Terra Industries 10-Q 2006 Q3 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For the quarterly period ended September 30, 2006

OR

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

For the transition period from                    to                    

Commission file number: 1-8520

TERRA INDUSTRIES INC.

(Exact name of registrant as specified in its charter)

Maryland (State or other jurisdiction of incorporation or organization)	52-1145429 (I.R.S. Employer Identification No.)
Terra Centre P.O. Box 6000 600 Fourth Street Sioux City, Iowa (Address of principal executive offices)	51102-6000 (Zip Code)

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

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ Noo

     Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act

Large accelerated filero           Accelerated filerþ           Non-accelerated filero

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).o Yesþ No

     As of October 23, 2006, the following shares of the registrant’s stock were outstanding:

Common Shares, without par value 92,605,538 shares

TABLE OF CONTENTS

Part I — FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets	3
Consolidated Statements of Operations	4
Consolidated Statements of Cash Flows	5
Consolidated Statements of Changes in Common Shareholders’ Equity	6
Notes to Consolidated Financial Statements	7
Item 2. Management Discussion and Analysis of Financial Condition and Results of Operations	31
Item 3. Quantitative and Qualitative Disclosures About Market Risk	38
Item 4. Controls and Procedures	38
Part II — OTHER INFORMATION
Item 1. Legal Proceedings	39
Item 1A. Risk Factors	39
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	39
Item 3. Defaults Upon Senior Securities	39
Item 4. Submission of Matters to a Vote of Security Holders	39
Item 5. Other Information	40
Item 6. Exhibits	41
Amendment No.3 to Amended and Restated Credit Agreement
302 Certification of Chief Executive Officer
302 Certification of Chief Financial Officer
Section 906 Certification

2

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TERRA INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

(unaudited)

	September 30,			December 31,			September 30,
	2006			2005			2005
Assets
Cash and cash equivalents	$	122,170		$	86,366		$	166,704
Restricted cash		—			8,595			8,861
Accounts receivable, less allowance for doubtful accounts of $371, $234 and $233		193,339			206,407			176,487
Inventories		160,191			190,314			144,963
Other current assets		26,158			54,578			84,792
Total current assets		501,858			546,260			581,807
Property, plant and equipment, net		722,952			733,536			764,737
Equity method investments		161,455			183,884			190,805
Deferred plant turnaround costs, net		40,577			27,447			22,272
Intangible assets, net		6,115			7,526			20,166
Other assets		27,164			24,972			5,316
Total assets	$	1,460,121		$	1,523,625		$	1,585,103
Liabilities
Accounts payable	$	115,734		$	125,863		$	105,163
Customer prepayments		27,949			52,913			34,081
Accrued expenses and other current liabilities		80,970			84,996			123,118
Debt due within one year		4			38			77
Total current liabilities		224,657			263,810			262,439
Long-term debt and capital lease obligations		331,300			331,300			331,304
Deferred income taxes		58,922			65,998			95,655
Pension liabilities		112,729			120,236			102,322
Other liabilities		37,619			41,320			51,138
Minority interest		95,014			92,258			95,698
Total liabilities and minority interest		860,241			914,922			938,556
Preferred Stock— liquidation value of $120,000		115,800			115,800			115,800
Common Shareholders’ Equity
Capital stock
Common Shares, authorized 133,500 shares; 92,639 outstanding; 95,171 and 93,870		144,968			146,994			146,997
Paid-in capital		693,944			712,671			712,681
Accumulated other comprehensive loss		(52,362	)		(70,143	)		(48,003	)
Unearned compensation		—			(5,369	)		(6,085	)
Accumulated deficit		(302,470	)		(291,250	)		(274,843	)
Total common shareholders’ equity		484,080			492,903			530,747
Total liabilities and minority interest, preferred stock and common shareholders’ equity	$	1,460,121		$	1,523,625		$	1,585,103

See Accompanying Notes to the Consolidated Financial Statements.

3

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per-share amounts)
(unaudited)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2006			2005			2006			2005
Revenues
Product revenues	$	461,533		$	484,082		$	1,381,084		$	1,419,420
Other income		3,248			1,612			6,135			6,279
Total revenues		464,781			485,694			1,387,219			1,425,699
Costs and Expenses
Cost of sales		422,523			446,908			1,337,210			1,269,238
Selling, general and administrative expense		13,679			10,139			38,395			36,638
Equity in earnings of unconsolidated affiliates		(809	)		(3,330	)		(15,830	)		(12,737	)
		435,393			453,717			1,359,775			1,293,139
Income from operations		29,388			31,977			27,444			132,560
Interest income		2,091			2,970			5,499			6,391
Interest expense		(11,786	)		(11,829	)		(35,340	)		(41,812	)
Loss on early retirement of debt		—			—			—			(27,193	)
Change in fair value of warrant liability		—			—			—			8,860
Income (loss) before income taxes and minority interest		19,693			23,118			(2,397	)		78,806
Income tax benefit (provision)		(6,000	)		(7,704	)		2,002			(25,864	)
Minority interest		(3,352	)		(4,328	)		(7,000	)		(15,723	)
Net income (loss)		10,341			11,086			(7,395	)		37,219
Preferred share dividends		(1,275	)		(1,275	)		(3,825	)		(3,859	)
Net Income (Loss) Available to Common Shareholders	$	9,066		$	9,811		$	(11,220	)	$	33,360
Basic and diluted income (loss) per share:
Basic	$	0.10		$	0.10		$	(0.12	)	$	0.36
Diluted	$	0.10		$	0.10		$	(0.12	)	$	0.35
Basic and diluted weighted average shares outstanding:
Basic		91,817			93,416			92,994			92,087
Diluted		93,405			95,219			92,994			106,942

See Accompanying Notes to the Consolidated Financial Statements.

4

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

(unaudited)

	Nine Months Ended
	September 30,
	2006			2005
Operating Activities
Net income (loss)	$	(7,395	)	$	37,219
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Depreciation of property, plant and equipment and amortization of deferred plant turnaround costs		78,859			83,569
Deferred income taxes		(2,002	)		29,553
Minority interest in earnings		7,000			15,723
Equity in undistributed earnings		9,135			(12,737	)
Non-cash loss on derivatives		2,775			8,057
Share-based compensation		4,285			1,684
Amortization of intangible and other assets		8,128			7,427
Non-cash loss on early retirement of debt		—			22,543
Change in fair value of warrant liability		—			(8,860	)
Term loan discount accretion		—			1,773
Changes in operating assets and liabilities:
Accounts receivable		25,785			(28,901	)
Inventories		36,592			(1,480	)
Accounts payable and customer prepayments		(38,859	)		(92,737	)
Other assets and liabilities, net		(21,029	)		11,693
Net cash flows from operating activities		103,274			74,526
Investing Activities
Purchase of property, plant and equipment		(40,785	)		(17,406	)
Plant turnaround expenditures		(31,987	)		(9,677	)
Distributions received from unconsolidated affiliates		9,660			33,125
Changes in restricted cash		8,595			(8,861	)
Proceeds from the sale of property, plant and equipment		9,666			6,485
Net cash flows from investing activities		(44,851	)		3,666
Financing Activities
Payments under borrowings arrangements		(34	)		(125,124	)
Preferred share dividends paid		(3,825	)		(4,675	)
Payments under share repurchase program		(18,796	)		—
Proceeds from exercise of stock options		363			160
Distributions to minority interests		(4,244	)		(12,223	)
Net cash flows from financing activities		(26,536	)		(141,862	)
Effect of exchange rate changes on cash		3,917			(3,424	)
Increase (decrease) to cash and cash equivalents		35,804			(67,094	)
Cash and cash equivalents at beginning of period		86,366			233,798
Cash and cash equivalents at end of period	$	122,170		$	166,704
Supplemental cash flow information:
Interest paid	$	21,394		$	24,572
Income tax refunds received	$	—		$	11,049
Income taxes paid	$	1,569		$	398

See Accompanying Notes to the Consolidated Financial Statements.

5

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS’ EQUITY

NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005

(in thousands)

(unaudited)

							Accumulated
							Other
	Common			Paid-In			Comprehensive			Unearned			Accumulated						Comprehensive
	Stock			Capital			Loss			Compensation			Deficit			Total			Income
Balance at January 1, 2006	$	146,994		$	712,671		$	(70,143	)	$	(5,369	)	$	(291,250	)	$	492,903
Comprehensive income (loss):
Net loss		—			—			—			—			(7,395	)		(7,395	)	$	(7,395	)
Foreign currency translation adjustment		—			—			22,638			—			—			22,638			22,638
Change in fair value of derivatives, net of taxes of $2,589		—			—			(4,857	)		—			—			(4,857	)		(4,857	)
Comprehensive income																			$	10,386
Preferred share dividends		—			—			—			—			(3,825	)		(3,825	)
Exercise of stock options		95			268			—			—			—			363
Nonvested stock		554			549			—			—			—			1,103
Shares purchased and retired under share repurchase program		(2,675	)		(16,121	)		—			—			—			(18,796	)
Reclassification for adoption of FAS 123 R		—			(5,369	)		—			5,369			—			—
Share-based compensation		—			1,946			—			—			—			1,946
Balance at September 30, 2006	$	144,968		$	693,944		$	(52,362	)	$	—		$	(302,470	)	$	484,080

					Accumulated
					Other
	Common		Paid-In		Comprehensive			Unearned				Accumulated						Comprehensive
	Stock		Capital		Loss			Compensation				Deficit			Total			Income
Balance at January 1, 2005	$	144,531	$	681,639	$	(55,994	)	$	(2,568	)		$	(308,203	)	$	459,405
Comprehensive income (loss):
Net income		—		—		—			—				37,219			37,219		$	37,219
Foreign currency translation adjustment		—		—		(20,924	)		—				—			(20,924	)		(20,924	)
Change in fair value of derivatives, net of taxes of $5,691		—		—		28,915			—				—			28,915			28,915
Comprehensive income																		$	45,210
Preferred share dividends		—		—		—			—				(3,859	)		(3,859	)
Conversion of preferred shares		2,069		14,650		—			—				—			16,719
Reclassification of warrant liability		—		12,240		—			—				—			12,240
Exercise of stock options		57		103		—			—				—			160
Nonvested stock		340		4,049		—			(4,800	)			—			(411	)
Amortization of unearned compensation		—		—		—			1,283		��		—			1,283
Balance at September 30, 2005	$	146,997	$	712,681	$	(48,003	)	$	(6,085	)		$	(274,843	)	$	530,747

See Accompanying Notes to the Consolidated Financial Statements.

