UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

 

(Mark One)

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

For the fiscal year ended December 31, 2005

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		51102-6000
600 Fourth Street		(Zip Code)
P. O. Box 6000
Sioux City, Iowa		(712) 277-1340
(Address of principal executive offices)		(Registrant’s telephone number)

		Name of each exchange
Title of each class		on which registered
Common Shares, without par value		New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No þ

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes o No þ

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statement incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or non-accelerated filer. See definition of accelerated filed and large accelerated filer in Rule 12b-2 of the 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 Act). Yes o No þ

The aggregate market value of the voting and non-voting common shares held by non-affiliates computed by reference to the price at which the common shares were last sold, or the average bid and asked price of such common shares, as of the last business day of the registrant’s most recently completed second fiscal quarter was $618,656,268.27.

The number of Common Shares, without par value, outstanding as of March 1, 2006 was 95,168,174.

Certain portions of the proxy statement for the Annual Meeting of Shareholders of Registrant to be held on May 2, 2006 are incorporated herein by reference into Part III hereof.

 

 

Part I
Item 1. Business			1
Item 1A. Risk Factors			14
Item 1B. Unresolved Staff Comments			18
Item 2. Properties			18
Item 3. Legal Proceedings			20
Item 4. Submission of Matters to a Vote of Security Holders			20
Executive Officers of Terra			21
Part II
Item 5. Market for Terra’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			22
Item 6. Selected Financial Data			23
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
Item 7A. Quantitative and Qualitative Disclosures About Market Risk			39
Item 8. Financial Statements and Supplementary Data			43
Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosures			90
Item 9A. Controls and Procedures			90
Item 9B. Other Information			93
Part III
Item 10. Directors and Executive Officers of Terra			93
Item 11. Executive Compensation			93
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			93
Item 13. Certain Relationships and Related Transactions			94
Item 14. Principal Accounting Fees and Services			94
Part IV
Item 15. Exhibits and Financial Statement Schedules			95
Signatures			106
Index to Financial Statement Schedules, Reports and Consents			S-1
Certificate of Incorporation
By-Laws
Form of Long-Term Incenitve Award
Form of Long-Term Incentive Award
2006 Officers and Key Employees Incentive Plan
Description of Compensatory Arrangements
Ratio of Earnings to Financial Charges
Subsidiaries
Subsidiaries
302 Certification of Chief Executive Officer
302 Certification of Chief Financial Officer
Section 906 Certification
Financial Statements

PART I

Item 1. Business

Terra Industries Inc., a Maryland corporation, is referred to as “Terra,” or “the Company” throughout this report. References to Terra also include the direct and indirect subsidiaries of Terra Industries Inc. where required by the context, including Mississippi Chemical Corporation (“MCC”), which Terra acquired in December 2004. Subsidiaries not wholly-owned by Terra include a limited partnership, Terra Nitrogen Company, L.P. (“TNCLP”), which, through its subsidiary, Terra Nitrogen, Limited Partnership, operates Terra’s manufacturing facility at Verdigris, Oklahoma. Terra is the sole general partner and the majority limited partner of TNCLP. Terra’s principal corporate office is located at Terra Centre, 600 Fourth Street, P.O. Box 6000, Sioux City, Iowa 51102-6000 and its telephone number is (712) 277-1340.

Terra makes available free of charge through its website, www.terraindustries.com, its Annual Report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports as soon as reasonably practicable after such material is electronically filed with the Securities and Exchange Commission. Terra’s internet website and the information contained or incorporated therein are not intended to be incorporated into this Annual Report on Form 10-K.

Business Overview

Terra is a leading North American and U.K. producer and marketer of nitrogen products, serving agricultural and industrial markets. In addition, Terra owns a 50% interest in Point Lisas Nitrogen Limited (“PLNL”), an ammonia production joint venture in the Republic of Trinidad and Tobago. Terra is one of the largest North American producers of ammonia, the basic building block of nitrogen fertilizers. The Company upgrades a significant portion of the ammonia it produces into higher value products, which are easier for distributors and farmers to transport, store and apply to crops than ammonia. Terra owns nine manufacturing facilities in North America and the U.K. capable of producing nitrogen products. Two of these facilities (Beaumont, Texas and Woodward, Oklahoma) can also produce methanol. The Beaumont, Texas facility, which historically has been a significant methanol producer, was mothballed in December 2004 and remains out of production.

Terra’s business is organized into a nitrogen business segment and a methanol business segment. The methanol segment has become less significant to the Company’s business since the closing of the Beaumont, Texas facility.

Nitrogen is both a global and local commodity: global because it is produced and traded in almost all regions of the world, local because fertilizer customers display preferences for nitrogen in one of four basic forms based upon local conditions. The principal forms of globally traded nitrogen fertilizer are ammonia (82% nitrogen by weight) and urea (46% nitrogen by weight). Ammonium nitrate (AN) (34% nitrogen by weight) is traded to a lesser extent, primarily in international markets. Urea ammonium nitrate solutions (UAN) (28% to 32% nitrogen by weight) have only recently been traded in international markets. UAN is less likely to be traded internationally because it carries relatively high transportation costs due to its high water content. Because transportation is a significant component of a customer’s total product cost, a key to competitiveness in the nitrogen business is proximity to the end user, which allows

a supplier to have the lowest delivered cost for the customer’s product of choice. In addition, a supplier must provide a reliable source of product.

The locations of Terra’s North American production facilities provide Terra a competitive advantage in serving agricultural customers in the Corn Belt and other major agricultural areas in the United States and Canada. Terra’s U.K. facilities are able to serve competitively the entire British agricultural market. The Point Lisas ammonia production facility in Trinidad and Tobago serves U.S. and international nitrogen markets and benefits from access to low-cost natural gas supplies. Terra’s facilities have the following production capacities:

		Annual Capacity1
Location		Ammonia2				UAN3				AN4				Urea5				Methanol6
Beaumont, Texas7			255,000				—				—				—				225,000,000
Donaldsonville, Louisiana8			500,000				—				—				—				—
Port Neal, Iowa			370,000				840,000				—				60,000				—
Verdigris, Oklahoma			1,050,000				2,200,000				—				—				—
Woodward, Oklahoma9			440,000				340,000				—				25,000				40,000,000
Yazoo City, Mississippi10			500,000				600,000				775,000	11			7,000				—
Courtright, Ontario			480,000				400,000				—				175,000				—
Severnside, U.K.			265,000				—				500,000				—				—
Billingham, U.K.12			550,000				—				520,000				—				—
Point Lisas, Trinidad and Tobago13			360,000				—				—				—				—
Total			4,770,000				4,380,000				1,795,000				267,000				265,000,000

1.		Annual capacity includes an allowance for planned maintenance shutdowns.
2.		Measured in gross tons of ammonia produced; net tons available for sale will vary with upgrading requirements.
3.		Measured in tons of UAN containing 28% nitrogen by weight.
4.		Measured in tons.
5.		Urea is sold as urea liquor from the Port Neal, Woodward and Yazoo City facilities and as either granular urea or urea liquor from the Courtright facility. Production capacities shown are for urea sold in tons.
6.		Measured in gallons.
7.		The Beaumont facility was mothballed in December 2004 and remains out of production. The Beaumont plant capacity depends on product mix (ammonia/methanol).
8.		The Donaldsonville facility’s manufacturing capacity consists of a single ammonia plant. This plant was mothballed in January 2005 and remains out of production.
9.		Woodward’s plant capacity depends on product mix (ammonia/methanol).
10.		The Yazoo City facility also produces merchant nitric acid; sales for the twelve months ended December 31, 2005 were 40,000 product tons.
11.		Terra’s full AN capacity at Yazoo City is 835,000 tons, however such production would limit Yazoo City’s UAN production to approximately 450,000 tons and increase urea production to 45,000 tons.
12.		The Billingham, England facility also produces merchant nitric acid; sales for the twelve months ended December 31, 2005 were 267,000 product tons.
13.		The Point Lisas plant capacity represents Terra’s 50% interest.

The principal customers for Terra’s North American nitrogen products are national agricultural retail chains, farm cooperatives, independent dealers and industrial customers. Industrial customers use nitrogen products to manufacture chemicals, plastics and other products such as acrylonitrile, polyurethanes, fibers, explosives and adhesives; to reduce nitrogen oxides (NOx) and other emissions from power plants; and in water treatment processes. In July 2005, Terra announced it had entered into a 10-year renewable agreement to supply industrial grade ammonium nitrate and ammonium nitrate solution to Orica USA Inc. from its Yazoo City facility.

		% of Total				U.S.				U.K.
		2005 Terra				Capacity				Capacity
Product		Revenues1				Position				Position
Ammonia			30.1	%			2				1
UAN			36.5	%			1				*
AN			17.8	%			1				1
Urea			3.6	%			4				*
Methanol			1.4	%			1				*

1	Revenues from sales of carbon dioxide, nitric acid and other nitrogen products and services, as well as industrial sales in the U.K., represented 10.5% of Terra’s total revenues for 2005.
*	Terra does not compete in these markets.

Agricultural customers accounted for approximately 70% and industrial customers approximately 30% of Terra’s North American nitrogen product revenue in 2005. In the U.K., revenues are divided approximately equally between agricultural and industrial customers. For more information on the nitrogen business, see the discussion under “Nitrogen Business Segment” below.

