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, 2006

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

For the transition period from ___ to ___

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)

     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 24, 2006, the following shares of the registrant’s stock were outstanding:

Common Shares, without par value                                       93,214,574 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			29
		Item 3.		Quantitative and Qualitative Disclosures About Market Risk			35
		Item 4.		Controls and Procedures			35
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			37
		Item 5.		Other Information			38
		Item 6.		Exhibits			39
Certification of CEO Pursuant to Section 302
Certification of CEO Pursuant to Section 302
Certification Pursuant to 906

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

TERRA INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands)

		June 30,				December 31,				June 30,
		2006				2005				2005
Assets
Cash and cash equivalents		$	85,243			$	86,366			$	92,451
Restricted cash			—				8,595				—
Accounts receivable, less allowance for doubtful accounts of $110, $234 and $207			195,504				206,407				161,600
Inventories			169,865				190,314				150,461
Other current assets			13,194				54,578				31,195
Total current assets			463,806				546,260				435,707
Property, plant and equipment, net			737,883				733,536				779,951
Equity method investments			160,691				183,884				187,897
Deferred plant turnaround costs			36,848				27,447				30,491
Intangible assets			6,586				7,526				10,525
Other assets			27,657				24,972				11,506
Total assets		$	1,433,471			$	1,523,625			$	1,456,077
Liabilities
Debt due within one year		$	8			$	38			$	113
Accounts payable			118,580				125,863				87,360
Customer prepayments			13,589				52,913				6,223
Accrued expenses and other current liabilities			62,687				84,996				59,291
Total current liabilities			194,864				263,810				152,987
Long-term debt and capital lease obligations			331,300				331,300				331,308
Deferred income taxes			57,174				65,998				74,036
Pension liabilities			119,900				120,236				119,555
Other liabilities			38,399				41,320				45,568
Minority interest			95,905				92,258				98,059
Total liabilities and minority interest			837,542				914,922				821,513
Preferred Stock - liquidation value of $120,000, $120,000 and $136,718			115,800				115,800				132,519
Common Shareholders’ Equity
Capital stock
Common Shares, authorized 133,500 shares; 93,215; 95,171 and 93,010 outstanding			145,044				146,994				144,580
Paid-in capital			696,861				712,671				693,875
Accumulated other comprehensive loss			(50,241	)			(70,143	)			(49,767	)
Unearned compensation			—				(5,369	)			(2,023	)
Accumulated deficit			(311,535	)			(291,250	)			(284,620	)
Total common shareholders’ equity			480,129				492,903				502,045
Total liabilities and minority interest, preferred stock and common shareholders’ equity		$	1,433,471			$	1,523,625			$	1,456,077

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(in thousands, except per-share amounts)

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2006				2005				2006				2005
Revenues
Product revenues		$	521,808			$	487,415			$	919,551			$	935,338
Other income			1,712				2,578				2,888				4,667
Total revenues			523,520				489,993				922,439				940,005
Costs and Expenses
Cost of sales			491,170				408,587				914,686				822,330
Selling, general and administrative expense			13,006				16,046				24,716				26,499
Equity in earnings of unconsolidated affiliates			(6,880	)			(4,401	)			(15,021	)			(9,407	)
			497,296				420,232				924,381				839,422
Income (loss) from operations			26,224				69,761				(1,942	)			100,583
Interest income			1,824				1,667				3,408				3,421
Interest expense			(11,782	)			(14,130	)			(23,554	)			(29,983	)
Loss on early retirement of debt			—				(16,389	)			—				(27,193	)
Change in fair value of warrant liability			—				3,960				—				8,860
Income (loss) before income taxes and minority interest			16,266				44,869				(22,088	)			55,688
Income tax benefit (provision)			(5,766	)			(15,975	)			8,000				(18,160	)
Minority interest			(4,243	)			(7,192	)			(3,647	)			(11,395	)
Net income (loss)			6,257				21,702				(17,735	)			26,133
Preferred share dividends			(1,275	)			(1,275	)			(2,550	)			(2,550	)
Net Income (Loss) Available to Common Shareholders		$	4,982			$	20,427			$	(20,285	)		$	23,583
Basic and diluted income (loss) per share:
Basic		$	0.05			$	0.22			$	(0.22	)		$	0.26
Diluted		$	0.05			$	0.20			$	(0.22	)		$	0.24
Basic and diluted weighted average shares outstanding:
Basic			93,317				91,439				93,592				91,415
Diluted			95,212				107,123				93,592				106,780

