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 June 30, 2007

OR

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

For the transition period from                      to                     

Commission file number: 1-8520

TERRA INDUSTRIES INC.

(Exact name of registrant as specified in its charter)

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

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 filer o		Accelerated filer þ		Non-accelerated filer o

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

As of July 23, 2007, the following shares of the registrant’s stock were outstanding:

Common Shares, without par value		91,856,667 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			7
		Notes to Consolidated Financial Statements			8
Item 2.		Management Discussion and Analysis of Financial Condition and Results of Operations			29
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			36
Item 4.		Controls and Procedures			36
Part II — OTHER INFORMATION
Item 1.		Legal Proceedings			37
Item 1A.		Risk Factors			37
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			37
Item 3.		Defaults upon Senior Securities			37
Item 4.		Submission of Matters to a Vote of Security Holders			38
Item 5.		Other Information			39
Item 6.		Exhibits			40
Exhibit 31.1
Exhibit 31.2
Exhibit 32

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TERRA INDUSTRIES INC.
CONSOLIDATED BALANCE SHEETS
(in thousands)
(unaudited)

		June 30,				December 31,				June 30,
		2007				2006				2006
Assets
Cash and cash equivalents		$	286,950			$	179,017			$	85,243
Accounts receivable, less allowance for doubtful accounts of $422, $333 and $110			242,415				198,791				195,504
Inventories			169,674				211,017				169,865
Other current assets			23,342				31,680				13,194
Total current assets			722,381				620,505				463,806
Property, plant and equipment, net			702,106				720,897				737,883
Equity method investments			165,201				164,099				160,691
Deferred plant turnaround costs, net			41,375				44,558				36,848
Intangible assets, net			4,704				5,645				6,586
Other assets			23,299				17,009				27,657
Total assets		$	1,659,066			$	1,572,713			$	1,433,471
Liabilities
Accounts payable			143,904				156,493				118,580
Customer prepayments			25,166				77,091				13,589
Accrued expenses and other current liabilities			110,390				75,863				62,695
Total current liabilities			279,460				309,447				194,864
Long-term debt and capital lease obligations			330,000				331,300				331,300
Pension liabilities			119,407				134,444				119,900
Other liabilities			157,801				104,039				95,573
Minority interest			105,549				94,687				95,905
Total liabilities and minority interest			992,217				973,917				837,542
Preferred Stock - liquidation value of $120,000			115,800				115,800				115,800
Common Shareholders’ Equity
Capital stock
Common Shares, authorized 133,500 shares; 91,857; 92,630 and 93,215 outstanding			144,202				144,976				145,044
Paid-in capital			680,819				693,896				696,861
Accumulated other comprehensive loss			(57,149	)			(63,739	)			(50,241	)
Accumulated deficit			(216,823	)			(292,137	)			(311,535	)
Total common shareholders’ equity			551,049				482,996				480,129
Total liabilities and minority interest, preferred stock and common shareholders’ equity		$	1,659,066			$	1,572,713			$	1,433,471

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(in thousands, except per-share amounts)
(unaudited)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2007				2006				2007				2006
Revenues
Product revenues		$	691,164			$	521,808			$	1,190,794			$	919,551
Other income			2,651				1,712				5,307				2,888
Total revenues			693,815				523,520				1,196,101				922,439
Costs and Expenses
Cost of sales			536,043				491,170				962,219				914,686
Selling, general and administrative expense			28,194				13,006				45,251				24,716
Equity in loss (earnings) of unconsolidated affiliates			804				(6,880	)			(4,813	)			(15,021	)
Total cost and expenses			565,041				497,296				1,002,657				924,381
Income (loss) from operations			128,774				26,224				193,444				(1,942	)
Interest income			3,482				1,824				6,369				3,408
Interest expense			(6,871	)			(11,782	)			(15,780	)			(23,554	)
Loss on early retirement of debt			(174	)			—				(38,836	)			—
Income (loss) before income taxes and minority interest			125,211				16,266				145,197				(22,088	)
Income tax (provision) benefit			(40,617	)			(5,766	)			(44,757	)			8,000
Minority interest			(13,939	)			(4,243	)			(22,576	)			(3,647	)
Net income (loss)			70,655				6,257				77,864				(17,735	)
Preferred share dividends			(1,275	)			(1,275	)			(2,550	)			(2,550	)
Net Income (Loss) Available to Common Shareholders		$	69,380			$	4,982			$	75,314			$	(20,285	)
Basic and diluted income (loss) per share:
Basic		$	0.76			$	0.05			$	0.82			$	(0.22	)
Diluted		$	0.66			$	0.05			$	0.73			$	(0.22	)
Basic and diluted weighted average shares outstanding:
Basic			91,496				93,317				91,677				93,592
Diluted			107,294				95,212				107,311				93,592