In December 2003, Terra entered into contracts with the Methanex Corporation (“Methanex”), providing it exclusive rights to all methanol production at the Beaumont facility for five years. In December 2004, this facility was mothballed. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, Terra will continue to realize revenues relating to the facility of up to $16.4 million per year consisting of $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin, if any, based on the plant’s methanol production capacity, reference prices and natural gas costs. There was no 2005 Beaumont cash margin. Terra also entered into an agreement for Methanex to market, under a commission arrangement, all methanol produced at the Woodward facility. For more information on the methanol business, see the discussion under “Methanol Business Segment” below.

Nitrogen Business Segment

Terra is a leading producer and marketer of nitrogen products, principally fertilizers. The Company upgrades a significant portion of the ammonia it produces into other nitrogen products, such as urea, ammonium nitrate (AN) and urea ammonium nitrate solutions (UAN). Ammonia, AN, urea and UAN are the principal nitrogen products the Company produces and sells in North America. Terra produces and sells primarily ammonia and AN in the U.K. The Point Lisas production facility in Trinidad provides ammonia for sale into both the U.S. and international nitrogen markets. Other products Terra manufactures include nitric acid, dinitrogen tetroxide and carbon dioxide. These products, along with a portion of Terra’s ammonia, AN and urea production, are used in non-agricultural applications. In late 2003, Terra formed its Terra Environmental Technologies division to provide products and services to customers using nitrogen products (primarily ammonia, aqua ammonia and liquid and dry urea) to reduce nitrogen oxides (NOx) emissions from various sources, including power plants, and in other environmental processes such as water treatment plants.

Although the different nitrogen fertilizer products are interchangeable to some extent, each has its own characteristics which make one product or another preferable to the end-user. Terra’s plants are designed to provide the fertilizer products preferred by end-users in the regions in which they are located. These preferences vary according to the crop planted, soil and weather conditions, regional farming practices, relative prices, and the cost and availability of storage, handling and application equipment. Terra’s nitrogen products and its 2005 production are described in greater detail below.

Anhydrous Ammonia

Anhydrous ammonia (or “ammonia”) is the simplest form of nitrogen fertilizer and the feedstock for the production of other nitrogen fertilizers, including urea, AN and UAN. Ammonia is also widely used in industrial applications. With the acquisition of Mississippi Chemical Corporation in December 2004, Terra became the leading U.S. producer of ammonia. Ammonia is produced when natural gas reacts with steam and air at high temperatures and pressures in the presence of catalysts. Ammonia has a nitrogen content of 82% by weight and is generally the least expensive form of fertilizer on a per-pound-of- contained-nitrogen basis. Although generally the cheapest source of nitrogen available to agricultural customers, ammonia can be less desirable to end-users than urea, AN and UAN because of its need for specialized application equipment and its limited application flexibility.

In 2005, Terra produced approximately 2,795,000 tons of ammonia at its North American facilities and approximately 758,000 tons of ammonia at its U.K. facilities. The Company is obligated by contract through 2018 to purchase one-half of the ammonia produced by Point Lisas Nitrogen in Trinidad at a discount to market, subject to a minimum price. In 2005, Terra purchased approximately 359,000 tons pursuant to its contract with Point Lisas Nitrogen. Terra sold a total of 1,898,000 tons of ammonia worldwide in 2005 and consumed approximately 2,507,000 tons of ammonia as a raw material to manufacture its other nitrogen products.

Urea Ammonium Nitrate Solutions (UAN)

UAN is a liquid fertilizer and, unlike ammonia, is odorless and does not require refrigeration or pressurization for transportation or storage. UAN is produced by combining liquid urea, liquid ammonium nitrate and water. The nitrogen content of UAN ranges from 28% to 32% by weight. (Unless specifically stated to the contrary, all references to UAN herein shall be to 28%.) Because of its high water content, UAN is relatively expensive to transport, making it largely a regionally distributed product.

UAN can be applied to crops directly or mixed with crop protection products, permitting the application of several materials simultaneously, reducing energy and labor costs and accelerating field preparation for planting. UAN may be applied from ordinary tanks and trucks and sprayed or injected into the soil, or applied through irrigation systems. In addition, UAN may be applied throughout the growing season, providing significant application flexibility. Due to its stability, UAN (like AN) may be used for no-till row crops where fertilizer is spread on the surface of the soil and is subject to evaporation losses.

Terra produced approximately 4,206,000 tons of UAN at its North American facilities in 2005 and sold approximately 4,368,0000 tons of UAN in 2005, primarily to U.S. fertilizer dealers and distributors.

Ammonium Nitrate (AN)

Terra is the largest manufacturer and marketer of agricultural-grade AN fertilizer in the U.S. and produces AN at two facilities in the U.K. AN is produced by combining nitric acid and ammonia into a liquid form which is then converted to a solid, largely for fertilizer applications. The nitrogen content of AN is 34% by weight. AN is less subject to volatilization (evaporation) losses than other nitrogen products. Due to its stability, AN is often the product of choice for pastures and “no-till” crops (that is, where the soil is not plowed prior to planting) where fertilizer is spread upon the surface and is subject to evaporation losses.

The Company produced approximately 643,000 tons of solid AN at its Yazoo City, Mississippi facility and approximately 1,054,000 tons of solid AN at its U.K. facilities in 2005. During this same period, the Company sold approximately 672,000 tons in the U.S. and 909,000 tons in the U.K.

Urea

Urea is produced by converting ammonia and carbon dioxide into liquid urea, which can be further processed into a solid, granular form. Urea is used for fertilizer and animal feed as well as in industrial applications. Granular urea has a nitrogen content of 46% by weight, the highest level of any solid nitrogen product. Terra produces both a granulated form of urea, generally for the fertilizer market, and urea liquor (liquid) for animal feed supplements and industrial applications.

In 2005, Terra produced approximately 235,000 tons of urea and urea liquor, all of it at North American plants. During this period, the Company sold approximately 247,000 tons of urea and urea liquor.

Nitric Acid

Nitric acid is made by oxidizing ammonia with air. The product is used as a raw material for other nitrogen products and by industrial customers to produce such products as nylon fibers, polyurethane foams and specialty fibers. In 2005, the Company produced approximately 893,000 tons of nitric acid worldwide. Approximately 320,000 of these tons were sold to industrial users and the remainder was used as a raw material for the production of Terra’s other nitrogen products.

Dinitrogen Tetroxide

Dinitrogen tetroxide (N₂O₄) is the propellant oxidizer used in various satellite, rocket and missile propulsion systems. It is also used by industrial customers in the manufacture of pharmaceuticals. Dinitrogen tetroxide is produced by cooling and condensing a slipstream of process gas from a nitric acid plant containing various oxides of nitrogen. The recovered product is filtered and its composition adjusted to meet final product specifications. Terra manufactured approximately 95,000 pounds of the product in 2005.

Marketing and Distribution

Terra’s customers are broadly segregated into two groups: (1) North American customers, including those receiving shipments of imported product from the Point Lisas Nitrogen facility, and (2) U.K. customers, including export sales to continental Europe and Australia.

The principal customers for Terra’s North American manufactured nitrogen products fall into two broad categories – agricultural fertilizer customers and industrial customers. The agriculture customers consist of independent dealers, national retail chains, and cooperatives. These agricultural customers, in turn, sell product to dealers, farmers and other users. Industrial customers use nitrogen products as a feedstock for a variety of chemical processes, in the manufacture of pulp, paper, fibers and to control nitrous oxide (NOx) emissions from power plants. Nearly all of Terra’s industrial customers are end-users. The Company’s agricultural and industrial customers are located primarily in the Gulf, midwestern plains and southern regions of the U.S. where the Company’s facilities are located. It is Terra’s objective to ship as much of its North American production as possible directly from its manufacturing facilities to its customers. Its five North American production facilities have total storage capacity for 190,000 tons of ammonia and 240,000 tons of UAN.

Terra’s Donaldsonville terminal has ready access to rail, truck and ammonia pipeline transportation and permits economical oceangoing vessel and barge transportation for imports and exports of nitrogen products. The terminal includes two ammonia storage tanks, each with a capacity of 30,000 tons, and can receive ocean-going vessels carrying up to 44,000 tons of ammonia. During 2005, the terminal received and shipped approximately 725,000 and 742,000 tons of ammonia, respectively. Terra is currently expanding the terminal’s capabilities by constructing a new UAN solution tank with a 50,000 ton capacity. Terra expects this tank and related receiving and shipping equipment to be completed by December 2006 and to cost approximately $8.5 million.

In July 2005 Terra sold to a subsidiary of Kinder Morgan Energy Partners Terra’s terminal assets in Blytheville, Arkansas, consisting of storage and supporting infrastructure for 40,000 tons of AN, 9,500 tons of UAN and 40,000 tons of urea. In conjunction with this sale of assets, Terra has entered into a long-term agreement to lease from Kinder Morgan exclusively these terminal assets. This arrangement will maintain Terra’s distribution capabilities in the Blytheville, Arkansas region.

Terra owns a 50% interest in the Houston Ammonia Terminal, located on the Houston Ship Channel near Pasadena, Texas. This entity has two 15,000 ton ammonia storage tanks which provide ammonia to industrial customers in the area via a pipeline system capable of shipping approximately 1,000 tons per day. The terminal can receive ocean-going vessels.

Terra’s U.K. sales are divided about equally between agricultural and industrial customers. Terra engages merchants and buying groups to sell its Nitram brand bagged AN fertilizer directly to British farmers. Terra also bags AN for other U.K. suppliers and sells it in bulk to suppliers who blend it with potash and phosphates, bag it and distribute it to farmers. Terra exports a small quantity of AN to continental Europe. Terra’s U.K. industrial products include ammonia, nitric acid and liquid carbon dioxide. Most industrial sales are to customers where Terra has a freight advantage.