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(in thousands)

		Six Months Ended
		June 30,
		2006				2005
Operating Activities
Net income (loss)		$	(17,735	)		$	26,133
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			52,696				60,131
Deferred income taxes			(8,000	)			22,833
Minority interest in earnings			3,647				11,395
Equity in undistributed earnings			9,944				(9,407	)
Non-cash loss on derivatives			1,573				460
Share-based compensation			2,317				941
Amortization of intangible and other assets			5,165				5,031
Non-cash loss on early retirement of debt			—				22,543
Change in fair value of warrant liability			—				(8,860	)
Term loan discount accretion			—				1,774
Changes in operating assets and liabilities:
Accounts receivable			16,200				(14,750	)
Inventories			27,994				(4,068	)
Accounts payable and customer prepayments			(49,790	)			(165,657	)
Other assets and liabilities, net			(1,928	)			42,269
Net cash flows from operating activities			42,083				(9,232	)
Investing Activities
Purchase of property, plant and equipment			(26,636	)			(10,213	)
Plant turnaround expenditures			(22,112	)			(7,375	)
Distributions received from unconsolidated affiliates			9,660				23,625
Changes in restricted cash			8,595				—
Proceeds from the sale of property, plant and equipment			275				—
Net cash flows from investing activities			(30,218	)			6,037
Financing Activities
Payments under borrowings arrangements			(30	)			(125,084	)
Preferred share dividends paid			(2,550	)			(3,400	)
Payments under share repurchase program			(14,428	)			—
Proceeds from exercise of stock options			363				114
Distributions to minority interests			—				(5,535	)
Net cash flows from financing activities			(16,645	)			(133,905	)
Effect of exchange rate changes on cash			3,657				(4,247	)
Increase (decrease) to cash and cash equivalents			(1,123	)			(141,347	)
Cash and cash equivalents at beginning of period			86,366				233,798
Cash and cash equivalents at end of period		$	85,243			$	92,451
Supplemental cash flow information:
Interest paid		$	21,066			$	24,302
Income tax refunds received			—				11,049
Income taxes paid			1,046				398

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CHANGES IN COMMON SHAREHOLDERS’ EQUITY

SIX MONTHS ENDED JUNE 30, 2006 AND 2005

(in thousands)

										Accumulated
										Other
		Common				Paid-In				Comprehensive				Unearned				Accumulated								Comprehensive
		Stock				Capital				Loss				Compensation				Deficit				Total				Loss
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

										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			—				—				—				—				26,133				26,133			$	26,133
Foreign currency translation adjustment			—				—				(19,215	)			—				—				(19,215	)			(19,215	)
Change in fair value of derivatives, net of taxes of $2,882			—				—				25,442				—				—				25,442				25,442
Comprehensive income																										$	32,360
Preferred share dividends			—				—				—				—				(2,550	)			(2,550	)
Reclassification of warrant liability			—				12,240				—				—				—				12,240
Exercise of stock options			42				62				—				—				—				104
Nonvested stock			7				(66	)			—				(146	)			—				(205	)
Amortization of unearned compensation			—				—				—				691				—				691
Balance at June 30, 2005		$	144,580			$	693,875			$	(49,767	)		$	(2,023	)		$	(284,620	)		$	502,045

See Accompanying Notes to the Consolidated Financial Statements.

TERRA INDUSTRIES INC.

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

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 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.

		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.
		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, 2006 and 2005:

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands, except per-share amounts)		2006				2005				2006				2005
Basic income (loss) per share computation:
Income (loss) from continuing operations		$	6,257			$	21,702			$	(17,735	)		$	26,133
Less: Preferred share dividends			(1,275	)			(1,275	)			(2,550	)			(2,550	)
Income (loss) available to common shareholders		$	4,982			$	20,427			$	(20,285	)		$	23,583
Weighted average shares outstanding			93,317				91,439				93,592				91,415
Basic income (loss) per common share			0.05				0.22			$	(0.22	)		$	0.26
Diluted income (loss) per share computation:
Income (loss) available to common shareholders		$	4,982			$	20,427			$	(20,285	)		$	23,583
Add: Preferred share dividends			—				1,275				—				2,550
Income (loss) available to common shareholders and assumed conversions		$	4,982			$	21,702			$	(20,285	)		$	26,133
Weighted average shares outstanding			93,317				91,439				93,592				91,415
Add incremental shares from assumed conversions:
Preferred shares			—				14,140				—				14,162
Nonvested stock			681				670				—				659
Common stock warrants			1,042				687				—				345
Common stock options			172				187				—				199
Dilutive potential common shares			95,212				107,123				93,592				106,780
Diluted income (loss) per common share		$	0.05			$	0.20			$	(0.22	)		$	0.24