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(in thousands)
(unaudited)

		Six Months Ended
		June 30,
		2007				2006
Operating Activities
Net income (loss)		$	77,864			$	(17,735	)
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			54,360				52,696
Deferred income taxes			34,981				(8,000	)
Minority interest in earnings			22,576				3,647
Distributions in excess of (less than) equity earnings			(3,813	)			9,944
Non-cash loss on derivatives			624				1,573
Share-based compensation			13,681				2,317
Amortization of intangible and other assets			4,485				5,165
Non cash loss on early retirement of debt			4,662				—
Changes in operating assets and liabilities:
Accounts receivable			(40,420	)			16,200
Inventories			48,192				27,994
Accounts payable and customer prepayments			(65,789	)			(49,790	)
Other assets and liabilities, net			31,438				(1,928	)
Net cash flows from operating activities			182,841				42,083
Investing Activities
Purchase of property, plant and equipment			(13,496	)			(26,636	)
Plant turnaround expenditures			(20,320	)			(22,112	)
Distributions received from unconsolidated affiliates			—				9,660
Changes in restricted cash			—				8,595
Proceeds from the sale of property, plant and equipment			—				275
Net cash flows from investing activities			(33,816	)			(30,218	)
Financing Activities
Issuance of debt			330,000				—
Payments under borrowings arrangements			(331,300	)			(30	)
Payments for debt issuance costs			(6,398	)			—
Preferred share dividends paid			(2,550	)			(2,550	)
Proceeds from exercise of stock options			406				363
Payments under share repurchase program			(19,211	)			(14,428	)
Distributions to minority interests			(11,714	)			—
Net cash flows from financing activities			(40,767	)			(16,645	)
Effect of exchange rate changes on cash			(325	)			3,657
Increase (decrease) to cash and cash equivalents			107,933				(1,123	)
Cash and cash equivalents at beginning of period			179,017				86,366
Cash and cash equivalents at end of period		$	286,950			$	85,243

See Accompanying Notes to the Consolidated Financial Statements.

Consolidated Statements of Cash Flows (continued)

		Six Months ended
		June 30
		2007				2006
Supplemental cash flow information:
Interest paid		$	472			$	21,066
Income tax refunds received		$	547			$	—
Income taxes paid		$	5,198			$	1,046
Supplemental schedule of unconsolidated affiliates distributions received:
Equity in earnings of unconsolidated affiliates		$	4,813			$	15,021
Distribution in excess of (less than) equity earnings			(3,813	)			9,944
Distributions received from unconsolidated affiliates			—				9,660
Total cash distributions received from unconsolidated affiliates		$	1,000			$	34,625

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.
CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS’ EQUITY
SIX MONTHS ENDED JUNE 30, 2007 AND 2006
(in thousands)
(unaudited)

										Accumulated
										Other
		Common				Paid-In				Comprehensive				Accumulated								Comprehensive
		Stock				Capital				Loss				Deficit				Total				Income
Balance at January 1, 2007		$	144,976			$	693,896			$	(63,739	)		$	(292,137	)		$	482,996
Comprehensive income (loss):
Net income			—				—				—				77,864				77,864			$	77,864
Foreign currency translation adjustment			—				—				11,486				—				11,486				11,486
Change in fair value of derivatives, net of taxes of $3,665			—				—				(6,809	)			—				(6,809	)			(6,809	)
Pension and post retirement benefit liabilities			—				—				1,913				—				1,913				1,913
Comprehensive income																						$	84,454
Preferred share dividends			—				—				—				(2,550	)			(2,550	)
Exercise of stock options			226				180				—				—				406
Shares purchased and retired under share repurchase program			(1,000	)			(18,211	)			—				—				(19,211	)
Share-based compensation			—				4,954				—				—				4,954
Balance at June 30, 2007		$	144,202			$	680,819			$	(57,149	)		$	(216,823	)		$	551,049