Methanol Business Segment

Terra’s methanol business segment has shrunk considerably since it mothballed its principal methanol production facility at Beaumont, Texas in December 2004. The facility remained closed throughout 2005 and remains closed to date. Terra’s remaining manufacturing facility capable of producing methanol is in Woodward, Oklahoma.

In December 2003, Terra entered into contracts with Methanex Corporation (“Methanex”) providing Methanex exclusive rights to all methanol production at Terra’s Beaumont, Texas facility for five years. Methanex paid $25 million for these rights and agreed to purchase Terra’s methanol production at amounts expected to approximate cash production costs. Methanex also agreed to pay Terra 50% of any gross profits earned from its sales of Beaumont product up to maximum payments of $12 million per year. The agreement also gave Methanex the right to terminate Beaumont’s production, with Terra being responsible for the costs of shutting down the facility. On December 1, 2004, at the request of Methanex and under the terms of the parties’ agreement, Terra ceased production at the Beaumont facility and mothballed the plant. The parties’ agreement stipulates that, beginning two years from the date of the shutdown, Terra may terminate the agreement by paying Methanex approximately $417,000 per month remaining in the agreement’s term. As long as the Beaumont facility remains idle through the December 2008 termination of the Methanex contract, Terra will continue to realize revenues relating to the facility of up to $16.4 million per year consisting of $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin, if any, attributable to idled methanol production based on reference prices and natural gas costs. There was no 2005 cash margin.

Terra has retained some employees to operate the Beaumont methanol storage and distribution terminal and potentially to operate the ammonia plant.

Manufacturing Facilities

Terra owns the plant and processing equipment at the Beaumont facility, which has an annual methanol production capacity of 225 million gallons. Terra did not produce any methanol at the Beaumont plant in 2005. For a description of the Beaumont facility, see the Beaumont, Texas description under Item 2 Properties. The Woodward, Oklahoma facility produced 30.4 million, 37.3 million and 33.8 million gallons of methanol in 2005, 2004 and 2003, respectively, and has an annual methanol production capacity of 40 million gallons. For a description of the Woodward facility, see the Woodward, Oklahoma listing under Item 2 Properties, Marketing and Distribution

In addition to the Beaumont production agreement, Terra also entered into an agreement with Methanex to market, under a commission arrangement, all methanol produced at the Woodward, Oklahoma facility. The customers served under these arrangements are primarily large domestic chemical producers.

Nitrogen Industry Overview

The three major nutrients required for plant growth are phosphorous, mined as phosphate rock; potassium, mined as potash; and nitrogen, produced from natural gas. Phosphorus plays a key role in the photosynthesis process. Potassium is an important regulator of plants’ physiological functions. Nitrogen is an essential element for most organic compounds in plants because it promotes protein formation. Nitrogen is also a major component of chlorophyll, which helps promote green healthy growth and high yields. There are no substitutes for nitrogen fertilizers in the cultivation of high-yield crops. These three nutrients occur naturally in the soil to a certain extent, but must be replaced because crops remove them from the soil. Nitrogen, to a greater extent than phosphate and potash, must be reapplied each year in areas of intense agricultural usage because of nitrogen absorption by crops and its tendency to escape from the soil by evaporation or leaching. Consequently, demand for nitrogen fertilizer tends to be more consistent on a year-by-year, per-acre-planted basis than is demand for phosphate or potash fertilizer.

The major nitrogen consuming crop in North America is corn and in the United Kindgom, wheat. Certain crops, such as soybeans and other legumes, can use atmospheric nitrogen and do not require nitrogen fertilizers.

Demand

Global demand for fertilizers typically grows at predictable rates and tends to correspond to growth in grain production. Global fertilizer demand is driven in the long term primarily by population growth, increases in disposable income and associated improvements in diet. Short-term demand depends on world economic growth rates and factors creating temporary imbalances in supply and demand. These factors include weather patterns, the level of world grain stocks relative to consumption, agricultural commodity prices, energy prices, crop mix, fertilizer application rates, farm income and temporary disruptions in fertilizer trade from government intervention, such as changes in the buying patterns of China or India.

Supply

Increased ammonia prices in 1995 led to capacity expansion projects globally that resulted in capacity growth that was, in the short term, substantially greater than demand, causing a structural imbalance in ammonia supply and demand. In addition, foreign government support for domestic production in India, China and the former Soviet Union has kept uneconomical plants running, further increasing supply.

This new global capacity has been partially offset by permanent plant closings in both the U.S. and Europe since 1999. According to Fertecon, since 1999, 23 U.S. ammonia production plants have been closed, indefinitely idled or mothballed, resulting in total lost annual production capacity of over 8.9 million short tons. Recent increases in natural gas costs in many regions of the world have forced temporary plant closures which, in addition to permanent plant closures, have provided support for nitrogen prices.

Imports account for a significant portion of U.S. nitrogen product supply. Producers from the former Soviet Union, Canada, the Middle East, Trinidad and Venezuela are major exporters to the U.S. These export producers are often competitive in regions close to the point of entry for imports, primarily the Gulf coast and east coast of North America. Due to higher freight costs and limited distribution infrastructure, importers are less competitive in serving the main corn-growing regions of the U.S., which are more distant from these ports.

Methanol Industry Overview

Methanol is a liquid made primarily from natural gas that is used as a feedstock in the production of formaldehyde, acetic acid, methyl tertiary-butyl ether (MTBE), and a variety of other chemical intermediates which form the foundation of a large number of secondary derivatives. Formaldehyde is used to produce urea-formaldehyde and phenol-formaldehyde resins, which are used as wood adhesives for plywood, particleboard, oriented strand board, medium-density fiberboard and other engineered wood products. In addition, formaldehyde is used in the manufacture of elastomers, paints, foams, polyurethane and automotive products. Acetic acid is used as a chemical intermediate to produce adhesives, paper, paints, plastics, resins, solvents, and textiles. MTBE, an oxygenate and octane enhancer, is used to reduce

hydrocarbon and carbon monoxide emissions from motor vehicles. Chemical intermediates are used to manufacture de-icer and windshield fluid, antifreeze, herbicides, pesticides, and poultry feed products.

Methanol is a typical commodity chemical and the methanol industry is characterized by cycles of oversupply resulting in lower prices and idled capacity, followed by periods of shortage and rapidly rising prices until increased prices justify new plant investments or the re-start of idled capacity. However, the expanding number of different uses for methanol and its derivatives over the last several years has resulted in the methanol industry becoming more complex and subject to increasingly diverse influences on supply and demand.

Demand

Due to an increasing range of end uses for methanol, demand has tended to move with the general level of economic activity in methanol’s major markets. The significant use of methanol for the production of chemicals used in the building products industry means that building and construction cycles are important factors in determining demand for methanol-based chemicals. MTBE is considered the preferred oxygenate by the refining industry and its production had grown rapidly until 2003 when initiatives in California and other states resulted in regulations that prohibit the addition of MTBE to gasoline.

Supply

Over the past several years significant industry restructuring has taken place with most North American methanol capacity shut down. New methanol production facilities have generally been constructed in locations with access to low-cost natural gas, although this advantage is partially offset by higher distribution costs due to distance from major markets.

Credit

Terra’s credit terms are generally 15-30 days in the U.S. and 30 days in the U.K., but may be extended for longer periods during certain sales seasons, consistent with industry practices.

Seasonality and Volatility

The fertilizer business is highly seasonal, based upon the planting, growing and harvesting cycles. Nitrogen fertilizer inventories must be accumulated to permit uninterrupted customer deliveries, and require significant storage capacity. This seasonality generally results in higher fertilizer prices during peak periods, with prices normally reaching their highest point in the spring, decreasing in the summer, and increasing again in the late fall – early winter period as depleted inventories are restored.

Nitrogen fertilizer prices can also be volatile as a result of a number of other factors. The most important of these factors are:

	•		Weather patterns and field conditions (particularly during periods of high fertilizer consumption);
	•		Quantities of fertilizers imported to primary markets;
	•		Current and projected grain inventories and prices, which are heavily influenced by U.S. exports and worldwide grain markets; and

•

Price fluctuations in natural gas, the principal raw material used to produce nitrogen fertilizer.

Governmental policies may directly or indirectly influence the number of acres planted, the level of grain inventories, the mix of crops planted and crop prices.

While most U.S. methanol is sold pursuant to long-term contracts based on market index pricing and fixed volumes, the spot market price of methanol can be volatile. The industry has experienced cycles of oversupply, resulting in depressed prices and idled capacity, followed by periods of shortages and rapidly rising prices. Future demand for methanol will depend in part on the emerging regulatory environment with respect to reformulated gasoline.

Raw Materials

The principal raw material used to produce manufactured nitrogen products and methanol is natural gas. Natural gas costs in 2005 accounted for approximately 72% of Terra’s total manufacturing costs and expenses. Significant increases in natural gas costs that are not hedged or recovered through increased prices to customers would have an adverse impact on the Company’s business, financial condition and results. Terra management believes there will be a sufficient supply of natural gas for the foreseeable future and will, as opportunities present themselves, enter into firm transportation contracts to minimize the risk of interruption or curtailment of natural gas supplies during the peak-demand winter season. The Company uses a combination of spot and term purchases of varied duration from a variety of suppliers to obtain natural gas supply.