6

TERRA INDUSTRIES INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

(unaudited)

1.	Financial Statement Presentation
	Basis of Presentation
	The accompanying unaudited consolidated financial statements and notes thereto contain all adjustments necessary, in the opinion of management, to summarize fairly the financial position of Terra Industries Inc. and all majority-owned subsidiaries (“Terra”, “the Company” and “it”) and the results of operations for the periods presented. Because of the seasonal nature of Terra’s operations and effects of weather-related conditions in several of its marketing areas, results of any interim reporting period should not be considered as indicative of results for a full year. These statements should be read in conjunction with the Company’s 2005 Annual Report on Form 10-K to Shareholders.
	Revenue Recognition
	Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the price is fixed or determinable, no obligations remain and collectibility is probable.
	Revenues are primarily comprised of sales of the Company’s nitrogen- and methanol-based products, including any realized hedging gains or losses related to nitrogen product derivatives, and are reduced by estimated discounts and trade allowances. Revenues also include profit sharing revenue under the Methanex supply contract when the estimated margin on an annualized basis is probable. Revenues include amounts related to shipping and handling charges to the Company’s customers.
	Cost of Sales
	Costs of sales are primarily related to manufacturing costs related to the Company’s nitrogen- and methanol-based products, including any realized hedging gains or losses related to natural gas derivatives. Cost of sales includes amounts related to shipping and handling charges to the Company’s customers.
	Derivatives and Financial Instruments
	The Company enters into derivative financial instruments, including swaps, basis swaps, purchased put and call options and sold call options, to manage the effect of changes in natural gas costs, to manage the prices of its nitrogen products and to manage foreign currency risk. The Company reports the fair value of the derivatives on its balance sheet. If the derivative is not designated as a hedging instrument, changes in fair value are recognized in earnings in the period of change. If the derivative is designated as a hedge, and to the extent such hedge is determined to be effective, changes in fair value are either (a) offset by the change in fair value of the hedged asset or liability, or (b) reported as a component of accumulated other comprehensive income (loss) in the period of change, and subsequently recognized in cost of sales in the period the offsetting hedged transaction occurs. If an instrument is settled early, any gains or losses are immediately recognized in cost of sales.

7

Share-Based Compensation

During the 2006 first quarter, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (SFAS 123 R) which requires the measurement and recognition of compensation expense for all share-based payment awards made to employees and directors based on estimated fair values. SFAS 123 R supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB 25) for periods beginning in 2006. In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (SAB 107) relating to SFAS 123 R. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123 R. The Company adopted SFAS 123 R using the modified prospective transition method, which requires the application of the accounting standard as of January 1, 2006 (See Note 11).

On November 10, 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position No. SFAS 123 R-3,“Transition Election Related to Accounting for Tax Effects of Share-Based Awards.”The alternative transition method includes simplified methods to establish the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that are outstanding upon adoption of SFAS 123 R.

Plant Turnaround Costs

Costs related to the periodic scheduled major maintenance of continuous process production facilities (plant turnarounds) are deferred and charged to product costs on a straight-line basis during the period until the next scheduled turnaround , generally two years.

Impairment of Long-Lived Assets

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

Use of Estimates in Preparation of the Financial Statements

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

8

2.	Income (Loss) Per Share
	Basic income (loss) per share data is based on the weighted-average number of Common Shares outstanding during the period. Diluted income (loss) per share data is based on the weighted-average number of Common Shares outstanding and the effect of all dilutive potential common shares including stock options, nonvested shares, convertible preferred shares and common stock warrants. Nonvested stock carries dividend and voting rights, but is not involved in the weighted average number of common shares outstanding used to compute basic income (loss) per share.
	The following table provides a reconciliation between basic and diluted income (loss) per share for the three- and nine-month periods ended September 30, 2006 and 2005:

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
(in thousands, except per-share amounts)	2006			2005			2006			2005
Basic income (loss) per share computation:
Income (loss) from continuing operations	$	10,341		$	11,086		$	(7,395	)	$	37,219
Less: Preferred share dividends		(1,275	)		(1,275	)		(3,825	)		(3,859	)
Income (loss) available to common shareholders	$	9,066		$	9,811		$	(11,220	)	$	33,360
Weighted average shares outstanding		91,817			93,416			92,994			92,087
Basic income (loss) per common share	$	0.10		$	0.10		$	(0.12	)	$	0.36
Diluted income (loss) per share computation:
Income (loss) available to common shareholders	$	9,066		$	9,811		$	(11,220	)	$	33,360
Add: Preferred share dividends		—			—			—			3,859
Income (loss) available to common shareholders and assumed conversions	$	9,066		$	9,811		$	(11,220	)	$	37,219
Weighted average shares outstanding		91,817			93,416			92,994			92,087
Add incremental shares from assumed conversions:
Preferred shares		—			—			—			13,450
Nonvested stock		596			518			—			610
Common stock warrants		846			1,093			—			598
Common stock options		146			192			—			197
Dilutive potential common shares		93,405			95,219			92,994			106,942
Diluted income (loss) per common share	$	0.10		$	0.10		$	(0.12	)	$	0.35

For the three- and nine-month periods ended September 30, 2006 and 2005, common stock options totaling 0.1 million shares were excluded from the computation of diluted income per share because the exercise prices of these options exceeded the average market price of the Company’s stock for the respective periods, and the effect of their inclusion would have been antidilutive.

9

	For the three-month periods ending September 30, 2006 and 2005, preferred shares of 0.1 million were excluded from the computation of diluted earnings per share. These preferred shares were antidilutive using the if-converted method.
	For the nine-month period ended September 30, 2006, all preferred shares, nonvested stock, common stock warrants and common stock options were antidilutive because the Company was in a net loss position. As such, these instruments were excluded from the computation of the diluted income (loss) per share for the nine-month period ended September 30, 2006.
3.	Inventories
	Inventories consisted of the following:

	September 30,		December 31,		September 30,
(in thousands)	2006		2005		2005
Raw materials	$	29,679	$	22,487	$	21,593
Supplies		53,642		55,647		53,763
Finished goods		76,870		112,180		69,607
Total	$	160,191	$	190,314	$	144,963

	Inventory is valued at actual first in — first out cost. Costs include raw material, labor and overhead.
4.	Derivative Financial Instruments
	Terra manages risk using derivative financial instruments for (a) changes in natural gas supply prices (b) interest rate fluctuations (c) changes in nitrogen prices and (d) currency. Derivative financial instruments have credit risk and market risk.
	To manage credit risk, Terra enters into derivative transactions only with counter-parties who are currently rated as BBB or better or equivalent as recognized by a national rating agency. Terra will not enter into transactions with a counter-party if the additional transaction will result in credit exposure exceeding $20 million. The credit rating of counter-parties may be modified through guarantees, letters of credit or other credit enhancement vehicles.
	Terra classifies a derivative financial instrument as a hedge if all of the following conditions are met:

1.	The item to be hedged must expose Terra to currency, interest or price risk.
2.	It must be probable that the results of the hedge position substantially offset the effects of currency, interest or price changes on the hedged item (e.g., there is a high correlation between the hedge position and changes in market value of the hedge item).
3.	The derivative financial instrument must be designated as a hedge of the item at the inception of the hedge.

Natural gas supplies to meet production requirements at Terra’s North American and United Kingdom (U.K.) production facilities are purchased at market prices. Natural gas market prices are volatile and Terra effectively fixes prices for a portion of its natural gas production requirements and inventory through the use of futures contracts, swaps and options. The North American contracts reference physical natural gas prices or appropriate NYMEX futures contract prices. Contract physical prices for North America are frequently based on prices at the Henry Hub in Louisiana, the most common and financially liquid location of reference for financial derivatives related to natural gas. However, natural gas supplies for Terra’s North American production facilities are purchased at

10

locations other than Henry Hub, which often creates a location basis differential between the contract price and the physical price of natural gas. Accordingly, the use of financial derivatives may not exactly offset the change in the price of physical gas. The U.K. contracts are based on the Intercontinental Exchange (ICE) index price. Physical delivery prices in the U.K. are based on the ICE index. The contracts are traded in months forward and settlement dates are scheduled to coincide with gas purchases during that future period.

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

Terra will also use a collar structure where it will enter into a swap, sell a call at a higher price and buy a put. The collar structure allows for greater participation in a decrease to natural gas prices and protects against moderate price increases. However, the collar exposes Terra to large price increases.

The following summarizes open natural gas derivative contracts at September 30, 2006 and 2005:

	Other		Other
	Current		Current			Deferred			Net
(in thousands)	Assets		Liabilities			Taxes			Asset (Liability)
September 30, 2006	$	7,050	$	(22,129	)		5,365		$	(9,714	)
December 31, 2005		22,152		(34,213	)		2,861			(9,200	)
September 30, 2005		61,734		(45,419	)		(5,691	)		10,624

Certain derivatives outstanding at September 30, 2006 and 2005, which settled during October 2006 and 2005, respectively, are included in the position of open natural gas derivatives in the table above. The October 2006 derivatives settled for an approximate $14.5 million loss. All open derivatives will settle during the next 12 months.

At September 30, 2006, the Company determined that certain derivative contracts were ineffective hedges for accounting purposes and recorded a charge of $1.2 million and $2.8 million to cost of sales for the three- and nine-month periods ending September 30, 2006, respectively. Derivatives outstanding at September 30, 2005 included gains of $0.5 million and $1.0 million that were recorded as an ineffective position and credited to cost of sales for the three- and nine-month periods ending September 30, 2005, respectively.

The effective portion of gains and losses on derivative contracts that qualify for hedge treatment are carried as accumulated other comprehensive income (loss) and credited or charged to cost of sales in the month in which the hedged transaction settles. Gains and losses on the contracts that do not qualify for hedge treatment are credited or charged to cost of sales based on the positions’ fair value. The risk and reward of outstanding natural gas positions are directly related to increases or decreases in natural gas prices in relation to the underlying NYMEX and ICE natural gas contract prices.