										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			—				—				—				—				(17,735	)			(17,735	)		$	(17,735	)
Foreign currency translation adjustment			—				—				19,371				—				—				19,371				19,371
Change in fair value of derivatives, net of taxes of $321			—				—				531				—				—				531				531
Comprehensive income																										$	2,167
Preferred share dividends			—				—				—				—				(2,550	)			(2,550	)
Exercise of stock options			95				268				—				—				—				363
Shares purchased and retired under share repurchase program			(2,045	)			(12,383	)			—				—				—				(14,428	)
Reclassification for adoption of FAS 123 R			—				(5,369	)			—				5,369				—				—
Share-based compensation			—				1,674				—				—				—				1,674
Balance at June 30, 2006		$	145,044			$	696,861			$	(50,241	)		$	—			$	(311,535	)		$	480,129

See Accompanying Notes to the Consolidated Financial Statements.

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 2006 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. The Company classifies amounts directly or indirectly billed to its customers for shipping and handling as revenue.

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. The Company classifies amounts directly or indirectly billed for delivery of products to its customers or its terminals as cost of sales.

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.

Inventories

Inventories are stated at the lower of average cost or estimated net realizable value. The Company performs a monthly analysis of its inventory balances to determine if the carrying amount of inventories exceeds its net realizable value. The analysis of estimated realizable value is based on customer orders, market trends, and historical pricing. If the carrying amount exceeds the estimated net realizable value, the carrying amount is reduced to the estimated net realizable value.

Production costs include the cost of direct labor and materials, depreciation and amortization, and overhead costs related to manufacturing activity. The cost of inventories is determined using the first- in, first-out method.

The Company estimates a reserve for obsolescence and excess of its materials and supplies inventory. Inventory is stated net of the reserve.

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.

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 six-month periods ended June 30, 2007 and 2006:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands, except per-share amounts)		2007				2006				2007				2006
Basic income (loss) per share computation:
Income (loss) from continuing operations		$	70,655			$	6,257			$	77,864			$	(17,735	)
Less: Preferred share dividends			(1,275	)			(1,275	)			(2,550	)			(2,550	)
Income (loss) available to common shareholders		$	69,380			$	4,982			$	75,314			$	(20,285	)
Weighted average shares outstanding			91,496				93,317				91,677				93,592
Basic income (loss) per common share		$	0.76			$	0.05			$	0.82			$	(0.22	)
Diluted income (loss) per share computation:
Income (loss) available to common shareholders		$	69,380			$	4,982			$	75,314			$	(20,285	)
Add: Preferred share dividends			1,275				—				2,550				—
Income (loss) available to common shareholders and assumed conversions		$	70,655			$	4,982			$	77,864			$	(20,285	)
Weighted average shares outstanding			91,496				93,317				91,677				93,592
Add incremental shares from assumed conversions:
Preferred shares			12,048				—				12,048				—
Nonvested stock			753				681				681				—
Common stock warrants			2,887				1,042				2,760				—
Common stock options			110				172				145				—
Dilutive potential common shares			107,294				95,212				107,311				93,592
Diluted income (loss) per common share		$	0.66			$	0.05			$	0.73			$	(0.22	)

For the three- and six-month periods ended June 30, 2006, 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. For the three-month period ending June 30, 2006, 120,000 preferred shares were excluded from the computation of diluted earnings per share. These preferred shares were antidilutive using the if-converted method.

For the six-month period ended June 30, 2006, all preferred shares, nonvested stock 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 six-month period ended June 30, 2006.

3.