		For the three- and six-month periods ended June 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.
		For the three-month period ending June 30, 2006, 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 six-month period ended June 30, 2006, all preferred shares, nonvested stock and common stock options were antidilutive in 2006 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)		2006				2005				2005
Raw materials		$	23,500			$	22,487			$	22,330
Supplies			55,517				55,647				53,315
Finished goods			90,848				112,180				74,816
Total		$	169,865			$	190,314			$	150,461

		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 International Petroleum Exchange (IPE) index price. Physical delivery prices in the U.K. are based on the IPE 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 June 30, 2006 and 2005:

(in thousands)		2006								2005
		Contract				Open Position				Contract				Open Positions
		MMBtu				Gain (Loss)				MMBtu				Gain (Loss)
Swaps			13,497			$	(9,513	)			19,459			$	15,900
Basis swaps			7,060				569				—				—
Purchased put options			230				304				18,638				(4,288	)
Sold call options			230				—				16,488				(2,103	)
Unrealized gain (loss) of open positions							(8,640	)							9,509
Ineffective positions (credited) charged to cost of sales							1,606								(460	)
Deferred gain (loss) of open positions							(7,034	)							9,049
Income tax benefit (provision)							2,456								(2,914	)
Accumulated other comprehensive gain (loss)						$	(4,578	)						$	6,135

		Gains and losses on settlement of these contracts and premium payments on option 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 closes. 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 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, 2006 and 2005 follows:

		Three Months Ended
		June 30,
		2006								2005
(in thousands)		Gross				Net of tax				Gross				Net of tax
Beginning accumulated gain (loss)		$	(3,962	)		$	(2,599	)		$	23,366			$	14,487
Net increase (decrease) in market value			(10,799	)			(6,929	)			(5,758	)			(5,095	)
Reclassification into earnings			7,727				4,950				(8,559	)			(3,257	)
Ending accumulated gain (loss)		$	(7,034	)		$	(4,578	)		$	9,049			$	6,135

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, 2006 and 2005 follows:

		Six Months Ended
		June 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			(41,738	)			(27,080	)			17,931				17,970
Reclassification into earnings			42,590				27,611				7,947				7,472
Ending accumulated gain (loss)		$	(7,034	)		$	(4,578	)		$	9,049			$	6,135

		Approximately $4.6 million of the accumulated other comprehensive loss, net of tax, at June 30, 2006 will be reclassified into earnings during 2006.
		At times, the Company uses forward derivative instruments to fix or set floor prices for a portion of its nitrogen sales volumes. At June 30, 2006, the Company had no open swap contracts.
5.		Equity Investments
		Terra’s investments in companies that are accounted for on the equity method of accounting consists 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 $160.7 million at June 30, 2006. Terra includes the net earnings of these investments as an element of income from operations since the investee’s 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)		2006				2005				2006				2005
Condensed income statement information:
Net sales		$	47,197			$	36,933			$	101,865			$	79,736
Net income		$	12,199			$	11,226			$	28,481			$	29,769
Terra’s equity in earnings of unconsolidated affiliates		$	6,880			$	4,401			$	15,021			$	9,407

		June 30,				June 30,
(in thousands)		2006				2005
Condensed balance sheet information:
Current assets		$	41,210			$	56,467
Long-lived assets			200,317				245,257
Total assets		$	241,527			$	301,724
Current liabilities		$	31,929			$	22,417
Long-term liabilities			—				300
Equity			209,598				279,007
Total liabilities and equity		$	241,527			$	301,724