Terra owns a 50% interest in Point Lisas Nitrogen Limited, a 50/50 ammonia production joint venture with KNC Trinidad Limited. Point Lisas Nitrogen Limited has a contract to purchase natural gas from the National Gas Company of Trinidad and Tobago. The joint venture’s cost of natural gas has historically been significantly lower than U.S. natural gas costs, which has resulted in the joint venture being substantially more profitable than comparable North American facilities.

Pursuant to a policy approved by the board of directors, Terra employs natural gas hedges with a goal of mitigating risk from increases to natural gas prices. Terra hedges natural gas prices through the use of supply contracts, financial derivatives and other instruments. Terra enters into these positions when it believes such arrangements would not result in costs greater than expected selling prices for the finished products.

If natural gas prices rise, Terra may benefit from the use of forward-pricing techniques. Conversely, if natural gas prices fall, the Company may incur costs above the then-available spot market price. The settlement dates of forward-pricing contracts coincide with gas purchase dates. Forward-pricing contracts are based on a specified price referenced to spot market prices or appropriate NYMEX futures contract prices.

Transportation

Terra uses several modes of transportation to distribute products to customers, including railroad cars, common carrier trucks, barges and common carrier pipelines.

Railcars are the major mode of transportation at Terra’s North American manufacturing facilities. At December 31, 2005, Terra had 2,487 railcars under lease. Terra owns 10 nitric acid railcars. In addition, Terra operates Terra Express, Inc., a common carrier covering the 48 contiguous United States which is most active in the middle third of the country. Terra Express specializes in transporting liquid bulk products, including UAN, urea liquor, ethanol, ammonia and propane. Terra Express employs one driver and 38 owner-operators. In the U.K., Terra’s AN production is transported primarily by contract carrier trucks, and ammonia is transported primarily by pipelines that the Company owns.

Terra transports purchased natural gas to its Woodward, Oklahoma facility via both intrastate and interstate pipelines and to Terra’s Verdigris, Oklahoma facility via intrastate pipeline. The intrastate pipelines serving Woodward and Verdigris are not open-access carriers, but are nonetheless part of a widespread regional system through which Woodward and Verdigris can receive natural gas from any major Oklahoma source. Terra also has limited access to out-of-state natural gas supplies for these facilities. Terra’s Beaumont, Texas facility sources natural gas via four intrastate pipelines. The Courtright, Ontario facility sources natural gas at delivery points at Parkway and Dawn, Ontario and a local utility. Terra transports purchased natural gas for its Port Neal, Iowa facility via interstate, open-access pipelines. At the Billingham and Severnside, England locations, purchased natural gas is transported to the facilities via a nationwide, open-access pipeline system. Terra’s Donaldsonville, Louisiana facility sources purchased natural gas from two intrastate pipelines. Terra’s Yazoo City facility is served by three interstate pipelines and one intrastate pipeline.

FMCL Limited Liability Company, Terra’s 50/50 ammonia shipping joint venture with KNC Trinidad Limited, leases a vessel for transportation of ammonia, primarily between the Point Lisas Nitrogen Limited facility in Trinidad and the United States. Use of this vessel is shared between the joint venture partners, Terra and KNC Trinidad Limited.

Research and Development

At the present time, Terra is not undertaking any significant, ongoing research and development efforts.

Competition

The markets in which Terra operates are highly competitive. Competition in agricultural input markets takes place largely on the bases of price, supply reliability, delivery time and quality of service. Feedstock availability to production facilities and the cost and efficiency of production, transportation and storage facilities are also important competitive factors. Government intervention in international trade can distort the competitive environment. The relative cost and availability of natural gas are also important competitive factors. Significant determinants of a plant’s competitive position are the natural gas acquisition and transportation contracts negotiated with its major suppliers as well as proximity to natural gas sources and/or end-users.

Terra’s domestic competitors in the nitrogen fertilizer markets are primarily other independent fertilizer companies. Nitrogen fertilizers imported into the United States compete with domestically produced nitrogen fertilizers, including those produced by Terra. Countries with inexpensive sources of natural gas (whether as a result of government regulation or otherwise) can produce nitrogen fertilizers at a low cost. A substantial amount of new ammonia capacity is expected to be added abroad in the foreseeable future.

Importers of this new supply will face higher transportation costs, which will reduce their advantage of inexpensive natural gas.

In the methanol segment, production and trade have become increasingly globalized and a number of foreign competitors produce methanol primarily for the export market. Many of these foreign competitors have access to favorably priced sources of natural gas and are relatively insensitive to raw material price fluctuations. However, because of low domestic demand, foreign competitors aggressively pursue the U.S. and other export markets.

Environmental and Other Regulatory Matters

Terra’s U.S. operations are subject to various federal, state and local environmental, health and safety laws and regulations, including laws relating to air quality, hazardous or solid wastes and water quality. Terra’s operations in Canada are subject to various federal and provincial regulations regarding such matters, including the Canadian Environmental Protection Act administered by Environment Canada, and the Ontario Environmental Protection Act administered by the Ontario Ministry of the Environment. Terra’s U.K. operations are subject to similar regulations under a variety of acts governing hazardous chemicals, transportation and worker health and safety. All of Terra’s facilities require operating permits that are subject to review by governmental agencies. Terra is also involved in the manufacture, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by federal, state, provincial or other regulatory agencies. The Company takes precautions to reduce the likelihood of accidents involving these materials. If such materials have been or are disposed of at sites that are targeted for investigation and/or remediation by federal or state regulatory agencies, Terra may be responsible under CERCLA or analogous laws for all or part of the costs of such investigation and remediation, and damages to natural resources.

The State of Arizona designated Inspiration Consolidated Copper Company (“Inspiration”), a Terra subsidiary that disposed of its assets in 1988 and no longer operates a business, as one of several potentially responsible parties (“PRP”) under the state Superfund law at the Pinal Creek Drainage Basin Site (“Pinal Site”) in Globe/Miami, Arizona, based upon Inspiration’s prior ownership and operation of copper mining and production facilities. Under state and federal Superfund laws, all PRPs may be jointly and severally liable for the costs of investigation and/or remediation of an environmentally impaired site regardless of fault or the legality of original disposals. The Pinal Site is the subject of ongoing investigation and cleanup to address groundwater releases of acidic metal-bearing solutions from past copper mining and production facilities. The remedial actions are governed by a 1997 consent decree (“1997 Consent Decree”) between the Arizona Department of Environmental Quality and the two current owners/operators of the copper mining and production facilities (one of whom is the successor to Inspiration’s buyer), both of whom the State designated as PRPs, and Inspiration (collectively with Terra, the “Group”). The Group’s members are jointly financing and performing the work, but Inspiration no longer owns assets or is conducting any activities at the Pinal Site. Also, the Group has filed an action for cost-recovery against other former owners and operators at the Pinal Site, a substantial portion of which has been settled. In a related matter, more than a decade ago, residents in an area of the Pinal Site brought a class action lawsuit against the Group seeking property damages and medical monitoring for potential personal injuries allegedly related to the acidic metal-bearing groundwater. The class action lawsuit was settled in September 2000, although plaintiffs reserved the right to assert personal injury claims individually. In the 1988 sale agreement, Inspiration was contractually indemnified by its buyer (which

includes the buyer’s successor) for all environmental claims relating to the Pinal Site. In April 2005, Inspiration and its successor settled most claims relating to the 1988 indemnity, confirming that the successor will indemnify Inspiration for past and future costs arising out of the 1997 Consent decree, for allocation claims arising out of the cost-recovery lawsuit, and for legal fees of common counsel in the various lawsuits. After consideration of such factors as the number of PRPs and levels of financial responsibility, including the ongoing litigation and contractual indemnities, Terra believes its liability with respect to these matters will not be material.

Terra retained a small number (less than 10%) of its retail locations after the sale of its distribution business in 1999. Some of these locations are now, or are expected in the future to be, the subject of environmental clean-up activities for which the Company has retained liability. Terra does not believe that such environmental costs and liabilities will have a material effect on its results of operations, financial position or net cash flows. As of September 30, 2005, there were 14 remaining locations, six of which were undergoing environmental clean-up activities prior to the sale or release of those properties to the landowner. The total net cost associated with the former retail locations in 2006 and beyond (including environmental expenditures and proceeds from voluntary clean-up reimbursements and sale of properties) is not expected to exceed $2 million.

With respect to the Verdigris, Oklahoma facility, Freeport-McMoRan Resource Partners, Limited Partnership (a former owner and operator of the facility) retained liability for certain environmental matters. With respect to the Beaumont, Texas facility, DuPont retains responsibility for certain environmental costs and liabilities stemming from conditions or operations to the extent such conditions or operations existed or occurred prior to its sale of the facility to Terra in 1991. Likewise, with respect to the Billingham and Severnside, England facilities, the seller, ICI, indemnified Terra, subject to certain conditions, for pre-December 31, 1997 environmental contamination associated with the purchased assets. Known conditions are not expected to result in material expenditures but discovery of unknown conditions or the failure of prior owners and operators and indemnitors to meet their obligations could require significant expenditures.

In the wake of the September 11 tragedy, both the U.S. Congress and U.K. Parliament are considering various additional security and handling requirements for hazardous chemicals, including AN, which can be used to manufacture explosives. Terra’s facilities already have the basic plans and vulnerability assessments in place that may be required under new legislation. Accordingly, such legislation is unlikely to have an adverse impact on Terra’s operations, financial position, or cash flow.

Terra may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors, at certain facilities to comply with applicable environmental requirements. Terra estimates that the total cost of additional equipment to comply with these requirements in 2006 and the next two years will be less than $20 million.