Inventories

Inventories consisted of the following:

		June 30,				December 31,				June 30,
(in thousands)		2007				2006				2006
Raw materials		$	23,187			$	26,583			$	23,500
Supplies			49,882				54,542				55,517
Finished goods			96,605				129,892				90,848
Total		$	169,674			$	211,017			$	169,865

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 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 may 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. At June 30, 2007 there were no collars outstanding.

The following summarizes open natural gas derivative contracts at June 30, 2007 and 2006 and December 31, 2006:

		Other				Other
		Current				Current				Deferred				Net
(in thousands)		Assets				Liabilities				Taxes				Asset (Liability)
June 30, 2007		$	2,523			$	(30,749	)		$	10,040			$	(18,186	)
December 31, 2006		$	4,731			$	(22,591	)		$	6,373			$	(11,487	)
June 30, 2006		$	1,347			$	(9,984	)		$	2,455			$	(6,182	)

Certain derivatives outstanding at June 30, 2007 and 2006, which settled during July 2007 and 2006, respectively, are included in the position of open natural gas derivatives in the table above. The July 2007 derivatives settled for an approximate $5.5 million loss. Substantially all open derivatives will settle during the next 12 months.

At June 30, 2007, the Company determined that certain derivative contracts were ineffective hedges for accounting purposes and recorded a charge of $0.3 million to cost of sales for the three-month period and a credit of $0.5 million for the six-month period ending June 30, 2007. Derivatives outstanding at June 30, 2006 included a loss of $1.6 million that was recorded as an ineffective position and a charge to cost of sales for the three- and six-months ending June 30, 2006.

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 June 30, 2007 and 2006 follows:

		Three Months Ended
		June 30,
		2007								2006
(in thousands)		Gross				Net of tax				Gross				Net of tax
Beginning accumulated gain (loss)		$	4,210			$	2,736			$	(3,962	)		$	(2,599	)
Reclassification into earnings			(2,375	)			(1,544	)			7,727				4,950
Net change in market value			(30,519	)			(19,837	)			(10,799	)			(6,929	)
Ending accumulated gain (loss)		$	(28,684	)		$	(18,645	)		$	(7,034	)		$	(4,578	)

The activity to accumulated other comprehensive income (loss), net of income taxes, relating to current period hedging transactions for the six-month periods ended June 30, 2007 and 2006 follows:

		Six Months Ended
		June 30,
		2007								2006
(in thousands)		Gross				Net of tax				Gross				Net of tax
Beginning accumulated gain (loss)		$	(18,210	)		$	(11,836	)		$	(7,886	)		$	(5,109	)
Reclassification into earnings			352				229				42,590				27,611
Net change in market value			(10,826	)			(7,038	)			(41,738	)			(27,080	)
Ending accumulated gain (loss)		$	(28,684	)		$	(18,645	)		$	(7,034	)		$	(4,578	)

At times, the Company also uses forward derivative instruments to fix or set floor prices for a portion of its nitrogen sales volumes. At June 30, 2007, the Company had open contracts covering 45,000 tons of nitrogen solutions. When outstanding, the nitrogen solution contracts do not qualify for hedge treatment due to inadequate trading history to demonstrate effectiveness. Consequently, these contracts are marked-to-market and unrealized gains or losses are reflected in revenue in the statement of operations. For the three- and six-month periods ending June 30, 2007, the Company recognized a loss of $1.1 million and $2.0 million, respectively, on nitrogen forward derivative instruments. For the three- and six-month periods ending June 30, 2006, there were no gains or losses on nitrogen forward derivative instruments.

5.

Unrecognized Tax Benefit

The Company adopted the provision of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty to Income Taxes (FIN 48), on January 1, 2007. Under FIN 48, tax benefits are recorded only for tax positions that are more likely than not to be sustained upon examination by tax authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50% likely to be realized upon ultimate settlement. Unrecognized tax benefits are tax benefits claimed in the Company’s tax returns that do not meet these recognition and measurement standards.