		The carrying value of these investments at June 30, 2006 was $55.9 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 six-month period ending June 30, 2006, Terra purchased approximately $55.8 million of ammonia from PLNL. As of June 30, 2006 PLNL made cash distributions to its shareholders, of which Terra’s portion was $33.8 million during the six-month period. During the first half of 2005, Terra purchased approximately $33.4 million of ammonia from PLNL. During the first half of 2005, Terra’s portion of cash distributions from PLNL was $22.5 million.
6.		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)		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			8				38				121
Total long-term debt and capital lease obligations			331,308				331,338				331,421
Less current maturities			8				38				113
Total long-term debt and capital lease obligations		$	331,300			$	331,300			$	331,308

The Company has revolving credit facilities totaling $200 million that expire June 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 June 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 June 30, 2006, the LIBOR rate was 5.35%. 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 June 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 June 30, 2006, the Company had no outstanding revolving credit borrowings and $16.0 million in outstanding letters of credit. The $16.0 million in outstanding letters of credit reduced the Company’s borrowing availability to $184.0 million at June 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.
		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								Six Months Ended
		June 30,								June 30,
(in thousands)		2006				2005				2006				2005
Service cost		$	744			$	683			$	1,488			$	1,366
Interest cost			5,888				3,917				11,776				7,834
Expected return on plan assets			(5,394	)			(3,070	)			(10,788	)			(6,140	)
Amortization of prior service cost			(7	)			5				(14	)			11
Amortization of actuarial loss			1,408				1,222				2,816				2,444
Amortization of net assets			—				13				—				25
Termination charge			291				—				582				—
Pension Expense		$	2,930			$	2,770			$	5,860			$	5,540

		Cash contributions to the defined benefit pension plans for the three months ended June 30, 2006 and 2005 were $1.8 million and $2.7 million, respectively. Cash contributions to the defined benefit pension plans for the six months ended June 30, 2006 and 2005 were $3.5 million and $4.3 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, 2006 and 2005 totaled $1.3 million and $1.1 million, respectively. Contributions to these plans for the six-month periods ending June 30, 2006 and 2005 were $2.8 million and $2.3 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.
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 six months ended June 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			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	)
Balance December 31, 2004		$	14,287			$	(19,307	)		$	(50,974	)		$	(55,994	)
Change in foreign translation adjustment			(19,215	)			—				—				(19,215	)
Reclassification to earnings			—				7,472				—				7,472
Change in fair value of derivatives			—				17,970				—				17,970
Balance June 30, 2005		$	(4,928	)		$	6,135			$	(50,974	)		$	(49,767	)

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.
		The following summarizes operating results by business segment:

		Three Months Ended								Six Months Ended
		June 30								June 30
(in thousands)		2006				2005				2006				2005
Revenues — Nitrogen Products		$	516,591			$	477,549			$	912,962			$	915,385
- Methanol			5,217				9,866				6,589				19,953
- Other			1,712				2,578				2,888				4,667
Total revenues		$	523,520			$	489,993			$	922,439			$	940,005
Income (loss) from operations
- Nitrogen Products		$	29,676			$	73,839			$	4,689			$	105,497
- Methanol			(3,250	)			(2,415	)			(6,042	)			(3,089	)
- Other			(202	)			(1,663	)			(589	)			(1,825	)
Income (loss) from operations		$	26,224			$	69,761			$	(1,942	)		$	100,583

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

		Three Months Ended								Six Months Ended
		June 30								June 30
(in thousands)		2006				2005				2006				2005
United States		$	402,821			$	393,982			$	710,184			$	730,924
Canada			19,559				18,806				35,882				30,475
United Kingdom			101,140				77,205				176,373				178,606
		$	523,520			$	489,993			$	922,439			$	940,005

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.
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 June 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 1,117,000 and 2,427,000 were available and reserved, respectively, for share-based compensation grants as of June 30, 2006.
		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 six-month periods ended June 30, 2006, the Company recorded $0.2 million and $0.6 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 six-month periods ended June 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 $0.5 million and $0.9 million on nonvested stock awards and phantom share awards in the three- and six-month periods ended June 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.

