

Well, the company's not for sale, sir.

Thank you.

Thank you.

Ladies and gentlemen, at this time, there are no further questions. I would like to turn the floor back over to management for any closing comments.

I would like to thank all of you for listening today and I'd like to urge you to stay on the line to hear some very important information about forward-looking statements that we made during the presentation, and I'll turn it over to Carol.

Thanks again for listening in today. The comments today contained certain forward-looking statements. All statements other than statements of historical facts are forward looking statements. Statements that include the words expects, intends, plans, believes, projects, anticipates, estimates and similar statements of a future or forward-looking nature identify forward-looking statements including, but not limited to, all statements about or any forecast pertaining to indicators are trending upward; we are moving in the right direction; we are optimistic about the long-term future of our company; we are not yet up to our potential; we have added working capital to finance ongoing operations as well as organic growth opportunities; there will be a gradual recovery in commercial construction and we will participate and be stronger and more competitive; we continue to do things we believe will build this business for the long term; we continue to increase sales of our (inaudible) products; we believe there is a long-term trend toward energy-efficient and green construction; and we are positioned with the right products to take advantage of this; strong grain values should be favorable to increased fertilizer demand in prices; we are optimistic and remain bullish about long-term demand for agricultural products; we anticipate modest increased demand for our large industrial and our mining customers; we believe that in the long run there will be steady requirements for our industrial assets; Pryor facility will enhance production; long-term outlook for the Pryor facility's products is even stronger; we believe Pryor is a valuable asset that will contribute to earnings; outlook for agricultural product demand is strong; the Pryor facility nitric acid and urea plants will be activated to produce UAN in proper sequence.

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 ended December 31, 2009, and our quarterly report on Form 10-Q for the quarters ended March 31, 2010; June 30, 2010 and September 30, 2010, 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 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 does end tonight's teleconference. You may disconnect your lines at this time. Thank you very much for your participation and have a wonderful evening.