The primary jurisdictions in which the Company or one of its subsidiaries files income tax returns are the United States, Canada and the United Kingdom. In most United States jurisdictions, the Company has significant net operating loss (“NOL”) carryforwards that date back to 1999 and will remain subject to examination by tax authorities as those NOL positions may be used to offset future taxable earnings. For jurisdictions in Canada and the United Kingdom, income tax returns remain subject to examination by tax authorities for calendar years beginning in 2001 and 2005, respectively.

The adoption of FIN 48 had no impact on the Company’s financial statements. The Company’s other liabilities include an unrecognized tax benefit of $33.5 million at June 30, 2007, which had been previously recognized under FASB Statement No. 5 Accounting for Contingencies or FASB Statement No. 109 Accounting for Income Taxes. There were no changes in unrecognized tax positions during the period, and there are no expected changes in the next twelve months. If recognized, the $33.5 million of unrecognized tax benefit would have an impact on the effective tax rate.

When applicable, the Company recognizes interest accrued and penalties related to unrecognized tax benefits in income taxes on the statement of operations. Due to the Company’s NOL carryforward position, no interest or penalties were recognized at June 30, 2007.

6.

Other Liabilities

Other liabilities consisted of the following:

		June 30,				December 31,				June 30,
(in thousands)		2007				2006				2006
Deferred income taxes		$	66,186			$	63,851			$	57,173
Unrecognized tax benefit			33,560				—				—
Long-term medical and closed facility reserve			23,618				23,206				23,679
Other			34,437				16,982				14,721
		$	157,801			$	104,039			$	95,573

7.

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 $165.2 million at June 30, 2007. Terra includes the net earnings of these investments as an element of income from operations since the investees’ operations provide additional capacity to Terra.

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands)		2007				2006				2007				2006
Condensed income statement information:
Net sales		$	25,696			$	47,197			$	55,059			$	101,865
Net income		$	2,382			$	12,199			$	9,494			$	28,481
Terra’s (loss) equity in earnings of unconsolidated affiliates		$	(804	)		$	6,880			$	4,813			$	15,021

		June 30,				June 30,
(in thousands)		2007				2006
Condensed balance sheet information:
Current assets		$	51,141			$	41,210
Long-lived assets			201,217				200,317
Total assets		$	252,358			$	241,527
Current liabilities		$	24,502			$	31,929
Long-term liabilities			—				—
Equity			227,856				209,598
Total liabilities and equity		$	252,358			$	241,527

The carrying value of these investments at June 30, 2007 was $51.3 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’s equity in earnings of unconsolidated subsidiaries is different than its ownership interest in income reported by the unconsolidated subsidiaries due to different accounting policies, deferred profits on intergroup transactions and amortization of basis differences.

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 six-month period ending June 30, 2007, Terra purchased approximately $31.9 million of ammonia from PLNL. During 2007, PLNL performed a turnaround, resulting in lower production levels and consequently, lower purchases by the Company. During the first half of 2006, Terra purchased approximately $55.8 million of ammonia from PLNL.

During the first half of 2007 there were $1.0 million in cash distributions from all of the Company’s equity investments. The total distributions from all investments were $34.6 million for the six-month period ended June 30, 2006.

8.

Long-term Debt and Capital Lease Obligation

Long-term debt and capital lease obligations consisted of the following:

		June 30,				December 31,				June 30,
(in thousands)		2007				2006				2006
Unsecured Senior Notes, 7.0% due 2017		$	330,000			$	—			$	—
Secured Senior Notes, 12.875% due 2008			—				200,000				200,000
Second Priority Senior Secured Notes, 11.5%, due 2010			—				131,300				131,300
Other			—				1				8
Total long-term debt and capital lease obligations			330,000				331,301				331,308
Less current maturities			—				1				8
Total long-term debt and capital lease obligations		$	330,000			$	331,300			$	331,300