The activity to accumulated other comprehensive income (loss), net of income taxes, relating to current period hedging transactions for the three-month periods ended September 30, 2006 and 2005 follows:

11

	Three Months Ended
	September 30,
	2006						2005
(in thousands)	Gross			Net of tax			Gross			Net of tax
Beginning accumulated gain (loss)	$	(7,034	)	$	(4,578	)	$	9,049		$	6,135
Net increase (decrease) in market value		(8,263	)		(5,374	)		20,697			12,835
Reclassification into earnings		(34	)		(14	)		(14,406	)		(9,362	)
Ending accumulated gain (loss)	$	(15,331	)	$	(9,966	)	$	15,340		$	9,608

The activity to accumulated other comprehensive income (loss), net of income taxes, relating to current period hedging transactions for the nine-month periods ended September 30, 2006 and 2005 follows:

	Nine Months Ended
	September 30,
	2006						2005
(in thousands)	Gross			Net of tax			Gross			Net of tax
Beginning accumulated loss	$	(7,886	)	$	(5,109	)	$	(16,829	)	$	(19,307	)
Net increase (decrease) in market value		(50,001	)		(32,454	)		38,256			32,884
Reclassification into earnings		42,556			27,597			(6,087	)		(3,969	)
Ending accumulated gain (loss)	$	(15,331	)	$	(9,966	)	$	15,340		$	9,608

	Approximately $10.0 million of the accumulated other comprehensive loss, net of tax, at September 30, 2006 will be reclassified into earnings during the next twelve-month period ending September 30, 2007.
	At times, the Company uses forward derivative instruments to fix or set floor prices for a portion of its nitrogen sales volumes. At September 30, 2006, the Company had no open nitrogen sales swap contracts.
5.	Equity Investments
	Terra’s investments in companies that are accounted for on the equity method of accounting consist of the following: (1) 50% ownership interest in Point Lisas Nitrogen Limited, (“PLNL”) which operates an ammonia production plant in Trinidad (2) 50% interest in an ammonia storage joint venture located in Houston, Texas and (3) 50% interest in a joint venture in Oklahoma CO2 at Terra’s nitrogen plant. These investments were $161,455 at September 30, 2006. Terra includes the net earnings of these investments as an element of income from operations since the investees’ operations provide additional capacity to Terra.

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

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2006		2005		2006		2005
Condensed income statement information:
Net sales	$	28,078	$	45,726	$	129,943	$	125,462
Net income	$	4,483	$	13,752	$	32,964	$	43,521
Terra’s equity in earnings of unconsolidated affiliates	$	809	$	3,330	$	15,830	$	12,737

	September 30,		September 30,
(in thousands)	2006		2005
Condensed balance sheet information:
Current assets	$	45,964	$	64,646
Long-lived assets		194,549		199,878
Total assets	$	240,513	$	264,524
Current liabilities	$	26,473	$	22,999
Long-term liabilities		—		188
Equity		214,040		241,337
Total liabilities and equity	$	240,513	$	264,524

The carrying value of these investments at September 30, 2006 was $54.4 million more than Terra’s share of the affiliates’ book value. The excess is attributable primarily to the step-up in basis for fixed asset values, which is being depreciated over a period of approximately 15 years.

Terra has transactions in the normal course of business with PLNL whereby Terra is obliged to purchase 50 percent of the ammonia produced by PLNL at current market prices. During the nine-month period ending September 30, 2006, Terra purchased approximately $63.4 million of ammonia from PLNL. As of September 30, 2006 PLNL made cash distributions to its shareholders, of which Terra’s portion was $33.8 million during the nine-month period. During the first nine months of 2005, Terra purchased approximately $59.1 million of ammonia from PLNL. During the first nine months of 2005, Terra’s portion of cash distributions from PLNL was $31.3 million.

The total distributions from all investments were $34.6 million and $33.1 million for the nine-month periods ended September 30, 2006 and 2005, respectively.

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6.	Long-term Debt and Capital Lease Obligation
	Long-term debt and capital lease obligations consisted of the following:

	September 30,		December 31,		September 30,
(in thousands)	2006		2005		2005
Secured Senior Notes, 12.875% due 2008	$	200,000	$	200,000	$	200,000
Second Priority Senior Secured Notes, 11.5%, due 2010		131,300		131,300		131,300
Other		4		38		81
Total long-term debt and capital lease obligations		331,304		331,338		331,381
Less current maturities		4		38		77
Total long-term debt and capital lease obligations	$	331,300	$	331,300	$	331,304

The Company has revolving credit facilities totaling $200 million that expire September 30, 2008. The revolving credit facility is secured by substantially all of the assets of the Company other than the assets collateralizing the Senior Secured Notes. Borrowing availability is generally based on 100% of eligible cash balances, 85% of eligible accounts receivable and 60% of eligible finished goods inventory less outstanding letters of credit issued under the facility. As of September 30, 2006, the Company had borrowing availability of $200 million. These facilities include $50 million only available for the use of Terra Nitrogen Company, L.P. (TNCLP), one of the Company’s consolidated subsidiaries. Borrowings under the revolving credit facility will bear interest at a floating rate plus an applicable margin, which can be either a base rate, or, at the Company’s option, a London Interbank Offered Rate (LIBOR). At September 30, 2006, the LIBOR rate was 5.32%. The base rate is the highest of (1) Citibank, N.A.’s base rate (2) the federal funds effective rate, plus one-half percent (0.50%) per annum and (3) the base three month certificate of deposit rate, plus one-half percent (0.50%) per annum, plus an applicable margin in each case. LIBOR loans will bear interest at LIBOR plus an applicable margin. The applicable margin for base rate loans and LIBOR loans are 0.50% and 1.75%, respectively, at September 30, 2006. The revolving credit facility requires an initial one-half percent (0.50%) commitment fee on the difference between committed amounts and amounts actually borrowed.

At September 30, 2006, the Company had no outstanding revolving credit borrowings and $17.6 million in outstanding letters of credit. The $17.6 million in outstanding letters of credit reduced the Company’s borrowing availability to $182.4 million at September 30, 2006. The credit facilities require that the Company adhere to certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. If the Company’s borrowing availability falls below $60 million, the Company is required to have achieved minimum operating cash flows or earnings before interest, income taxes, depreciation, amortization and other non-cash items of $60 million during the most recent four quarters.

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

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	In June 2005, the Company repaid the remaining $75.0 million of the term loan. The discounted book value of the debt prior to repayment was $63.7 million. As a result, the Company recognized a loss on the repayment of $11.3 million and other prepayment charges of $5.1 million during the second quarter of 2005.
7.	Pension Plans
	Terra maintains defined benefit and defined contribution pension plans that cover substantially all salaried and hourly employees. Benefits are based on a pay formula. The defined benefit plans’ assets consist principally of equity securities and corporate and government debt securities. The Company also has certain non-qualified pension plans covering executives, which are unfunded. Terra accrues pension costs based upon annual actuarial valuations for each plan and funds these costs in accordance with statutory requirements.
	The estimated components of net periodic pension expense follow:

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2006			2005			2006			2005
Service cost	$	744		$	683		$	2,232		$	2,048
Interest cost		5,888			3,917			17,664			11,752
Expected return on plan assets		(5,394	)		(3,070	)		(16,182	)		(9,210	)
Amortization of prior service cost		(7	)		6			(21	)		16
Amortization of actuarial loss		1,408			1,222			4,224			3,667
Amortization of net assets		—			12			—			37
Termination charge		291			—			873			—
Pension Expense	$	2,930		$	2,770		$	8,790		$	8,310

Cash contributions to the defined benefit pension plans for the three months ended September 30, 2006 and 2005 were $8.8 million and $15.1 million, respectively. Cash contributions to the defined benefit pension plans for the nine months ended September 30, 2006 and 2005 were $12.3 million and $19.4 million, respectively.

In the 2006 third quarter, the Pension Protection Act (PPA) was signed into law. Beginning in 2008, the PPA requires the Company’s qualified pension plans to meet a funding target over seven years. Annual cash funding is expected to equal the value of benefits accrued during the year plus one-seventh of any under-funded amount. The Company is currently evaluating the effects of this legislation.

Terra also sponsors defined contribution savings plans covering most full-time employees. Contributions made by participating employees are matched based on a specified percentage of employee contributions. The cost of the Company contributions to these plans for the three-month periods ending September 30, 2006 and 2005 totaled $1.2 million and $1.4 million, respectively. Contributions to these plans for the nine-month periods ending September 30, 2006 and 2005 were $4.0 million and $3.7 million, respectively.

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

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8.	Accumulated other comprehensive income (loss)
	Accumulated other comprehensive income (loss) refers to revenues, expenses, gains and losses that under accounting principles generally accepted in the United States are recorded as an element of shareholders’ equity but are excluded from net (loss) income. Terra’s accumulated other comprehensive income (loss) is comprised of (a) adjustments that result from translation of Terra’s foreign entity financial statements from their functional currencies to United States dollars, (b) adjustments that result from translation of intercompany foreign currency transactions that are of a long-term investment nature (that is, settlement is not planned or anticipated in the foreseeable future) between entities that are consolidated in Terra’s financial statements, (c) the offset to the fair value of derivative assets and liabilities (that qualify as hedged relationships) recorded on the balance sheet, and (d) minimum pension liability adjustments.
	The components of accumulated other comprehensive income (loss) for the nine months ended September 30, 2006 and 2005 follow:

	Foreign						Minimum
	Currency			Fair Value of			Pension
	Translation			Derivatives,			Liability, net of
(in thousands)	Adjustment			net of taxes			taxes			Total
Balance December 31, 2005	$	(9,100	)	$	(5,109	)	$	(55,934	)	$	(70,143	)
Change in foreign translation adjustment		22,638			—			—			22,638
Reclassification to earnings		—			27,597			—			27,597
Change in fair value of derivatives		—			(32,454	)		—			(32,454	)
Balance September 30, 2006	$	13,538		$	(9,966	)	$	(55,934	)	$	(52,362	)
Balance December 31, 2004	$	14,287		$	(19,307	)	$	(50,974	)	$	(55,994	)
Change in foreign translation adjustment		(20,924	)		—			—			(20,965	)
Reclassification to earnings		—			3,192			—			3,192
Change in fair value of derivatives		—			25,723			—			25,764
Balance September 30, 2005	$	(6,637	)	$	9,608		$	(50,974	)	$	(48,003	)

9.