Terra endeavors to comply in all material respects with applicable environmental, health and safety regulations and has incurred substantial costs in connection with such compliance. Because these regulations are expected to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. Terra does not expect its compliance with such

regulations to have a material adverse effect on its results of operations, financial position or net cash flows. However, there can be no guarantee that new regulations will not result in material costs.

Terra’s capital expenditures related to environmental control in 2005, 2004 and 2003 were approximately $1.3 million, $2.4 million and $1.3 million, respectively. Projected environmental capital expenditures are $4.5 million for 2006 and $9.1 million for 2007.

Terra believes that its policies and procedures now in effect are in compliance with applicable environmental laws and with the permits relating to the facilities in all material respects. However, in the normal course of its business, Terra is exposed to risks relating to possible releases of hazardous substances into the environment. Such releases could cause substantial damages or injuries. Although environmental expenditures have not been material during the past year, it is impossible to predict or quantify the impact of future environmental liabilities associated with releases of hazardous substances from Terra’s facilities.

Revenues and Assets

Terra’s revenues from external customers, measure of profit and loss, total assets and revenues and assets according to geography for the years 2002-2004 are set forth in Item 8 of this Annual Report on Form 10-K under the caption “Note 21 – Industry Segment Data” contained in the “Notes to Consolidated Financial Statements.”

Employees

Terra had 1,209 full-time employees at December 31, 2005, 253 of which joined Terra through its acquisition of MCC. All 386 U.K. employees are covered by a wage and working conditions arrangement similar to a collective bargaining agreement.

Item 1A. Risk Factors

In addition to the other information contained in this Form 10-K, the following risk factors should be considered carefully in evaluating Terra’s business. The Company’s business, financial condition, or results of operations could be materially adversely affected by any of these risks. Please note that additional risks not presently known to Terra or that its management currently deems immaterial may also impair the Company’s business and operations.

Terra’s inability to predict future seasonal nitrogen products demand accurately could result in low or excess inventory, potentially at costs in excess of market value.

The nitrogen products business is highly seasonal, with more nitrogen products used in North America during the second quarter, in conjunction with spring planting activity, than in any other quarter. Due to the seasonality of the business and the relatively brief periods during which products can be used by customers, Terra and/or its customers generally build inventories during the second half of the year in order to ensure timely product availability during the peak sales season. This increases Terra’s working capital needs during this period as the Company funds these inventory increases and supports its customers’ inventory carry. If Terra underestimates future demand, profitability will be negatively

impacted and customers may acquire products from our competitors. If Terra overestimates future demand, it will be left with excess inventory that will incur storage costs and/or Terra may liquidate such additional inventory at sales prices below its costs.

A substantial portion of Terra’s operating expense is related to the cost of natural gas, and an increase in such cost that is either unexpected or not accompanied by increases in selling prices of products could result in reduced profit margins and lower product production.

The principal raw material used to produce nitrogen products is natural gas. Natural gas costs in 2005 comprised about 72% of total costs and expenses. A significant increase in the price of natural gas (which can be driven by, among other things, supply disruptions, cold weather and oil price spikes) that is not hedged or recovered through an increase in the price of related nitrogen products could result in reduced profit margins and lower product production. Terra has in the recent past idled one or more of its plants in response to high natural gas prices. A significant portion of Terra’s competitors’ global nitrogen production occurs at facilities with access to fixed-priced natural gas supplies. The competitors’ facilities’ natural gas costs have been and likely will continue to be substantially lower than Terra’s.

Declines in the prices of Terra’s products may reduce profit margins.

Prices for nitrogen products are influenced by the global supply and demand conditions for ammonia and other nitrogen-based products. Long-term demand is affected by population growth and rising living standards that determine food consumption. Short-term demand is affected by world economic conditions and international trade decisions. Supply is affected by increasing worldwide capacity and the increasing availability of nitrogen product exports from major producing regions such as the former Soviet Union, Canada, the Middle East, Trinidad and Venezuela. A substantial amount of new ammonia capacity is expected to be added abroad in the foreseeable future. When industry oversupply occurs, as is common in commodity businesses, the price at which Terra sells its nitrogen products typically declines, which results in reduced profit margins, lower production of products and plant closures. Supply in the U.S. and Europe is also affected by trade regulatory measures, which restrict import supply into those markets. Changes in those measures would likely adversely impact available supply and pricing.

Terra’s products are subject to price volatility resulting from periodic imbalances of supply and demand, which may cause the results of operations to fluctuate.

Historically, Terra’s products’ prices have reflected frequent changes in supply and demand conditions. Changes in supply result from capacity additions or reductions and from changes in inventory levels. Demand for products is dependent on demand for crop nutrients by the global agricultural industry and on the level of industrial production. Periods of high demand, high capacity utilization and increasing operating margins tend to result in new plant investment and increased production until supply exceeds demand, followed by periods of declining prices and declining capacity utilization until the cycle is repeated. In addition, markets for Terra’s products are affected by general economic conditions. As a result of periodic imbalances of supply and demand, product prices have been volatile, with frequent and significant price changes. During periods of oversupply, the price at which Terra sells its products may be depressed and this could have a material adverse effect on Terra’s business, financial condition and results of operations.

Terra’s products are global commodities and Terra faces intense competition from other nitrogen fertilizer producers.

Nitrogen fertilizer products are global commodities and can be subject to intense price competition from both domestic and foreign sources. Customers, including end-users, dealers and other crop-nutrients producers and distributors, base their purchasing decisions principally on the delivered price and availability of the product. Terra competes with a number of U.S. producers and producers in other countries, including state-owned and government-subsidized entities. The U.S. and the European Commission each have trade regulatory measures in effect which are designed to address this type of unfair trade. Changes in these measures could have an adverse impact on Terra’s sales and profitability of the particular products involved. Some of Terra’s principal competitors have greater total resources and are less dependent on earnings from nitrogen fertilizer sales. In addition, a portion of global production benefits from natural gas contracts that have been, and could continue to be, substantially lower priced than our natural gas. Terra’s inability to compete successfully could result in the loss of customers, which could adversely affect sales and profitability.

The Company’s business is subject to risks related to weather conditions.

Adverse weather conditions may have a significant effect on demand for our nitrogen products. Weather conditions that delay or intermittently disrupt field work during the planting and growing season may cause agricultural customers to use less or different forms of nitrogen fertilizer, which may adversely affect demand for the forms that Terra sells. Weather conditions following harvest may delay or eliminate opportunities to apply fertilizer in the fall. Weather can also have an adverse effect on crop yields, which lowers the income of growers and could impair their ability to pay Terra’s customers.

Terra is substantially dependent on its manufacturing facilities, and any operational disruption could result in a reduction of sales volumes and could cause Terra to incur substantial expenditures.

Terra’s manufacturing operations may be subject to significant interruption if one or more of its facilities were to experience a major accident or were damaged by severe weather or other natural disaster. In addition, Terra’s operations are subject to hazards inherent in nitrogen fertilizer manufacturing. Some of those hazards may cause personal injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and may result in suspension of operations and the imposition of civil or criminal penalties. For example, an explosion at Terra’s Port Neal, Iowa facility in 1994 required Terra to rebuild nearly the entire facility. Also, a mechanical outage at the Courtright, Ontario facility in April 2001 required Terra to shut down that facility for approximately two months. Terra currently maintains property insurance, including business interruption insurance although there can be no assurance that it has sufficient coverage, or can in the future obtain sufficient coverage at reasonable costs.

Terra may be adversely affected by environmental regulations.

Terra’s operations are subject to various federal, state and local environmental, safety and health laws and regulations, including laws relating to air quality, hazardous and solid wastes and water quality. In the United States, Terra’s operations are subject to a comprehensive federal and state regulatory regime, including the federal Clean Air Act, Clean Water Act, Resource Conservation and Recovery Act, Emergency Planning and Community Right-to-Know Act, Toxic Substances Control Act and their state analogs. Terra’s operations in Canada are also subject to various federal and provincial regulations regarding such matters, including the Canadian Environmental Protection Act administered by Environment Canada, and the Ontario Environmental Protection Act administered by the Ontario Ministry of the Environment. Terra’s U.K. operations are subject to similar regulations under a variety of

requirements, including those arising under the Integrated Pollution Prevention and Control (“IPPC”) Program. Terra could incur substantial costs, including capital expenditures for equipment upgrades, fines and penalties and third-party claims for damages, as a result of compliance with, violations of or liabilities under environmental laws and regulations. Terra is also involved in the manufacture, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by federal, state, provincial or other regulatory agencies. If such materials have been or are disposed of or released at sites that require investigation and/or remediation, Terra may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act of 1980, or “CERCLA,” or analogous laws for all or part of the costs of such investigation and/or remediation, and for damages to natural resources. Under some of these laws, responsible parties may be held jointly and severally liable for such costs, regardless of fault or the legality of the original disposal or release.

Terra has liability as a potentially responsible party at certain sites under certain environmental cleanup laws. The Company has also been subject to related claims by private parties alleging property damage and possible personal injury arising from contamination relating to our discontinued operations. Terra may be subject to additional liability or additional claims in the future. Some of these matters may require the Company to expend significant amounts for investigation and/or cleanup or other costs.

Terra may be required to install additional pollution control equipment at certain facilities in order to maintain compliance with applicable environmental requirements.