In January 2007, Terra Capital, Inc., (“TCAPI”) a subsidiary of Terra Industries Inc., issued $330 million of 7.0% Senior Notes due 2017. The notes are unconditionally guaranteed by Terra Industries Inc. and its U.S. subsidiaries. Fees and expenses of the transaction totaled $6.4 million. These notes and guarantees are unsecured and will rank equal in right of payment with any existing and future senior obligations of such guarantors. The Indenture governing these notes contains covenants that limit, among other things, the Company’s ability to: incur additional debt, pay dividends on common stock of Terra Industries Inc. or repurchase shares of such common stock, make certain investments, sell any of the Company’s principal production facilities or sell other assets outside the ordinary course of business, enter into transactions with affiliates, limit dividends or other payments by our restricted subsidiaries to us, enter into sale and leaseback transactions, engage in other businesses, sell all or substantially all of the Company’s assets or merge with or into other companies, and reduce the Company’s insurance coverage. In addition, the Company is obligated to offer to repurchase these notes upon a Change of Control (as defined in the Indenture) at a cash price equal to 101% of the aggregate principal amount outstanding at that time, plus accrued interest to the date of purchase. The Indenture governing these notes contains events of default and remedies customary for a financing of this type. Offering proceeds were used to repurchase the Company’s 12.875% Senior Secured Notes and 11.5% Second Priority Secured Notes pursuant to a tender offer.

Both the 12.875% Senior Secured Notes and 11.5% Second Priority Secured Notes were repurchased pursuant to a tender offer. Following completion of the tender offer, $2.5 million face value of 11.5% Secured Notes were not tendered and remained outstanding at March 31, 2007. The remaining bonds were redeemed on June 1, 2007.

As a result of the Company’s debt refinancing the Company incurred costs of approximately $31.9 million for tender premiums, and approximately $2.2 million for make-whole payments and administrative expenses. In addition, the Company recognized approximately $4.7 million of expense related to deferred fees on the bonds that were repaid. In connection with the new bond offering the Company paid approximately $6.4 million for fees and administrative costs.

In the first quarter of 2007, the Company amended the $200 million revolving credit facility to extend the expiration date to January 31, 2012. The revolving credit facility is secured by substantially all of the assets of the Company. 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. 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 June 30, 2007, 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 margins for base rate loans and LIBOR loans are 0.50% and 1.75%, respectively, at June 30, 2007. 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 June 30, 2007, the Company had no outstanding revolving credit borrowings and $16.5 million in outstanding letters of credit. The $16.5 million in outstanding letters of credit reduced the Company’s borrowing availability to $183.5 million at June 30, 2007. 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.

9.

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								Six Months Ended
		June 30,								June 30,
(in thousands)		2007				2006				2007				2006
Service cost		$	748			$	744			$	1,496			$	1,488
Interest cost			6,231				5,888				12,462				11,776
Expected return on plan assets			(6,056	)			(5,394	)			(12,112	)			(10,788	)
Amortization of prior service cost			(9	)			(7	)			(18	)			(14	)
Amortization of actuarial loss			1,409				1,408				2,818				2,816
Termination charge			123				291				246				582
Pension Expense		$	2,446			$	2,930			$	4,892			$	5,860

Cash contributions to the defined benefit pension plans for the three months ended June 30, 2007 and 2006 were $5.7 million and $1.8 million, respectively. Cash contributions to the defined benefit pension plans for the six months ended June 30, 2007 and 2006 were $14.7 million and $3.5 million, respectively.

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 June 30, 2007 and 2006 totaled $1.8 million and $1.3 million, respectively. Contributions to these plans for the six-month periods ending June 30, 2007 and 2006 were $3.1 million and $2.8 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.

10.

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) pension and post-retirement benefit liabilities adjustments.