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 six months ended June 30, 2005:

		Three Months Ended				Six Months Ended
(in thousands, except per-share amounts)		June 30, 2005				June 30, 2005
Net income available to common shareholders		$	20,427			$	23,583
Add: Share based employee compensation expense included in reported net income, net of related tax effects			527				941
Deduct: Share based employee compensation expense determined under fair value based method for all awards, net of related tax effects			(527	)			(941	)
Pro forma net income available to common shareholders		$	20,427			$	23,583
Income per share:
Basic — as reported		$	0.22			$	0.26
Basic — pro forma			0.22			$	0.26
Diluted — as reported		$	0.20			$	0.24
Diluted — pro forma		$	0.20			$	0.24

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

		Three Months Ended								Six Months Ended
		June 30,								June 30,
(in thousands)		2006				2005				2006				2005
Compensation cost charged to SG&A expense		$	1,176			$	527			$	2,317			$	941
Total compensation cost charged to income		$	1,176			$	527			$	2,317			$	941
Income tax benefit		$	537			$	184			$	1,112			$	329

		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 June 30, 2006, and changes during the six 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

The following table summarizes information about stock options outstanding and exercisable at June 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				3.1			$	3.72				399			$	3.72
	7.81		—				7.81				6				2.1				7.81				6				7.81
	12.13		—				14.75				92				1.1				13.04				92				13.04
Total											497				2.7			$	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 June 30, 2006, and changes during the six 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			344				6.39
Vested			—				—
Forfeited			(4	)			1.43
Outstanding at June 30, 2006			1,930			$	5.35

		At June 30, 2006, the total unrecognized compensation cost related to all nonvested share awards was $5.7 million. That cost is expected to be recognized over a weighted-average period of 1.2 years.
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

June 30, 2008, and at such prices, as determined appropriate by the Company. Purchases may be commenced or suspended at any time without notice. During the 2006 second quarter, 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
			2,045			$	7.08			$	14,422

		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.		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 June 30, 2006; December 31, 2005; and June 30, 2005 are presented below for purposes of complying with the reporting requirements of the Guarantor Subsidiaries. Statements of operations for the three- and six months and statements of cash flows for the six months ended June 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.

Consolidating Balance Sheet as of June 30, 2006:

										Guarantor				Non-Guarantor
(in thousands)		Parent				TCAPI				Subsidiaries				Subsidiaries				Eliminations				Consolidated
Assets
Cash and cash equivalents		$	1			$	(23,653	)		$	75,791			$	33,105			$	(1	)		$	85,243
Accounts receivable, net			—				—				43,674				151,830				—				195,504
Inventories			—				—				47,723				122,007				135				169,865
Other current assets			1,710				36				5,043				6,406				(1	)			13,194
Total current assets			1,711				(23,617	)			172,231				313,348				133				463,806
Property, plant and equipment, net			—				—				269,030				468,852				1				737,883
Equity method investments			—				—				—				160,691				—				160,691
Intangible assets, other assets and deferred plant turnaround costs			—				9,046				4,543				57,504				(2	)			71,091
Investments in and advanced to (from) affiliates			736,627				568,191				1,384,256				510,029				(3,199,103	)			—
Total assets		$	738,338			$	553,620			$	1,830,060			$	1,510,424			$	(3,198,971	)		$	1,433,471
Liabilities
Debt due within one year		$	—			$	—			$	8			$	—			$	—			$	8
Accounts payable			18				—				31,554				87,008				—				118,580
Accrued expenses and other current liabilities			173				91,340				31,864				28,805				(75,906	)			76,276
Total current liabilities			191				91,340				63,426				115,813				(75,906	)			194,864
Long-term debt and capital lease obligations			—				331,300				—				—				—				331,300
Deferred income taxes			—				—				—				57,174				—				57,174
Pension and other liabilities			147,261				(337	)			9,893				1,482				—				158,299
Minority interest			—				18,753				77,152				—				—				95,905
Total liabilities and minority interest			147,452				441,056				150,471				174,469				(75,906	)			837,542
Preferred stock			115,800				—				—				—				—				115,800
Common Shareholders’ Equity
Common stock			145,044				—				73				49,709				(49,782	)			145,044
Paid-in capital			696,861				150,218				1,797,069				1,529,005				(3,476,292	)			696,861
Accumulated other comprehensive income (loss) compensation			(60,277	)			—				—				28,961				(18,925	)			(50,241	)
Retained earnings (deficit)			(306,542	)			(37,654	)			(117,553	)			(271,720	)			421,934				(311,535	)
Common shareholders’ equity			475,086				112,564				1,679,589				1,335,955				(3,123,065	)			480,129
Total liabilities and minority interest, preferred stock and common shareholders equity		$	738,338			$	553,620			$	1,830,060			$	1,510,424			$	(3,198,971	)		$	1,433,471