Continued government and public emphasis on environmental issues can be expected to result in increased future investments for environmental controls at ongoing operations. Terra may be required to install additional air and water quality control equipment, such as low emission burners, scrubbers, ammonia sensors and continuous emission monitors, at certain of its facilities in order to maintain compliance with applicable environmental requirements. Such investments would reduce income from future operations. Present and future environmental laws and regulations applicable to operations, more vigorous enforcement policies and discovery of unknown conditions may require substantial expenditures and may have a material adverse effect on results of operations, financial position or net cash flows.

Government regulation and agricultural policy may reduce the demand for Terra’s products.

Existing and future government regulations and laws may reduce the demand for Terra products. Existing and future agricultural and/or environmental laws and regulations may impact the amounts and locations of fertilizer application and may lead to decreases in the quantity of nitrogen fertilizer applied to crops. Any such decrease in the demand for fertilizer products could result in lower unit sales and lower selling prices for nitrogen fertilizer products. U.S. and E.U. governmental policies affecting the number of acres planted, the level of grain inventories, the mix of crops planted and crop prices could also affect the demand and selling prices of Terra’s products. In addition, Terra manufactures and sells ammonium nitrate (AN) in the U.K. and in the U.S. Ammonium nitrate can be used as an explosive and was used in the Oklahoma City bombing in April 1995. It is possible that either the U.S. or U.K. governments could impose limitations on the use, sale or distribution of AN, thereby limiting Terra’s ability to manufacture or sell this product.

Terra is subject to risks associated with international operations.

Terra’s international business operations are subject to numerous risks and uncertainties, including difficulties and costs associated with complying with a wide variety of complex laws, treaties and regulations; unexpected changes in regulatory environments; currency fluctuations; tax rates that may exceed those in the U.S.; earnings that may be subject to withholding requirements; and the imposition of tariffs, exchange controls or other restrictions. During 2005 Terra derived approximately 24% of its net sales from outside of the U.S. Terra’s business operations include a 50% interest in an ammonia production joint venture in the Republic of Trinidad and Tobago and a 50% interest in an ammonia shipping joint venture that provides transportation of ammonia from the Trinidad facility to the U.S. and other world markets.

Terra’s business may be adversely impacted by the Company’s high-cost leverage, which requires the use of a substantial portion of excess cash flow to service debt and may limit Terra’s access to additional capital.

Terra’s debt could have important consequences on its business. For example, it could (i) increase Terra’s vulnerability to adverse economic and industry conditions by limiting flexibility in reacting to changes in the business industry, (ii) reduce Terra’s cash flow available to fund working capital, capital expenditures and other general corporate purposes, (iii) place Terra at a competitive disadvantage compared to competitors that have less leverage and (iv) limit Terra’s ability to borrow additional funds and increase the cost of funds that Terra can borrow. Terra may not be able to reduce its financial leverage when it chooses to do so, and may not be able to raise capital to fund growth opportunities.

Terra may not be able to finance a change of control offer.

If Terra considers an offer that would result in a “change of control” (as defined in its bond indentures and the instruments governing its Series A convertible preferred shares), it may need to refinance large amounts of debt. If a change of control occurs, Terra must offer to buy back the notes under its indentures and the Series A convertible preferred shares for a price equal to 101% of the notes’ principal amount or 100% of the liquidation value of the Series A convertible preferred shares, as applicable, plus any interest or dividends which has accrued and remains unpaid as of the repurchase date. There can be no assurance that there will be sufficient funds available for any repurchases that could be required by a change of control.

Item 1B.		Unresolved Staff Comments

Not applicable.

Item 2.		Properties

Terra’s manufacturing facilities and the Point Lisas manufacturing facility in which it owns a 50% interest, are designed to operate continuously, except for planned shutdowns (usually biennial) for maintenance and efficiency improvements. Capacity utilization (gross tons produced divided by capacity tons at expected operating rates and on-stream factors) of the nitrogen products manufacturing facilities (excluding 2004 production at the Blytheville, Arkansas plant which closed in May 2004, and the 2003 and 2004 production at the plants acquired in the Mississippi Chemical acquisition) during 2005 was approximately 96%, 99% and 96% in 2005, 2004 and 2003, respectively.

Terra owns all of its manufacturing facilities, unless otherwise indicated below. Substantially all of Terra’s manufacturing facilities are mortgaged to secure indebtedness under the Company’s credit agreements and its notes due in 2008 and 2010.

Beaumont, Texas. The Beaumont facility is located six miles south of Beaumont, Texas on the Neches River. Terra owns the plant and processing equipment at the Beaumont facility, which has an annual methanol production capacity of 225 million gallons. The facility also contains an “ammonia loop” which provides an annual ammonia production capacity of 255,000 tons. The facility’s real estate is leased from E.I. DuPont de Nemours and Company (“DuPont”) at a nominal rate under a lease that expires in 2090. The facility is entirely contained within an industrial complex owned and operated by DuPont, and DuPont provides access to the facility as well as essential services such as security, emergency response, product loading and unloading, and a waste water effluent system. The facility also contains a methanol storage and distribution terminal containing two 7.5 million gallon methanol storage tanks and one 20,000 ton ammonia storage tank. The Beaumont facility is currently out of production, however Terra continues to operate the terminal. See further discussion of the Beaumont facility under the “Methanol Business Segment” heading, which follows.

Donaldsonville, Louisiana. The Donaldsonville facility is located on approximately 766 acres fronting the Mississippi River and, in 2004, included two ammonia plants, a urea plant and two melamine crystal production plants. During 2005 all of these plants, except for one ammonia plant, were decommissioned and sold for parts or scrap. The remaining ammonia plant has been mothballed. The facility contains a deep-water port facility on the Mississippi River, allowing for barge transportation and making Donaldsonville one of the northernmost points on the river capable of receiving economical ocean-going vessels.

Port Neal, Iowa. The Port Neal facility is located approximately 12 miles south of Sioux City, Iowa on the Missouri River. The facility consists of an ammonia plant, two urea plants, two nitric acid plants and a UAN plant.

Verdigris, Oklahoma. The Verdigris facility is located on 650 acres northeast of Tulsa, Oklahoma, near the Verdigris River. It is the second largest UAN production facility in North America. The facility comprises two ammonia plants, two nitric acid plants, two UAN plants and a port terminal. Terra owns the plants and leases the port terminal from the Tulsa-Rogers County Port Authority. Terra renewed its leasehold interest in the port terminal for five years in April 2004, and has an option to renew the lease for an additional five-year term in 2009.

Woodward, Oklahoma. The Woodward facility is located in rural northwest Oklahoma and consists of an integrated ammonia/methanol plant, a nitric acid plant, a urea plant and a UAN plant.

Yazoo City, Mississippi. The Yazoo City facility is located on approximately 2,240 acres in Yazoo County, Mississippi with approximately 60 acres of such land subject to a long-term lease with Yazoo County. The facility includes two ammonia plants (one of which is mothballed), five nitric acid plants, an AN plant, two urea plants, a UAN plant and a dinitrogen tetroxide production and storage facility.

In July 2005, Terra entered into a 10-year agreement to supply industrial grade ammonium nitrate (IGAN) and ammonium nitrate solution (ANS) to Orica USA Inc. Under the terms of this arrangement, Terra will

modify the smaller of its Yazoo City facility ammonium nitrate (AN) towers, which is currently limited to converting ANS to agricultural grade AN. When the modifications are complete, the tower will be equipped to convert ANS to either agricultural grade AN or IGAN, a prilled, low-density industrial grade product. Terra expects the tower modifications to be complete by September 2006.

Courtright, Ontario, Canada. The Courtright facility is located on 700 acres south of Sarnia, Ontario near the St. Clair River. The facility consists of one ammonia plant, a UAN plant, a nitric acid plant and two urea plants.

Billingham, U.K. The Billingham facility, located in the Teesside chemical area, is geographically split among three separate areas: the main site contains an ammonia plant, three nitric acid plants and a carbon dioxide plant; the Portrack site approximately two miles away contains an AN fertilizer plant and the north Tees site approximately five miles away has an ammonia storage and import/export facility that Terra uses under license from the Crown and under an agreement with a third-party operator.

Severnside, U.K. The Severnside facility is located in southwestern England. The facility consists of two ammonia plants, two nitric acid plants and an AN plant.

Trinidad. The Point Lisas Nitrogen facility in the Republic of Trinidad and Tobago is owned by a 50/50 joint venture with KNC Trinidad Limited. This facility has the capacity to produce annually 720,000 tons of ammonia from natural gas supplied under contract with the National Gas Company of Trinidad and Tobago. Terra is obligated to buy 50% of the joint venture’s ammonia output at market prices, which is transported primarily to the U.S. Gulf Coast and resold to Terra’s customers. The joint venture’s natural gas costs have recently been significantly lower than U.S. natural gas costs, which has made the joint venture substantially more profitable than comparable North American facilities.

PLNL produced 636,935 tons of ammonia in 2005 of which Terra purchased 358,582 tons. All of the PLNL ammonia tons purchased by Terra was delivered to Terra’s Donaldsonville terminal for subsequent sale or delivery. Terra received in 2005 $42.8 million of cash distributions from PLNL.

Item 3.		Legal Proceedings

From time to time, the Company is involved in litigation, administrative proceedings and claims, including environmental matters, arising in the ordinary course of business. Terra does not believe that the matters in which it is currently involved, either individually or in the aggregate, will have a material adverse effect on its business, results of operations, financial position or net cash flows.

Item 4.		Submission of Matters to a Vote of Security Holders

No matters were submitted to a vote of security holders of Terra during the fourth quarter of 2005.