The components of accumulated other comprehensive income (loss), net of tax, for the six months ended June 30, 2007 and 2006 follow:

		Foreign
		Currency								Pension and Post-
		Translation				Fair Value of				Retirement Benefit
(in thousands)		Adjustment				Derivatives				Liabilities				Total
Balance January 1, 2007		$	24,518			$	(11,836	)		$	(76,421	)		$	(63,739	)
Change in pension and post retirement benefit liabilities			—				—				1,913				1,913
Change in foreign translation adjustment			11,486				—				—				11,486
Reclassification to earnings			—				229				—				229
Change in fair value of derivatives			—				(7,038	)			—				(7,038	)
Balance June 30, 2007		$	36,004			$	(18,645	)		$	(74,508	)		$	(57,149	)
Balance January 1, 2006		$	(9,100	)		$	(5,109	)		$	(55,934	)		$	(70,143	)
Change in foreign translation adjustment			19,371				—				—				19,371
Reclassification to earnings			—				(27,080	)			—				(27,080	)
Change in fair value of derivatives			—				27,611				—				27,611
Balance June 30, 2006		$	10,271			$	(4,578	)		$	(55,934	)		$	(50,241	)

11.

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.

The following summarizes operating results by business segment:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands)		2007				2006				2007				2006
Revenues
- Nitrogen Products		$	680,384			$	516,591			$	1,167,483			$	912,962
- Methanol			10,780				5,217				23,311				6,589
- Other			2,651				1,712				5,307				2,888
Total revenues		$	693,815			$	523,520			$	1,196,101			$	922,439
Income (loss) from operations
- Nitrogen Products		$	128,241			$	29,676			$	192,302			$	4,689
- Methanol			774				(3,250	)			1,562				(6,042	)
- Other			(241	)			(202	)			(420	)			(589	)
Income (loss) from operations		$	128,774			$	26,224			$	193,444			$	(1,942	)

The following summarizes geographic revenues information:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands)										2007				2006
United States		$	543,252			$	402,821			$	941,798			$	710,184
Canada			29,413				19,559				43,286				35,882
United Kingdom			121,150				101,140				211,017				176,373
		$	693,815			$	523,520			$	1,196,101			$	922,439

12.

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 30.5 million MMBtu’s. As of June 30, 2007, these natural gas commitments were $0.8 million above the respective index prices.

13.

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 June 30, 2008, and at such prices, as determined appropriate by the Company. Purchases may be commenced or suspended at any time without notice. In 2006 there were 2.7 million shares repurchased for an aggregate cost of $18.8 million, which resulted in a balance of 6.8 million shares available for repurchase under the program.

During 2007, the Company repurchases under the stock program were:

(In thousands, except		Number of				Average Price				Total Cost of
average price of shares		Shares				of Shares				Shares
repurchased)		Repurchased				Repurchased				Repurchased
January 2007			—			$	—			$	—
February 2007			—				—				—
March 2007			—				—				—
April 2007			—				—				—
May 2007			650				18.79				12,220
June 2007			350				19.53				6,991
Total			1,000			$	19.20			$	19,211

14.

New Accounting Pronouncements

In September 2006, the FASB issued SFAS 157, Fair Value Measurements, (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 disclosure and requirements of SFAS 157 are effective for the Company in 2008 first quarter and the Company expects no significant impact from adopting the Standard.

In February 2007, the FASB issued Statement of Financial Accounting Standards (SFAS 159), The Fair Value Option for Financial Assets and Financial Liabilities (SFAS 159). SFAS 159 permits entities to choose to measure many financial instruments and certain other items at fair value at specified election dates. SFAS 159 is effective for the Company beginning in the first quarter of 2008. The Company is currently assessing the impact SFAS 159 may have on its financial statements.

15.

Subsequent Events

United Kingdom Joint Venture

On July 11, 2007, the U.K. Competition Commission approved a joint venture planned by Kemira GrowHow Oyj and the Company to combine the fertilizer and associated process chemicals businesses of both companies in the United Kingdom. The approval is conditional upon the divestment of certain processes — which account for less than three percent of sales for the planned joint venture — as well as amendment of certain terms for carbon dioxide supplies.

Kemira GrowHow and the Company will each own a 50% interest in the joint venture, which will include the Kemira GrowHow site at Ince and the Company’s Teeside and Severnside sites. Upon final approval and formation of the joint venture, the Company will account for its 50% interest as an equity investment. The June 30, 2007 book value of net assets to be transferred by the Company to the joint venture approximated $280 million. The joint venture will perform a determination of its fair value shortly after inception. In the event that the Company’s interest in the fair value of the joint venture is less than the Company’s book value of its equity method investment, the Company will be required to write down its equity method investment to fair value and include the write down amount as a charge to net income for the period.