Industry Segment Data

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

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The following summarizes operating results by business segment:

	Three Months Ended						Nine Months Ended
	September 30						September 30
(in thousands)	2006			2005			2006			2005
Revenues — Nitrogen Products	$	442,612		$	478,118		$	1,355,574		$	1,393,503
— Methanol		18,921			5,964			25,510			25,917
— Other		3,248			1,612			6,135			6,279
Total revenues	$	464,781		$	485,694		$	1,387,219		$	1,425,699
Income (loss) from operations
— Nitrogen Products	$	20,409		$	38,971		$	25,098		$	144,469
— Methanol		9,405			(6,673	)		3,363			(9,762	)
— Other		(426	)		(321	)		(1,017	)		(2,147	)
Income from operations	$	29,388		$	31,977		$	27,444		$	132,560

The following summarizes geographic revenues information for the three- and nine-month period ending September 30:

	Three Months Ended				Nine Months Ended
	September 30				September 30
(in thousands)	2006		2005		2006		2005
United States	$	337,958	$	353,188	$	1,048,142	$	1,084,112
Canada		12,874		11,632		48,755		42,107
United Kingdom		113,949		120,874		290,322		299,480
	$	464,781	$	485,694	$	1,387,219	$	1,425,699

10.	Commitments and Contingencies
	The Company is involved in various claims and legal actions arising in the ordinary course of business, including employee injury claims. Based on the facts currently available, management believes that the ultimate disposition of these matters will not have a material adverse effect on the Company’s consolidated financial position, results of operation or liquidity and that the likelihood that a loss contingency will occur in connection with these claims is remote.
	The Company has entered into natural gas supply agreements through December 31, 2007 for approximately 49.7 million MMBtu’s. As of September 30, 2006, these natural gas commitments were $1.3 million above market prices.
11.	Share-based Compensation
	The Company sponsors three share-based compensation plans – the Inspiration Resources Corporation 1992 Stock Incentive Plan (the “1992 Plan”), the Terra Industries Inc. 1997 Stock Incentive Plan (the “1997 Plan”) and the Terra Industries Inc. Stock Incentive Plan of 2002 (the “2002 Plan”). Upon the adoption of the 2002 Plan, the Company no longer issues share-based awards from the 1992 Plan or the 1997 Plan, however, approximately 497,000 authorized shares have been reserved for awards that were issued prior to the adoption of the 2002 plan. As of September 30, 2006, there were approximately 3,997,000 shares of common stock authorized for issuance under the plans, including approximately 3,500,000, 464,000 and 33,000 authorized for the 2002 Plan, 1997 Plan and 1992 Plan, respectively. Shares for approximately 1,540,000 and 2,000,000 were available and reserved, respectively, for share-based compensation grants as of September 30, 2006.

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Awards granted under the plans may consist of incentive stock options (ISOs) or non-qualified stock options (NQSOs), stock appreciation rights (SARs), nonvested stock awards or other share-based awards (i.e. performance shares), with the exception that non-employee directors may not be granted SARs and only employees of the Company may be granted ISOs.

The Compensation Committee of the Company’s Board of Directors administers the plans and determines the exercise price, exercise period, vesting period and all other terms of the grant. All share-based awards to directors, officers and employees expire ten years after the date of grant. ISOs and NQSOs, which are not exercised after vesting, expire ten years after the date of the award. The vesting period for nonvested stock is determined at the grant date of the award; the vesting period is usually three years. The vesting date for other share-based awards is also set at the time of the award but can vary in length; there is usually no expiration date for other share-based awards.

The Company also issues phantom share awards to certain employees. The phantom share awards settle in cash based on the stock price on the vesting date, which is usually three years after the grant date. The Company has recorded a liability for the phantom share awards. For the three- and nine-month periods ended September 30, 2006, the Company recorded $0.5 million and $1.1 million, respectively, of expense related to the phantom share awards.

Prior to January 1, 2006, the Company accounted for awards issued under its share-based compensation plans using the intrinsic-value method. The Company did not recognize compensation expense on stock options in the three- and nine-month periods ended September 30, 2005 as all options granted under the Company’s plans had an exercise price equal to the market price of the Company’s stock on the date of grant and were fully vested. The Company did recognize compensation expense of $0.7 million and $1.7 million on nonvested stock awards and phantom share awards in the three- and nine-month periods ended September 30, 2005, respectively, based on intrinsic value, which was equal to the market price of the Company’s stock on the date of grant.

On January 1, 2006, the Company adopted SFAS 123 R using the modified prospective method. This Statement requires the Company to recognize in net income an estimate of expense for stock awards and options over their vesting periods, typically determined as of the date of grant. Under the modified prospective application, this Statement applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, the Company recognized compensation cost for the portion of awards for which the requisite service has not been rendered that were outstanding on January 1, 2006. The compensation cost for that portion of awards was based on the grant-date fair value of those awards as calculated for either recognition or pro forma disclosures under SFAS No. 123. The unearned compensation related to the unvested awards was reclassified against paid-in capital as of January 1, 2006. The cumulative effect of the adoption of SFAS 123 R related to estimating forfeitures of outstanding awards was not significant. Results for prior periods have not been restated.

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The following table illustrates the effect on net income and net income per share if the Company had accounted for share-based compensation using the fair value method in the nine months ended September 30, 2005:

	Three Months Ended			Nine Months Ended
(in thousands, except per-share amounts)	September 30, 2005			September 30, 2005
Net income available to common shareholders	$	9,811		$	33,360
Add: Share based employee compensation expense included in reported net income, net of related tax effects		743			1,684
Deduct: Share based employee compensation expense determined under fair value based method for all awards, net of related tax effects		(743	)		(1,684	)
Pro forma net income available to common shareholders	$	9,811		$	33,360
Income per share:
Basic — as reported	$	0.10		$	0.36
Basic — pro forma		0.10		$	0.36
Diluted — as reported	$	0.10		$	0.35
Diluted — pro forma	$	0.10		$	0.35

Compensation cost charged against income and the total income tax benefit recognized for share-based compensation arrangements is included below:

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(in thousands)	2006		2005		2006		2005
Compensation cost charged to SG&A expense	$	1,968	$	743	$	4,285	$	1,684
Total compensation cost charged to income	$	1,968	$	743	$	4,285	$	1,684
Income tax benefit	$	419	$	223	$	913	$	505

Stock options

The Company has stock options with service conditions. No compensation cost is recognized for the stock options as these instruments were fully vested upon adoption of SFAS 123 R.

A summary of stock option activity as of September 30, 2006, and changes during the nine months then ended is presented below:

				Weighted
				Average
				Exercise
(options in thousands)	Number			Price
Outstanding — beginning of period		592		$	5.24
Expired/terminated		—			—
Exercised		(95	)		3.82
Outstanding — end of period		497		$	5.51

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The following table summarizes information about stock options outstanding and exercisable at September 30, 2006:

(options in thousands)

	Options Outstanding						Options Exercisable
			Weighted		Weighted				Weighted
			Average		Average				Average
Range of	Number		Remaining		Exercise		Number		Exercise
Exercise Prices	Outstanding		Life (years)		Price		Exercisable		Price
$1.43 - $3.88		399		2.9	$	3.72		399	$	3.72
7.81 -   7.81		6		1.8		7.81		6		7.81
12.13 - 14.75		92		0.8		13.04		92		13.04
Total		497		2.5	$	5.51		497	$	5.51

No options were granted during 2006.

Nonvested Stock Shares and Phantom Share Awards

The Company currently has outstanding nonvested shares with both service conditions and performance conditions. Nonvested stock shares and phantom share awards with service and performance conditions usually “cliff vest” in three years from the grant date. If the financial performance conditions are not satisfied, the grant will be forfeited.

The Company recognizes compensation expense for nonvested stock share awards over the vesting periods based on fair value, which is equal to the market price of the Company’s stock on the date of grant. The Company recognizes compensation expense for the phantom share awards over the vesting periods based on fair value, which is equal to the market price of the Company’s stock at each reporting period date. Compensation costs for nonvested stock shares and phantom share awards are discounted for estimated forfeitures and then amortized to expense using the straight-line method.

A summary of the status of the Company’s nonvested share awards as of September 30, 2006, and changes during the nine months then ended, is:

				Weighted-
				Average
				Grant-Date
(in thousands, except fair values)	Shares			Fair Value
Outstanding at January 1, 2006		1,590		$	5.12
Granted		662			6.67
Vested		(687	)		2.01
Forfeited		(111	)		6.88
Outstanding at September 30, 2006		1,454		$	7.16

At September 30, 2006, the total unrecognized compensation cost related to all nonvested share awards was $6.0 million. That cost is expected to be recognized over a weighted-average period of 1.7 years.

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12.

Share Information

On April 25, 2006, the Board of Directors authorized the Company to repurchase a maximum of 10 percent, or 9,516,817 shares, of its outstanding common stock. The stock buyback program has been and will be conducted on the open market, in private transactions or otherwise at such times prior to September 30, 2008, and at such prices, as determined appropriate by the Company. Purchases may be commenced or suspended at any time without notice. During 2006, the Company’s repurchases under the stock buyback program were:

	Number of		Average Price		Total Cost
(in thousands, except average	Shares		of Shares		of Shares
price of shares repurchased)	Repurchased		Repurchased		Repurchased
April 2006		—	$	—	$	—
May 2006		488		7.49		3,655
June 2006		1,557		6.92		10,767
July 2006		—		—		—
August 2006		560		6.93		3,879
September 2006		70		7.03		495
		2,675	$	7.03	$	18,796