Executive Officers of Terra

The following paragraphs set forth the name, age and offices of each present executive officer of Terra, the period during which each executive officer has served as such and each executive officer’s business experience during the past five years:

		Present positions and offices with the Company
Name		and principal occupations during the past five years
Michael L. Bennett		President and Chief Executive Officer of Terra since April 2001; Executive Vice President and Chief Operating Officer of Terra from February 1997 to April 2001; President and Chief Executive Officer of Terra Nitrogen Division since June 1998. Age 52.
Joe A. Ewing		Vice President, Human Resources and Corporate Communications of Terra since December 2004; Vice President, Human Resources of Mississippi Chemical Corporation from April 2003 to December 2004; Vice President, Marketing and Distribution of Mississippi Chemical Corporation from 1999 to April 2003. Age 55.
Joseph D. Giesler		Senior Vice President, Commercial Operations of Terra since December 2004; Vice President of Industrial Sales and Operations of Terra from December 2002 to December 2004; Global Director, Industrial Sales of Terra from September 2001 to December 2002; Director of Marketing of Terra from June 2000 to August 2001; and Director of Western Division of Terra from July 1998 to May 2000. Age 47.
Daniel D. Greenwell		Vice President, Controller of Terra since April 2005; Corporate Controller for Belden CDT Inc. from 2002 to 2005; and Chief Financial Officer of Zoltek Companies Inc. from 1996 to 2002. Age 43.
Mark A. Kalafut		Vice President, General Counsel and Corporate Secretary of Terra since June 2001; Vice President and Associate General Counsel of Terra from April 1997 through June 2001. Age 52.
Francis G. Meyer		Senior Vice President and Chief Financial Officer of Terra since November 1995. Age 53.
W. Mark Rosenbury		Senior Vice President and Chief Administrative Officer of Terra since August 1999. Age 58.
Richard S. Sanders Jr.		Vice President, Manufacturing of Terra since August 2003; Plant Manager, Verdigris, Oklahoma manufacturing facility from 1995 to August, 2003. Age 48.

		Present positions and offices with the Company
Name		and principal occupations during the past five years
Paul Thompson		Vice President, Sales and Marketing of Terra since December 2004; Global Director, Ag Sales and Terra U.K. Managing Director from August 1999 to December 2004. Age 51.

There are no family relationships among the executive officers and directors of Terra or arrangements or understandings between any executive officer and any other person pursuant to which any executive officer was selected as such. Officers of Terra are elected annually to serve until their respective successors are elected and qualified.

PART II

Item 5.		Market for Terra’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities

The main market in which Terra’s common shares are traded is the NYSE. Set forth below are the high and low sales prices of Terra’s common shares during each quarter specified as reported on the NYSE.

(per-share data and stock prices)		March 31				June 30				Sept. 30				Dec. 31
2005
Common Share Price:
High		$	9.27			$	7.88			$	8.59			$	6.65
Low			7.29				6.27				6.10				4.87
2004
Common Share Price:
High		$	6.66			$	6.55			$	8.95			$	9.38
Low			3.20				4.15				5.50				7.00

As of March 1, 2006 there were approximately 6,906 record holders of Terra’s common stock.

Item 6.		Selected Financial Data

Financial Summary

(in thousands, except per share data)		2005(1)				2004(2)				2003(3)				2002(4)				2001
Income Statement Data:
Revenues		$	1,939,065			$	1,509,110			$	1,351,055			$	1,043,983			$	1,037,310
Income (loss) from operations			113,696				134,746				(23,560	)			(5,407	)			(61,818	)
Net income (loss) from continuing operations			22,087				67,596				(12,481	)			(36,174	)			(79,843	)
Net income (loss)			22,087				67,596				(12,481	)			(258,325	)			(79,843	)
Preferred share dividends			(5,134	)			(1,029	)			—				—				—
Basic income per share:
Continuing operations			0.18				0.87				(0.16	)			(3.43	)			(1.06	)
Discontinued operation			—				—				—				(0.22	)			—
Cumulative effect of change in accounting principle			—				—				—				(2.73	)			—
Basic income per share			0.18				0.87				(0.16	)			(3.43	)			(1.06	)
Diluted income per share		$	0.18			$	0.85			$	(0.16	)		$	(3.43	)		$	(1.06	)
Balance Sheet Data:
Total assets		$	1,523,625			$	1,685,508			$	1,125,062			$	1,128,110			$	1,336,043
Long-term debt and capital leases		$	331,300			$	435,238			$	402,206			$	400,358			$	436,534
Preferred stock		$	115,800			$	133,069			$	—			$	—			$	—

Item 7.		Management’s Discussion and Analysis of Financial Condition and Results of Operations

Introduction

Terra Industries Inc. (“Terra” or “the Company”) produces and markets nitrogen products for agricultural and industrial markets with production facilities located in North America and the United Kingdom. During December 2004, the Company acquired Mississippi Chemical Corporation (MCC).

Nitrogen products are commodity chemicals that are sold at prices reflecting global supply and demand conditions. The nitrogen products industry has cycles of oversupply, resulting in lower prices and idled capacity, followed by supply shortages, resulting in high selling prices and higher industry-wide

production rates. To be viable in this industry, a producer must be among the low-cost suppliers in the markets it serves and have a financial position that can sustain it during periods of oversupply.

Natural gas is the most significant raw material in the production of nitrogen products. North American natural gas costs have increased substantially since 1999. Since some of the Company’s products compete with nitrogen products imported from regions with lower natural gas costs, the Company and other North American producers have not always been able to increase selling prices to levels necessary to cover the natural gas cost increases. This has resulted in curtailments of North American nitrogen production. These curtailments contributed to reductions in global nitrogen product supplies.

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

The Company’s sales volumes depend primarily on its plants’ operations and imports from PLNL. The Company may purchase product from other manufacturers or importers for resale; however, gross margins on those volumes have historically been insignificant. Profitability and cash flows from the Company’s nitrogen products business are affected by the Company’s ability to manage its costs and expenses (other than natural gas), most of which do not materially change for different levels of production or sales. Other factors affecting the Company’s nitrogen products results include the number of planted acres, transportation costs, weather conditions (particularly during planting season), grain prices and other variables described in Item 1 “Business” and Item 2 “Properties.”

The Company also produces methanol in the U.S. Similar to nitrogen products, methanol is a commodity chemical manufactured from natural gas. Consequently, natural gas costs and the supply/demand balance for methanol significantly affect methanol earnings and cash flows. A significant portion of U.S. methanol demand is met by imports from regions with natural gas costs lower than those available to U.S. producers. U.S. methanol demand has declined over the past year and is expected to continue to decline due to reduced U.S. consumption of MTBE, a gasoline oxygenate and octane enhancer that uses methanol as a feedstock. In December 2003, the Company entered into contracts with the Methanex Corporation (“Methanex”) assigning it the Company’s sales contracts and providing it exclusive rights to all methanol production at the Beaumont facility for five years as more fully described in Item 1 “Business” and Item 2 “Properties.” As permitted under these contracts, Methanex elected to shut down the Beaumont facility as of December 1, 2004. As long as the Beaumont, Texas facility remains idle through the December 2008 termination of the Methanex contract, the Company may realize revenues relating to the facility of up to $16.4 million per year due to $4.4 million from annual amortization of deferred revenues plus one-half of the annual cash margin based on the plant’s methanol production capacity, methanol reference prices and natural gas costs. Due to the high cost of natural gas, there was no cash margin realized during 2005.

During the fourth quarter of 2005, the Company temporarily suspended all production at the Woodward, Oklahoma facility, ammonia production at the Yazoo City, Mississippi facility and ammonia production at the Billingham, Teeside facility in the U.K. These temporary suspensions of production were due to the high cost of natural gas during the period.

Overview of Consolidated Results

The Company’s revenues were $1.9 billion, $1.5 billion and $1.4 billion during 2005, 2004 and 2003, respectively. Terra generated net income (loss) of $22.1 million, $67.6 million and $(12.5) million in 2005, 2004 and 2003, respectively. Diluted income (loss) per share was $0.18, $0.85 and $(0.16) in 2005, 2004 and 2003, respectively.

Income (loss) from operations was $113.7 in 2005, $134.7 million in 2004 and $(23.6) million in 2003. Revenues for 2005 increased $423.6 million as compared to 2004, primarily due to the Mississippi Chemical Corporation (MCC) acquisition in December 2004 and higher sales prices. The sales prices were higher as a result of increased demand and lower supplies primarily due to reduced production capacity in North America. Costs associated with the 2005 MCC revenues and higher natural gas prices were the primary factors that increased cost of sales by $452.2 million in 2005 as compared to 2004. The Company recognized $21.4 million of earnings from equity in unconsolidated affiliates during 2005, primarily as a result of equity investments acquired in the MCC acquisition. During 2005, the Company recorded a $27.2 million loss ($24.9 million, net of tax) on the early repayment of debt and an $8.9 million gain ($8.9 million, net of tax) on change in fair value of warrants issued.

The 2004 net income was increased by $27.9 million of income tax benefits due to a favorable settlement with a foreign taxing authority. The 2004 net income also included $11.6 million attributable to an insurance recovery of product claim costs (representing $17.9 million of operating income less $6.3 million of related income taxes) and a $7.1 million loss from the early retirement of long-term debt (representing $11.1 million of losses less $4.0 million of related income taxes).

During 2003, the Company recorded a $27.0 million net charge for the impairment of its Blytheville, Arkansas facility (representing a $53.1 million impairment charge to operating income less $9.9 million allocated to minority interest and $16.2 million of income tax benefit). The 2003 net loss was reduced by $36.4 million of income tax benefits for a reduced assessment by a foreign taxing authority and reversals of tax reserves that had been provided in prior years.