Beaumont Facilities

On July 18, 2007, the Company announced it has executed with Eastman Chemical Company (“Eastman”) an agreement giving Eastman an exclusive and irrevocable option to purchase all the assets of Terra’s Beaumont, Texas facility. Eastman may exercise its option to purchase the Beaumont facility no later than October 1, 2007. Should Eastman elect to exercise its option to purchase the Beaumont assets, that transaction would close on or before January 1, 2009.

As a result of this option agreement, the Company determined that the value of its Beaumont property is impaired. The Company expects to record an estimated $42 million impairment charge for the quarter ended September 30, 2007. The impairment charge reduces Terra’s investment in the Beaumont property to approximately $47 million.

16.

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 2012 for June 30, 2007; December 31, 2006; and June 30, 2006 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries. Statements of operations and statements of cash flows for the six months ended June 30, 2007 and 2006 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries. The guarantees of the Guarantor Subsidiaries are full and unconditional. The Subsidiary issuer and the Guarantor Subsidiaries guarantees are joint and several with the Parent.

Guarantor subsidiaries include subsidiaries that own the Woodward, Oklahoma; Port Neal, Iowa; Yazoo City, Mississippi, and Beaumont, Texas plants as well as the corporate headquarters facility in Sioux City, Iowa. All guarantor subsidiaries are wholly owned by the Parent. All other company facilities are owned by non-guarantor subsidiaries.

Consolidating Balance Sheet as of June 30, 2007:

										Guarantor				Non-Guarantor
(in thousands)		Parent				TCAPI				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Assets
Cash and cash equivalents		$	1			$	49,114			$	176,703			$	531,140			$	(470,008	)		$	286,950
Accounts receivable, net			—				—				94,706				147,710				(1	)			242,415
Inventories			—				—				90,822				84,175				(5,323	)			169,674
Other current assets			2,274				6,900				9,244				11,281				(6,357	)			23,342
Total current assets			2,275				56,014				371,475				774,306				(481,689	)			722,381
Property, plant and equipment, net			—				—				361,308				340,799				(1	)			702,106
Equity method investments			—				—				11,072				154,129				—				165,201
Intangible assets, other assets and deferred plant turnaround costs			(1,839	)			8,702				24,216				45,358				(7,059	)			69,378
Investments in and advanced to (from) affiliates			679,441				343,352				1,488,733				(212,242	)			(2,299,284	)			—
Total assets		$	679,877			$	408,068			$	2,256,804			$	1,102,350			$	(2,788,033	)		$	1,659,066
Liabilities
Accounts payable		$	27			$	—			$	62,376			$	81,501			$	—			$	143,904
Accrued expenses and other current liabilities			28,819				9,128				60,702				42,582				(5,675	)			135,556
Total current liabilities			28,846				9,128				123,078				124,083				(5,675	)			279,460
Long-term debt and capital lease obligations			—				330,000				—				—				—				330,000
Pension and other liabilities			153,912				(342	)			15,580				53,556				54,502				277,208
Minority interest			—				20,597				84,951				—				1				105,549
Total liabilities and minority interest			182,758				359,383				223,609				177,639				48,828				992,217
Preferred stock — liquidation value of 120,000			115,800				—				—				—				—				115,800
Common Shareholders’ Equity
Common stock			144,202				—				73				49,709				(49,782	)			144,202
Paid-in capital			680,819				150,218				2,006,068				1,244,369				(3,400,655	)			680,819
Accumulated other comprehensive income (loss)			(83,135	)			—				—				9,018				16,968				(57,149	)
Accumulated deficit			(360,567	)			(101,533	)			27,054				(378,385	)			596,608				(216,823	)
Common shareholders’ equity			381,319				48,685				2,033,195				924,711				(2,836,861	)			551,049
Total liabilities and minority interest, preferred stock and common shareholders equity		$	679,877			$	408,068			$	2,256,804			$	1,102,350			$	(2,788,033	)		$	1,659,066