	During 2004 and in connection with the MCC acquisition, Terra issued warrants to purchase 4.0 million of its common shares at $5.48 per share. These warrants were valued at $21.1 million at the MCC closing. At December 31, 2004, the value of the warrants was carried as a current liability pending shareholder approval to issue the underlying shares. During 2005, shareholders approved the issuance of the underlying shares and the warrant value was reclassified to common stockholders’ equity.
13.	New Accounting Pronouncements
	In July 2006, the Financial Accounting Standards Board (FASB) issued FASB Interpretation No. 48“Accounting for Uncertainty in Income Taxes”(FIN 48). FIN 48 requires that realization of an uncertain income tax position must be “more likely than not” (i.e. greater than 50% likelihood of receiving a benefit) before it can be recognized in the financial statements. Further, FIN 48 prescribes the benefit to be recorded in the financial statements as the amount most likely to be realized assuming a review by tax authorities having all relevant information and applying current conventions. FIN 48 also clarifies the financial statement classification of tax-related penalties and interest and sets forth new disclosures regarding unrecognized tax benefits. FIN 48 is effective in the first quarter 2007 for the Company. The Company plans to adopt FIN 48 when required. FIN 48 is currently being evaluated by the Company for its full impact. At this time, the Company believes it has properly and adequately provided for all income tax positions and therefore expects minimal impact from adopting the Interpretation.
	In September 2006, the FASB issued Statement of Financial Accounting Standards (SFAS) 157,“Fair Value Measurement”(SFAS 157). SFAS 157 is definitional and disclosure oriented and addresses how companies should approach measuring fair value when required by generally accepted accounting principles (GAAP); it does not create or modify any current GAAP requirements to apply fair value accounting. SFAS 157 provides a single definition for fair value that is to be applied consistently for all accounting applications, and also generally describes and prioritizes according to reliability the methods and input used in valuations. SFAS 157 prescribes various disclosures about financial statement categories and amounts which are measured at fair value, if such disclosures are not already specified elsewhere in GAAP. The new measurement and

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	disclosure and requirements of SFAS 157 are effective for the Company in the 2008 first quarter and the Company expects no significant impact from adopting the Standard.
	In September 2006, the FASB issued SFAS 158,“Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans”(SFAS 158). SFAS 158 focuses primarily on balance sheet reporting for the funded status of benefit plans and requires recognition of benefit liabilities for under-funded plans and benefit assets for over-funded plans, with offsetting impacts to shareholders equity. These changes are required to be adopted prospectively, effective with the Company’s December 31, 2006 financial statements. The Company is in a net under-funded position for its pension and retiree health care plans and will therefore recognize incremental retirement benefit liabilities on adoption. The Company has not yet quantified these amounts. The new rules will also require companies to measure benefit plan assets and liabilities and determine the discount rate for subsequent year expense recognition as of the balance sheet date for financial reporting purposes, thus eliminating the opportunity to use a measurement of date up to 90 days prior to the balance sheet date. The effective date for this change is delayed until year-end 2008. The Company currently uses an October 1 measurement date and will adopt a December 31 measurement date in 2008 as required. Switching to the new measurement date will require a one-time adjustment to retained earnings per the transition guidance in SFAS 158. None of the changes prescribed by SFAS 158 will impact the Company’s results of operations or cash flows.
	In September 2006, the SEC issued SFAS 108,“Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”(SAB 108). SAB 108 provides interpretive guidance on how the effects of prior-year uncorrected misstatements should be considered when quantifying misstatements in the current year financial statements. SAB 108 requires registrants to quantify misstatements using both an income statement and balance sheet approach and then evaluate whether either approach results in a misstatement that, when all relevant quantitative and qualitative factors are considered, is material. If prior year errors that had been previously considered immaterial now are considered material based on either approach, no restatement is required so long as management properly applied its previous approach and all relevant facts and circumstances were considered. If prior year’s financial statements are not restated, the cumulative effect adjustment is recorded in opening accumulated deficit as of the beginning of the fiscal year of adoption. SAB 108 is effective for the Company at the end of 2006. The Company is currently assessing the impact the adoption of SAB 108 will have on its Consolidated Financial Statements.
14.	Subsequent Event
	On October 19, 2006, the Company entered into a Memorandum of Understanding with Kemira GrowHow Oyj to create a joint venture to operate the fertilizer and associated process chemicals businesses of both companies in the United Kingdom.
	The Memorandum of Understanding is a non-legally binding agreement and is subject,inter alia, to clearance from the UK competition authorities, negotiation of definitive documents and lender consent. It is not subject to approval of shareholders in either Terra Industries Inc. or Kemira GrowHow Oyj.
	The proposed joint venture is expected to be held 50/50 by Terra Industries Inc. and Kemira GrowHow and to own and operate the sites of Terra Nitrogen (UK) Limited’s facilities on Teeside and Severnside and the site of Kemira GrowHow UK Limited at Ince.

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15.	Guarantor Subsidiaries
	The consolidating statement of financial position of Terra Industries Inc. (the “Parent”), Terra Capital, Inc. (“TCAPI”), the Guarantor Subsidiaries and subsidiaries of the Parent that are not guarantors of the Senior Secured Notes due 2008 for September 30, 2006; December 31, 2005; and September 30, 2005 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries. Statements of operations for the three- and nine months and statements of cash flows for the nine months ended September 30, 2006 and 2005 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries.
	Guarantor subsidiaries include subsidiaries that own the Woodward, Oklahoma; Port Neal, Iowa and Beaumont, Texas plants as well as the corporate headquarters facility in Sioux City, Iowa. All other company facilities are owned by non-guarantor subsidiaries.

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     Consolidating Balance Sheet as of September 30, 2006:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Assets
Cash and cash equivalents	$	1		$	(17,081	)	$	89,612		$	49,639		$	(1	)	$	122,170
Accounts receivable, net		—			—			89,173			104,166			—			193,339
Inventories		—			—			62,019			98,172			—			160,191
Other current assets		(857	)		10,863			7,461			5,368			3,323			26,158
Total current assets		(856	)		(6,218	)		248,265			257,345			3,322			501,858
Property, plant and equipment, net		—			—			389,524			333,429			(1	)		722,952
Equity method investments		—			—			7,193			154,262			—			161,455
Intangible assets, other assets and deferred plant turnaround costs		—			8,314			23,898			41,644			—			73,856
Investments in and advanced to (from) affiliates		727,320			551,576			1,453,292			437,194			(3,169,382	)		—
Total assets	$	726,464		$	553,672		$	2,122,172		$	1,223,874		$	(3,166,061	)	$	1,460,121
Liabilities
Debt due within one year	$	—		$	—		$	4		$	—		$	—		$	4
Accounts payable		107			900			36,015			78,712			—			115,734
Accrued expenses and other current liabilities		7,904			100,512			48,556			28,237			(76,290	)		108,919
Total current liabilities		8,011			101,412			84,575			106,949			(76,290	)		224,657
Long-term debt and capital lease obligations		—			331,300			—			—			—			331,300
Deferred income taxes		—			—			18,608			40,314			—			58,922
Pension and other liabilities		140,659			(509	)		9,127			1,071			—			150,348
Minority interest		—			18,564			76,450			—			—			95,014
Total liabilities and minority interest		148,670			450,767			188,760			148,334			(76,290	)		860,241
Preferred stock		115,800			—			—			—			—			115,800
Common Shareholders’ Equity
Common stock		144,968			—			73			49,709			(49,782	)		144,968
Paid-in capital		693,944			150,218			2,026,502			1,265,009			(3,441,729	)		693,944
Accumulated other comprehensive income (loss) compensation		(63,636	)		—			—			30,080			(18,806	)		(52,362	)
Retained earnings (deficit)		(313,282	)		(47,313	)		(93,163	)		(269,258	)		420,546			(302,470	)
Common shareholders’ equity		461,994			102,905			1,933,412			1,075,540			(3,089,771	)		484,080
Total liabilities and minority interest, preferred stock and common shareholders equity	$	726,464		$	553,672		$	2,122,172		$	1,223,874		$	(3,166,061	)	$	1,460,121

24

Consolidating Statement of Operations for the three months ended September 30, 2006:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	375,329		$	86,204		$	—		$	461,533
Other income		—			—			747			2,500			1			3,248
		—			—			376,076			88,704			1			464,781
Cost and Expenses
Cost of sales		—			—			370,874			65,206			(13,557	)		422,523
Selling, general and administrative expenses		616			(2,286	)		(6,206	)		7,996			13,559			13,679
Equity in the (earnings) loss of subsidiaries		8,658			(26,829	)		(16,848	)		14,949			19,261			(809	)
Total cost and expenses		9,274			(29,115	)		347,820			88,151			19,263			435,393
Income (loss) from operations		(9,274	)		29,115			28,256			553			(19,262	)		29,388
Interest income		—			(1,274	)		5,194			(3,576	)		1,747			2,091
Interest expense		(465	)		(10,024	)		(3,357	)		2,809			(749	)		(11,786	)
Income (loss) before income taxes and minority interest		(9,739	)		17,817			30,093			(214	)		(18,264	)		19,693
Income tax provision		(5,657	)		—			—			(343	)		—			(6,000	)
Minority interest		—			(647	)		(2,706	)		—			1			(3,352	)
Net (loss) income	$	(15,396	)	$	17,170		$	27,387		$	(557	)	$	(18,263	)	$	10,341

Consolidating Statement of Operations for the nine months ended September 30, 2006:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues
Product revenues	$	—		$	—		$	645,275		$	735,809		$	—		$	1,381,084
Other revenues		—			—			4,328			1,807			—			6,135
Total revenues		—			—			649,603			737,616			—			1,387,219
Cost and Expenses																		��
Cost of sales		—			—			675,913			701,056			(39,759	)		1,337,210
Selling, general and administrative expenses		1,623			(6,848	)		(8,317	)		12,177			39,760			38,395
Equity in the (earnings) loss of subsidiaries		27,336			(66,108	)		(16,848	)		(43,459	)		83,249			(15,830	)
Total cost & expenses		28,959			(72,956	)		650,748			669,774			83,250			1,359,775
Income (loss) from operations		(28,959	)		72,956			(1,145	)		67,842			(83,250	)		27,444
Interest income		—			(224	)		5,194			(1,218	)		1,747			5,499
Interest expense		(1,395	)		(33,610	)		(6	)		(3,745	)		3,416			(35,340	)
Income (loss) before income taxes and minority interest		(30,354	)		39,122			4,043			62,879			(78,087	)		(2,397	)
Income tax benefit		(2,835	)		—			—			4,835			2			2,002
Minority interest		—			(1,351	)		(5,649	)		—			—			(7,000	)
Net (loss) income	$	(33,189	)	$	37,771		$	(1,606	)	$	67,714		$	(78,085	)	$	(7,395	)

25

Consolidating Statement of Cash Flows for the nine months ended September 30, 2006:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities
Net income (loss)	$	(33,189	)	$	37,771		$	(1,606	)	$	67,714		$	(78,085	)	$	(7,395	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Depreciation and amortization		—			2,196			44,488			40,302			1			86,987
Deferred income taxes		—			—			18,608			(20,610	)		—			(2,002	)
Minority interest in earnings		—			515			6,485			—			—			7,000
Equity in undistributed earnings		(27,336	)		66,108			16,848			43,459			(89,944	)		9,135
Non-cash loss on derivatives		—			—			1,703			1,072			—			2,775
Share-based compensation		4,285			—			—			—			—			4,285
Change in operating assets and liabilities		90			11,674			(71,167	)		48,279			13,613			2,489
Net Cash Flows from Operating Activities		(56,150	)		118,264			15,359			180,216			(154,415	)		103,274
Investing Activities
Purchase of property, plant and equipment		—			—			(25,549	)		(15,236	)		—			(40,785	)
Plant turnaround expenditures		—			—			(13,458	)		(18,529	)		—			(31,987	)
Distributions received from unconsolidated affiliates		—			—			—			9,660			—			9,660
Changes in restricted cash		—			—			8,595			—			—			8,595
Proceeds from the sale of property, plant and equipment		—			—			7,544			2,122			—			9,666
Net Cash Flows from Investing Activities		—			—			(22,868	)		(21,983	)		—			(44,851	)
Financing Activities
Principal payments under borrowing arrangements		—			—			(22	)		(12	)		—			(34	)
Preferred share dividends paid		(3,825	)		—			—			—			—			(3,825	)
Proceeds from exercise of stock options		363			—			—			—			—			363
Payments under share repurchase program		(18,796	)		—			—			—			—			(18,796	)
Distributions to minority interests		—			—			(4,244	)		—			—			(4,244	)
Change in investments and advances from (to) affiliates		78,408			(146,853	)		34,015			(119,985	)		154,415			—
Net Cash Flows from Financing Activities		56,150			(146,853	)		29,749			(119,997	)		154,415			(26,536	)
Effect of Foreign Exchange Rate on Cash		—			—			—			3,917			—			3,917
Increase (decrease) in Cash and Cash Equivalents		—			(28,589	)		22,240			42,153			—			35,804
Cash and Cash Equivalents at Beginning of Year		1			11,508			67,372			7,486			(1	)		86,366
Cash and Cash Equivalents at End of Year	$	1		$	(17,081	)	$	89,612		$	49,639		$	(1	)	$	122,170

26

Consolidating Balance Sheet for the Year Ended December 31, 2005:

							Guarantor			Non-Guarantor
	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Assets
Cash, cash equivalents and restricted cash	$	1		$	11,508		$	75,967		$	7,486		$	(1	)	$	94,961
Accounts receivable, net		—			1,563			54,486			150,357			1			206,407
Inventories		—			—			60,350			119,061			10,903			190,314
Other current assets		9,198			12,704			9,720			22,763			193			54,578
Total current assets		9,199			25,775			200,523			299,667			11,096			546,260
Property, plant and equipment, net		—			—			275,223			458,313			—			733,536
Equity investments		—			—			—			183,884			—			183,884
Deferred plant turnaround costs, intangible and other assets		—			10,861			7,299			42,139			(354	)		59,945
Investments in and advances to (from) affiliates		747,233			536,937			1,358,920			618,155			(3,261,245	)		—
Total Assets	$	756,432		$	573,573		$	1,841,965		$	1,602,158		$	(3,250,503	)	$	1,523,625
Liabilities
Debt due within one year	$	—		$	—		$	26		$	12		$	—		$	38
Accounts payable		210			—			48,501			77,152			—			125,863
Accrued and other liabilities		3,119			92,984			54,855			63,670			(76,719	)		137,909
Total current liabilities		3,329			92,984			103,382			140,834			(76,719	)		263,810
Long-term debt and capital Lease obligations		—			331,300			—			—			—			331,300
Deferred income taxes		—			—			—			70,088			(4,090	)		65,998
Pension and other liabilities		148,793			—			11,173			1,591			(1	)		161,556
Minority interest		—			18,049			74,209			—			—			92,258
Total liabilities and minority interest		152,122			442,333			188,764			212,513			(80,810	)		914,922
Preferred stock		115,800			—			—			—			—			115,800
Stockholders’ equity
Common stock		146,994			—			73			49,709			(49,782	)		146,994
Paid in capital		712,671			150,218			1,741,688			1,473,065			(3,364,971	)		712,671
Accumulated other comprehensive income income (loss) and unearned compensation		(63,728	)		—			—			5,232			(17,016	)		(75,512	)
Retrained earnings (deficit)		(307,427	)		(18,978	)		(88,560	)		(138,361	)		262,076			(291,250	)
Total stockholders’ equity		488,510			131,240			1,653,201			1,389,645			(3,169,693	)		492,903
Total liabilities and stockholders’ equity	$	756,432		$	573,573		$	1,841,965		$	1,602,158		$	(3,250,503	)	$	1,523,625

27

Condensed Consolidating Balance Sheet as of September 30, 2005:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Assets
Cash and short-term investments and restricted cash	$	1		$	89,016		$	71,722		$	14,826		$	—		$	175,565
Accounts receivable, net		—			162			38,997			137,327			1			176,487
Inventories		—			—			31,702			101,341			11,920			144,963
Other current assets		28,842			3,051			10,117			42,780			2			84,792
Total current assets		28,843			92,229			152,538			296,274			11,923			581,807
Property, plant and equipment, net		—			—			283,422			484,754			(3,439	)		764,737
Equity method investments		—			—			—			190,805			—			190,805
Intangible other assets and deferred plant turnaround costs		2,650			11,400			8,680			21,583			3,441			47,754
Investments in and advanced to (from) affiliates		770,571			602,874			1,312,399			795,170			(3,481,014	)		—
Total assets	$	802,064		$	706,503		$	1,757,039		$	1,788,586		$	(3,469,089	)	$	1,585,103
Liabilities
Debt due within one year	$	—		$	—		$	49		$	28		$	—		$	77
Accounts payable		69			268			26,022			78,805			(1	)		105,163
Accrued and other liabilities		14,961			101,773			56,014			58,900			(74,449	)		157,199
Total current liabilities		15,030			102,041			82,085			137,733			(74,450	)		262,439
Long-term debt and capital lease obligations		—			331,300			4			—			—			331,304
Deferred income taxes		(2,044	)		—			—			91,802			5,897			95,655
Pension and other liabilities		104,431			(501	)		13,722			35,805			3			153,460
Minority interest		—			18,718			76,979			—			1			95,698
Total liabilities and minority interest		117,417			451,558			172,790			265,340			(68,549	)		938,556
Preferred stock		115,800			—			—			—			—			115,800
Stockholders’ Equity
Common stock		146,997			—			73			49,709			(49,782	)		146,997
Paid-in capital		712,681			150,218			1,747,295			1,478,729			(3,376,242	)		712,681
Accumulated other comprehensive income (loss) and unearned compensation		(57,834	)		—			—			22,022			(18,276	)		(54,088	)
Retained earnings (deficit)		(232,997	)		104,727			(163,119	)		(27,214	)		43,760			(274,843	)
Total stockholders’ equity		568,847			254,945			1,584,249			1,523,246			(3,400,540	)		530,747
Total liabilities and stockholders equity	$	802,064		$	706,503		$	1,757,039		$	1,788,586		$	(3,469,089	)	$	1,585,103

28

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

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	144,002		$	342,864		$	(2,784	)	$	484,082
Other income, net		—			—			(1,809	)		637			2,784			1,612
Total revenues		—			—			142,193			343,501			—			485,694
Cost and Expenses
Cost of sales		—			—			169,523			311,470			(34,085	)		446,908
Selling, general and administrative expenses		795			(1,136	)		(17,779	)		(3,532	)		31,791			10,139
Equity in the (earnings) loss of subsidiaries		(49,221	)		(59,410	)		—			(11,694	)		116,995			(3,330	)
Total cost & expenses		(48,426	)		(60,546	)		151,744			296,244			114,701			453,717
Income from operations		48,426			60,546			(9,551	)		47,257			(114,701	)		31,977
Interest income		—			382			1,390			(2,001	)		3,199			2,970
Interest expense		(491	)		(10,860	)		(10	)		4,513			(4,981	)		(11,829	)
Income before income taxes and minority interest		47,935			50,068			(8,171	)		49,769			(116,483	)		23,118
Income tax provision		3,688			—			—			(5,494	)		(5,898	)		(7,704	)
Minority interest		—			(847	)		(3,481	)		—			—			(4,328	)
Net Income	$	51,623		$	49,221		$	(11,652	)	$	44,275		$	(122,381	)	$	11,086

Condensed Consolidating Statement of Operations for the nine months ended September 30, 2005:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Revenues
Net sales	$	—		$	—		$	423,563		$	994,377		$	1,480		$	1,419,420
Other income, net		—			—			6,318			1,441			(1,480	)		6,279
Total revenues		—			—			429,881			995,818			—			1,425,699
Cost and Expenses
Cost of sales		—			—			425,415			878,700			(34,877	)		1,269,238
Selling, general and administrative expenses		1,892			(5,319	)		981			4,206			34,878			36,638
Equity in the (earnings) loss of subsidiaries		(82,905	)		(112,456	)		—			(46,166	)		228,790			(12,737	)
Total cost & expenses		(81,013	)		(117,775	)		426,396			836,740			228,791			1,293,139
Income from operations		81,013			117,775			3,485			159,078			(228,791	)		132,560
Interest income		—			1,886			3,754			(84	)		835			6,391
Interest expense		(1,472	)		(33,680	)		(20	)		(4,595	)		(2,045	)		(41,812	)
Loss on early retirement of debt		—			—			—			(27,193	)		—			(27,193	)
Change in fair value of warrant liability		8,860			—			—			—			—			8,860
Income before income taxes and minority interest		88,401			85,981			7,219			127,206			(230,001	)		78,806
Income tax provision		(10,645	)		—			—			(9,321	)		(5,898	)		(25,864	)
Minority interest		—			(3,076	)		(12,648	)		—			1			(15,723	)
Net Income	$	77,756		$	82,905		$	(5,429	)	$	117,885		$	(235,898	)	$	37,219

29

Condensed Consolidating Statement of Cash Flows for the nine months ended September 30, 2005:

							Guarantor			Non-Guarantor
(in thousands)	Parent			TCAPI			Subsidiaries			Subsidiaries			Eliminations			Consolidated
Operating Activities
Net income (loss)	$	77,756		$	82,905		$	(5,429	)	$	117,885		$	(235,898	)	$	37,219
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Noncash loss on early retirement of debt		—			—			—			22,543			—			22,543
Change in fair value of warrant liability		(8,860	)		—			—			—			—			(8,860	)
Depreciation and amortization		—			—			32,413			51,156			—			83,569
Deferred taxes		17,278			—			—			16,314			(4,039	)		29,553
Minority interest in earnings		—			3,076			12,648			—			(1	)		15,723
Equity earnings of unconsolidated affiliates		(82,905	)		(112,456	)		—			(46,166	)		228,790			(12,737	)
Noncash loss on derivatives		—			—			8,057			—			—			8,057
Amortization of unearned compensation		1,684			—			—			—			—			1,684
Term loan discount accretion		—			—			—			1,773			—			1,773
Change in operating assets and liabilities		(47,745	)		166,146			11,028			(60,890	)		(172,537	)		(103,998	)
Net Cash Flows from Operating Activities		(42,792	)		139,671			58,717			102,615			(183,685	)		74,526
Investing Activities
Purchase of property, plant and equipment		—			—			(2,047	)		(15,359	)		—			(17,406	)
Plant turnaround expenditures		—			—			—			(9,677	)		—			(9,677	)
Distributions received from unconsolidated affiliates		—			—			—			33,125			—			33,125
Restricted cash		—			—			(8,861	)		—			—			(8,861	)
Proceeds from the sale of property, plant and equipment		168			—			—			6,485			(168	)		6,485
Net Cash Flows from Investing Activities		168			—			(10,908	)		14,574			(168	)		3,666
Financing Activities
Payments under borrowings arrangements		—			—			(77	)		(125,047	)		—			(125,124	)
Preferred share dividends paid		(4,675	)		—			—			—			—			(4,675	)
Change in investments and advances from (to) affiliates		47,139			(252,954	)		—			22,121			183,694			—
Proceeds from exercise of stock options		160			—			—			—			—			160
Stock issuance		—			—			(3,583	)		—			3,583			—
Distributions to minority interests		—			(2,392	)		(9,831	)		—			—			(12,223	)
Net Cash Flows from Financing Activities		42,624			(255,346	)		(13,491	)		(102,926	)		187,277			(141,862	)
Effect of Foreign Exchange Rate on Cash		—			—			—			—			(3,424	)		(3,424	)
Increase (decrease) in Cash and Short-term Investments		—			(115,675	)		34,318			14,263			—			(67,094	)
Cash and Short-term Investments at Beginning of Year		1			204,691			28,543			563			—			233,798
Cash and Short-term Investments at End of Year	$	1		$	89,016		$	62,861		$	14,826		$	—		$	166,704

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

Introduction

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

Natural gas is the most significant raw material in the production of nitrogen products. During the third quarter of 2005, the cost of natural gas increased to unprecedented levels due to supply disruptions caused by Hurricanes Katrina and Rita. During 2006, the cost of natural gas declined.

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

During the three- and nine-month periods ending September 30, 2006, Terra’s manufacturing plants operated at approximately 87 and 79 percent, respectively, of capacity in response to slow demand and high natural gas cost. Much of the curtailed production was replaced with purchased product from other suppliers.

During the second quarter of 2006 the Company’s ammonia production plant in Billingham, England incurred damage due to an explosion from a ruptured pipe. The repairs were completed and ammonia production resumed during the third quarter of 2006.

Terra’s sales volumes depend primarily on its plants’ operating rates. The Company also purchases product from other manufacturers and importers for resale; however, historic gross margins on these volumes have not been significant. Profitability and cash flows from Terra’s nitrogen products business are affected by the Company’s ability to manage its costs and expenses (other than natural gas), most of which do not materially change for different levels of production or sales. Other factors affecting Terra’s nitrogen products results include the level of planted acres, transportation costs, weather conditions (particularly during the planting season), grain prices and other variables described in Item 1 ��Business” and Item 2 “Properties” sections of Terra’s 2005 Form 10-K filing with the Securities and Exchange Commission.

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RESULTS OF OPERATIONS

QUARTER ENDED SEPTEMBER 30, 2006 COMPARED WITH
QUARTER ENDED SEPTEMBER 30, 2005

Consolidated Results

Terra reported net income of $10.3 million for the 2006 third quarter compared with 2005 net income of $11.1 million. The net income decrease is primarily due to lower sales volumes and lower sales prices, partially offset by lower natural gas costs.

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

Total revenues and income (loss) from operations by segment for the three-month period ended September 30, 2006 and 2005 follow:

(in thousands)	2006			2005
REVENUES:
Nitrogen Products	$	442,612		$	478,118
Methanol		18,921			5,964
Other		3,248			1,612
	$	464,781		$	485,694
INCOME (LOSS) FROM OPERATIONS:
Nitrogen Products	$	20,409		$	38,971
Methanol		9,405			(6,673	)
Other		(426	)		(321	)
	$	29,388		$	31,977

Nitrogen Products

Volumes and prices for the three-month periods ended September 30, 2006 and 2005 are:

VOLUMES AND PRICES

	2006				2005
	Sales		Average		Sales		Average
(quantities in thousands of tons)	Volumes		Unit Price*		Volumes		Unit Price*
Ammonia		466	$	281		428	$	293
Nitrogen solutions		1,031	$	129		1,120	$	154
Urea		32	$	236		38	$	257
Ammonium nitrate		323	$	226		461	$	204

* After deducting outbound freight costs

Nitrogen products segment revenues for the quarter ended September 30, 2006 decreased $35.5 million, or 7%, compared with the same 2005 quarter primarily due to lower nitrogen solutions and ammonium nitrate sales volumes and lower prices for ammonia, nitrogen solutions and urea. Price decreases reflected industry-wide decreased manufacturing costs, primarily related to natural gas. The nitrogen solution and

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ammonium nitrate sales volumes decreased due to decreased operating production in the 2006 third quarter as compared to the 2005 third quarter.

Operating income for the 2006 third quarter was $20.4 million, which was $18.6 million less than the $39.0 million in the 2005 third quarter. Lower third quarter unit prices and sales volumes decreased 2006 operating income approximately $20.0 million and $5.0 million, respectively. These factors were partially offset by lower third quarter 2006 costs of $6.4 million, comprised primarily of natural gas decreases of $27.4 million and higher freight and purchased product costs of $12.8 million. During the third quarter of 2006, the Company incurred approximately $8.2 million of repairs and additional costs for purchased ammonia due to damage from the incident at the Billingham, England ammonia plant.

Methanol

For the three months ended September 30, 2006 and 2005, the Methanol segment had revenues of $18.9 million and $6.0 million, respectively. In the 2005 third quarter, approximately 9.8 million gallons of methanol were sold at the Woodward, Oklahoma facility compared to approximately 6.8 million gallons of methanol sold in the 2006 third quarter.

The Company recorded profit sharing revenue of $11.6 million in the third quarter 2006 from the Methanex supply agreement due to continued cessation of the Beaumont operations. Under the terms of the Methanex supply agreement, profit sharing revenue can be earned whether the Beaumont facility is operating or not. Revenue is recognized when the estimated margin on an annualized basis is probable. The supply agreement limits the margin to $12.0 million on an annual basis. The third quarter of 2005 methanol results included a $3.3 million charge under the Beaumont production contract with Methanex due to the high natural gas costs during the 2005 third quarter.

The methanol segment had operating income of $9.4 million for the 2006 third quarter compared to operating loss of $6.7 million for the 2005 third quarter.

Selling, General and Administrative (SGA) Expense

The third quarter 2006 SGA expense increased $3.5 million to $13.7 million as compared to the 2005 third quarter. The increase is primarily due to higher legal, engineering and consulting fees associated with potential facility expansion in Trinidad.

Equity in Earnings of Unconsolidated Affiliates

Equity in earnings of unconsolidated affiliates decreased $2.5 in the 2006 third quarter as compared to the 2005 third quarter. The decrease is primarily due to lower operating rates in the third quarter 2006 associated with plant repair activities at Point Lisas Nitrogen Limited in Trinidad.

Minority Interest

Minority interest represents third-party interests in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2006 and 2005 amounts are directly related to TNCLP earnings and losses.

Income Taxes

Income taxes for the third quarter 2006 were recorded based on the estimated effective tax rate for the individual jurisdictions in which Terra operates. The annual effective tax rate was 36.7% and 41% in the

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quarters ended September 30, 2006 and 2005, respectively. The tax rate decrease was due primarily to losses in the United Kingdom operations at lower benefit rate of 30% as compared to higher rates in the United States and Canada and permanent differences.

RESULTS OF OPERATIONS

NINE MONTHS ENDED SEPTEMBER 30, 2006 COMPARED WITH
NINE MONTHS ENDED SEPTEMBER 30, 2005

Consolidated Results

Terra reported net loss of $7.4 million for the 2006 first nine months compared with a 2005 net income of $37.2 million. The 2005 net income included the effects of $27.2 million in losses on the early retirement of long-term debt and $8.9 million for gains on the revaluation of warrants. The net income decrease in 2006 is primarily due to decreased sales volumes and higher natural gas costs as well as costs of approximately $15.6 million of plant outages and repair from the UK operations resulting from an explosion during the 2006 second quarter. The decreased sales volumes is primarily due to fertilizer customers’ response to higher sales prices and the curtailment of certain production facilities as the result of the increased natural gas costs during the 2006 first quarter.

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

Total revenues and income (loss) from operations by segment for the nine-month period ended September 30, 2006 and 2005 follow:

(in thousands)	2006			2005
REVENUES:
Nitrogen Products	$	1,355,574		$	1,393,503
Methanol		25,510			25,917
Other		6,135			6,279
	$	1,387,219		$	1,425,699
INCOME (LOSS) FROM OPERATIONS:
Nitrogen Products	$	25,098		$	144,469
Methanol		3,363			(9,762	)
Other		(1,017	)		(2,147	)
	$	27,444		$	132,560

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Nitrogen Products

Volumes and prices for the nine-month periods ended September 30, 2006 and 2005 are:

VOLUMES AND PRICES

	2006				2005
	Sales		Average		Sales		Average
(quantities in thousands of tons)	Volumes		Unit Price*		Volumes		Unit Price*
Ammonia		1,417	$	320		1,446	$	286
Nitrogen solutions		2,799	$	143		3,305	$	150
Urea		116	$	267		124	$	252
Ammonium nitrate		879	$	226		1,199	$	198

* After deducting outbound freight costs

Nitrogen products segment revenues for the nine months ended September 30, 2006 declined $37.9 million compared with the same 2005 first nine months primarily due to lower sales volumes, offset by increased prices. Price increases reflected industry-wide increased manufacturing costs, primarily related to natural gas. However, the price increases and decreased acres of planted corn caused the Company’s customers to reduce 2006 nitrogen product purchases from the prior year.

The operating income for the 2006 first nine months was $25.1 million and was $119.4 million less than the $144.5 million in the 2005 first nine months. Higher 2006 unit prices contributed about $60.1 million to operating income, but were more than offset by higher costs for natural gas and purchased nitrogen products. First nine months 2006 gross profits also declined $23.2 million from 2005 as the result of lower sales volumes. The 2006 costs increased $140.7 million as compared to 2005 costs, which includes $53.6 million in higher natural gas costs and $87.1 million higher costs, primarily related to freight and purchased product costs. First nine months 2006 natural gas costs includes the effects of forward price contracts that were $42.3 million higher than spot prices. In addition, the 2006 first nine-months manufacturing output was curtailed to about 80% of capacity in response to slow demand and high natural gas costs with some of the curtailed production replaced by purchased product. During the second and third quarters of 2006, the Company incurred approximately $15.6 million of repairs and additional costs for purchased ammonia due to damage from the incident at the Billingham, England ammonia plant.

Methanol

For the nine months ended September 30, 2006 and 2005, the Methanol segment had revenues of $25.5 million and $25.9 million, respectively. In the 2005 first nine months, approximately 26.8 million gallons of methanol were sold at the Woodward, Oklahoma facility compared to approximately 11.6 million gallons of methanol sold in the 2006 first nine months.

During 2006, the Company recorded profit sharing revenue of $11.6 million under the Methanex supply contract due to the continued cessation of the Beaumont operations. Under the terms of the Methanex supply agreement, profit sharing revenue can be earned whether the Beaumont facility is operating or not. Revenue is recognized when the estimated margin on an annualized basis is probable. The supply agreement limits the margin to $12.0 million on an annual basis.

The methanol segment had operating income of $3.4 million for the 2006 first nine months compared to operating loss of $9.8 million for the 2005 first nine months.

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Interest Expense

Interest expense decreased approximately $6.5 million to $35.3 million during the 2006 first nine months as compared to $41.8 million for the prior year period due primarily to repayment of approximately $125.0 million of debt during 2005 first and second quarters.

Minority Interest

Minority interest represents third-party interests in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2006 and 2005 amounts are directly related to TNCLP earnings and losses.

Income Taxes

Income taxes for the first nine months of 2006 were recorded based on the estimated annual effective tax rate for the individual jurisdictions in which Terra operates. The annual effective tax rate was 21.3% and 41% in the first nine months ended September 30, 2006 and 2005, respectively. The tax rate increase was due primarily to losses in the United Kingdom operations at a lower benefit rate of 30% as compared to higher rates in the United States and Canada and permanent differences.

LIQUIDITY AND CAPITAL RESOURCES

Cash and cash equivalents totaled $122.2 million at September 30, 2006. Terra’s primary uses of funds are to fund its working capital requirements, make payments on its debt and other obligations, repurchase up to 10 percent of its common stock and fund plant turnarounds and capital expenditures. The principle sources of funds will be cash flow from operations and borrowings under available bank facilities.

Net cash provided by operations in the first nine months of 2006 was $103.3 million, composed of $100.8 million of cash provided from operating activities and $2.5 million from working capital changes. The primary working capital needs were to fund $38.9 million of accounts payable and customer prepayment reductions for seasonal customer shipments and lower natural gas values at the end of the first nine months. These needs were offset by declines to accounts receivable and inventories of $25.8 million and $36.6 million, respectively.

During the first nine months, Terra funded plant and equipment purchases of $40.8 million primarily for replacement or stay-in-business capital needs. Plant turnaround costs represent cash used for the periodic scheduled major maintenance of the Company’s continuous process production facilities that is performed at each plant, generally every two years. Terra funded $32.0 million of plant turnaround costs in the first nine months of 2006.

The total distributions from the company equity-method investments was $34.6 million and $33.1 million for the nine month periods ended September 30, 2006 and 2005, respectively.

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In April 2006, the Board of Directors authorized the Company to repurchase a maximum of 10%, or 9,516,817 shares, of its outstanding common stock on the open market in private transactions or otherwise. During the 2006 first nine months, the Company’s repurchases under the stock buyback program were:

	Number of		Average Price		Total Cost
(in thousands, except average	Shares		of Shares		of Shares
price of shares repurchased)	Repurchased		Repurchased		Repurchased
April 2006		—	$	—	$	—
May 2006		488		7.49		3,655
June 2006		1,557		6.92		10,767
July 2006		—		—		—
August 2006		560		6.93		3,879
September 2006		70		7.03		495
		2,675	$	7.03	$	18,796

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

The Company paid dividends on the outstanding preferred stock of $1.3 million and $3.8 million for the three- and nine-month periods, respectively ending September 30, 2006. The Company paid dividends on the outstanding preferred stock of $1.3 million and $4.7 million for the three- and nine-month periods ending September 30, 2005.

Distributions paid to the minority TNCLP common unitholders in the first nine months of 2006 and 2005 were $4.2 million and $12.2 million, respectively. TNCLP distributions are based on “Available Cash” as defined in the Partnership Agreement.

Terra has revolving credit facilities totaling $200 million that expire in September 2008. Borrowing availability under the credit facility is generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible inventory, less outstanding letters of credit. These facilities include $50 million only available for the use of TNCLP, one of Terra’s consolidated subsidiaries. At September 30, 2006, the Company had borrowing availability of $200 million. There were no outstanding revolving credit borrowings and there were $17.6 million in outstanding letters of credit, resulting in remaining borrowing availability of approximately $182.4 million under the facilities. The Company is required to maintain a combined minimum unused borrowing availability of $30 million. The credit facility also requires that the Company adhere to certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. In addition, if the Company’s borrowing availability falls below a combined $60 million, the Company is required to have generated $60 million of operating cash flows, or earnings before interest, income taxes, depreciation, amortization and other non-cash items (as defined in the credit facility) for the preceding four quarters.

The Company’s ability to meet credit facility covenants will depend on future operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to meet these covenants could result in additional costs and fees to amend the credit facility or could result in termination of the facility. Access to adequate bank facilities is critical to funding the Company’s operating cash needs. Based on current market conditions for our finished products and natural gas, the Company anticipates that it will be able to meet its covenants through 2006. If there were to be any adverse changes in the factors discussed above, the Company may need a waiver of its credit facility covenants, of which, there is no assurance that the Company could receive such waivers.

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There were no material changes outside the ordinary course of business to the Company’s contractual obligations presented in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of the Annual Report on Form 10-K for the period ended December 31, 2005.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risks relating to Terra’s operations result primarily from interest rates, foreign exchange rates, natural gas prices and nitrogen prices. Terra manages its exposure to these and other market risks through regular operating and financing activities and through the use of derivative financial instruments. Terra intends to use derivative financial instruments as risk management tools and not for speculative investment purposes. Item 7A, Quantitative and Qualitative Disclosures About Market Risk, of Terra’s Annual Report on Form 10-K for the year ended December 31, 2005 provides more information as to the types of practices and instruments used to manage risk. Natural gas prices have decreased substantially from December 31, 2005.

ITEM 4. CONTROLS AND PROCEDURES

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

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

FORWARD-LOOKING PRECAUTIONS

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

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

There were no significant changes in the Company’s risk factors during 2006 as compared to the risk factors identified in the Company’s 2005 Form 10-K.

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

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None

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

None

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ITEM 5. OTHER INFORMATION

Company Purchases of Equity Securities

The following table provides information about shared repurchases by the Company during the quarter ended September 30, 2006.

					Total Number of
	Total				Shares Purchased as		Maximum Number of
Month of	Number of		Average		Part of Publicly		Shares that May Yet Be
Share	Shares		Price Paid		Announced Plans or		Purchased Under the
Purchases	Purchased		per Share		Programs		Plans or Programs
April 2006		—	$	—		—		9,516,817
May 2006		488,100		7.49		488,100		9,028,717
June 2006		1,556,500		6.92		2,044,600		7,472,217
July 2006		—		—		2,044,600		7,472,217
August 2006		560,000		6.93		2,604,600		6,912,217
September 2006		70,500		7.03		2,675,100		6,841,717

On April 25, 2006, the Board of Directors authorized the Company to repurchase a maximum of 10 percent, or 9,516,817 shares, of its outstanding common stock. The stock buyback program has been and will be conducted on the open market, in private transactions or otherwise at such times prior to June 30, 2008, and at such prices, as determined appropriate by the Company. During 2006, the Company repurchased 2,675,100 shares at an average price of $7.03. The remaining number of shares that the Company is authorized to repurchase is 6,841,717 at September 30, 2006.

The calculation of the average price paid per share does not include the effect for any fees, commissions or other costs associated with the repurchase of such shares.

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ITEM 6. EXHIBITS

     (a) Exhibits

Exhibit *4.1	Amendment No. 3 to the Amended and Restated Credit Agreement dated July 29, 2005, among Terra Capital, Inc., Terra Mississippi Holdings Corp. (f/k/a Mississippi Chemical Corporation) and Terra Nitrogen (U.K.) Limited (collectively “Borrowers”), Terra Industries Inc., Terra Capital Holdings, Inc., the Lenders party hereto and Citicorp USA, Inc. as administrative agent for the Lenders and issuers.
Exhibit *31.1	Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit *31.2	Certification of the Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
Exhibit *32	Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

* filed herewith

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SIGNATURE

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

	TERRA INDUSTRIES INC.
Date: November 1, 2006	/s/ Francis G. Meyer
	Francis G. Meyer
	Senior Vice President and Chief Financial Officer and a duly authorized signatory

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