Other fluctuations to the Company’s income (loss) from continuing operations for 2005, 2004 and 2003 were primarily related to increases in the selling prices of nitrogen products, decreases in methanol sales due to an exclusivity agreement with Methanex and changes in the cost of natural gas, the Company’s primary raw material for manufacturing its products.

Factors That Affect Operating Results

Factors that may affect the Company’s operating results include: the relative balance of supply and demand for nitrogen fertilizers, industrial nitrogen and methanol, the availability and cost of natural gas, the number of agriculture-planted acres (which is affected by both worldwide demand and government policies), the types of crops planted, the effect of general weather patterns on the timing and duration of field work for crop planting and harvesting, the effect of environmental legislation on supply and demand for the Company’s products, the availability of financing sources to fund seasonal working capital needs, and the potential for interruption to operations due to accidents or natural disasters.

The principal raw material used to produce nitrogen products and methanol is natural gas. Natural gas costs in 2005 and 2004 accounted for approximately 72% and 60%, respectively, of the Company’s total

manufacturing costs and expenses. A significant increase in the price of natural gas that is not hedged or recovered through an increase in the price of the Company’s nitrogen and methanol products would have an adverse effect on the Company’s business, financial condition and results of operations. A portion of global nitrogen products and methanol production is at facilities with access to fixed-price natural gas supplies that have been, and could continue to be, substantially lower priced than natural gas costs at the Company’s North American and U.K. facilities. The Company’s facility at Point Lisas Nitrogen Limited, an unconsolidated subsidiary, is located in Trinidad with access to such lower-cost natural gas.

The Company enters into forward pricing contracts for some of its natural gas requirements when such arrangements would not result in costs greater than expected North American and U.K. selling prices for the Company’s finished products. The Company’s December 31, 2005 forward positions covered 16% of the Company’s expected 2006 natural gas requirements (excluding the natural gas requirements of Point Lisas Nitrogen Limited which purchases its gas under contract with the Natural Gas Company of Trinidad and Tobago).

Prices for nitrogen products are influenced by the world supply and demand balance for ammonia and other nitrogen-based products. Long-term demand is affected by population growth and rising living standards that determine food consumption. Short-term demand is affected by world economic conditions, international trade decisions and grain prices. Supply is affected by increasing worldwide capacity and the availability of nitrogen product exports from major producing regions such as the former Soviet Union, the Middle East and South America.

Methanol is used as a raw material in the production of formaldehyde, methyl tertiary-butyl ether (MTBE), acetic acid and numerous other chemical derivatives. The price of methanol is influenced by the supply and demand for each of these products. Environmental initiatives to ban or reduce the use of MTBE as a fuel additive, such as those currently underway in the United States, could affect demand for methanol.

Weather can have a significant effect on demand for the Company’s nitrogen products. Weather conditions that delay or intermittently disrupt field work during the planting and growing seasons may cause agricultural customers to use forms of nitrogen fertilizer that are more or less favorable to the Company’s products. Weather conditions following harvest may delay or eliminate opportunities to apply fertilizer in the fall. Weather can also have an adverse effect on crop yields, which lowers the income of growers and could affect their ability to pay for crop inputs purchased from the Company’s dealer customers.

The Company’s nitrogen business segment is seasonal, with the majority of nitrogen products consumed during the second quarter in conjunction with spring planting activity. Due to the business’ seasonality and the relatively brief periods during which customers consume nitrogen products, the Company and its customers generally build inventories during the second half of the year in order to ensure product availability during the peak sales season. For the Company’s current level of sales, it may require lines of credit to fund inventory increases and to support customer credit terms. The Company believes that its credit facilities are adequate for expected 2006 sales levels.

The Company’s manufacturing operations may be subject to significant interruption if one or more of its facilities were to experience a major accident or were damaged by severe weather or other natural

disaster. The Company currently maintains insurance, including business interruption insurance, which it believes is sufficient to allow it to recover from major damage to any of its facilities.

Critical Accounting Policies

The discussion and analysis of the Company’s financial condition and results of operations are based upon its consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires estimates and judgments that affect the amount of assets, liabilities, revenues and expenses as of the date of the financial statements. Actual results may differ from these estimates.

Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions.

Derivative and Financial Instruments

The Company enters into derivative financial instruments, including swaps, basis swaps and put and 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 the determination of net income in the period the offsetting hedged transaction occurs. If an instrument is settled early, any gains or losses are immediately recognized as adjustments to earnings.

Revenue Recognition

Revenue is recognized when persuasive evidence of a transaction 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 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.

Inventory Valuation

Inventories are stated at the lower of cost or estimated net realizable value. The cost of inventories is determined by using the first-in, first-out method. The Company performs a monthly analysis of its inventory balances to determine if the carrying amount of inventories exceeds their 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.

Equity Investments

Equity investments are carried at original cost adjusted for the Company’s proportionate share of the investees’ income, losses and distributions. The Company periodically assesses the carrying value of its equity investment and will record a loss on equity investments when a decline in the fair value of the investment that is other than temporary exists.

Pension Assets and Liabilities

Pension assets and liabilities are affected by the estimated market value of plan assets, estimates of the expected return on plan assets and discount rates. Actual changes in the fair market value of plan assets and differences between the actual return on plan assets and the expected return on plan assets will affect the amount of pension expense ultimately recognized. The Company’s pension projected benefit obligation was $454.5 million at December 31, 2005, which was $139.2 million higher than pension plan assets. The December 31, 2005 liability was computed based on an average 5.4% discount rate, which was based on yields for high-quality corporate bonds with a maturity approximating the duration of the Company’s pension liability. In addition, the pension liability for its U.K. pension plan, which includes provisions to adjust benefit payments for general inflation rates, was estimated based on an average 3.0% annual inflation rate. Declines in comparable bond yields or higher U.K. inflation rates would increase the Company’s pension liability. The Company’s net pension liability, after deduction of plan assets, could increase or decrease depending on the extent to which returns on pension plan assets are lower or higher than the discount rate.

Post-Retirement Benefits

Post-retirement benefits are determined on an actuarial basis and are affected by assumptions including the discount rate and expected trends in health care costs. Changes in the discount rate and differences between actual and expected health care costs could affect the recorded amount of post-retirement benefits expense ultimately recognized.

Deferred Income Taxes

Deferred income tax assets and liabilities reflect (a) differences between financial statement carrying amounts and corresponding tax bases and (b) temporary differences resulting from differing treatment of items for tax and accounting purposes. Deferred tax assets also include the expected benefits of carrying forward the Company’s net operating losses. The Company regularly reviews deferred tax assets for recoverability and reduces them if the Company cannot sufficiently determine that they will be realized. The Company bases this determination on projected future taxable income and the expected timing of the reversals of existing temporary differences.

At December 31, 2005, deferred tax assets representing future benefits for the Company’s U.S. net operating loss carryforwards totaled $167 million. If there is a material change in the effective tax rates or time period when temporary differences become taxable or deductible, the Company may have to additionally reduce all or a significant portion of its deferred tax assets.

Impairment of Long-Lived Assets

The Company reviews and evaluates its long-lived assets for impairment when events and changes in circumstances indicate that the carrying amount of its asset may not be recoverable. Impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying value of the asset. Future cash flows include estimates of production levels, pricing of the Company’s products, costs of natural gas and capital expenditures. If the assets are impaired, a calculation of fair value is performed; if the fair value is less than the carrying value of the assets, the assets are reduced to their fair value.

During 2005, events occurred that indicated that the carrying amount of the Beaumont, Texas assets may not be recoverable. As of December 31, 2005, the Beaumont assets had a carrying value, net of $14 million of deferred revenues, of approximately $96 million. The Company estimated the remaining useful life of the Beaumont facility at 13 years, assuming normal investment in maintenance and replacement capital throughout this 13-year period. The estimated cash flows over this 13-year period were based on the Company’s best estimate of future market and operating conditions at December 31, 2005. The estimated cash flows exceeded the carrying value of the Beaumont assets, therefore, no impairment charge was recorded. The cash flow estimates were made with the assumption that the Beaumont facility will remain idle through 2008, the term of the Company’s contract with Methanex, and that once restarted, the Beaumont facility will produce at historic rates and selling prices will be adequate to realize historic margins.

Results of Continuing Operations—2005 Compared with 2004

Consolidated Results

The Company reported 2005 net income of $22.1 million on revenues of $1.9 billion compared with a 2004 net income of $67.6 million on revenues of $1.5 billion. Diluted income per share for 2005 was $0.18 compared with $0.85 for 2004. The 2005 net income included a $27.2 million ($24.9 million, net of tax) loss related to the early retirement of debt and a $8.9 million ($8.9 million, net of tax) gain relating to change in fair value of warrants.

The 2004 net income included $27.9 million of income tax benefits due to a favorable settlement with a foreign taxing authority, $11.6 million of income attributable to an insurance recovery of product claim costs (representing $17.9 million of operating income less $6.3 million of related income taxes) and a $7.1 million loss from the early retirement of long-term debt (representing $11.1 million of losses less $4.0 million of related income taxes).

The Company classifies its operations into two business segments: Nitrogen Products and Methanol. The Nitrogen Products segment represents the sale of nitrogen products including that produced at the Company’s ammonia manufacturing and upgrading facilities. The Methanol segment represents sales of methanol including that produced at the Company’s two methanol manufacturing facilities.

Total revenues and operating income (loss) by segment for the years ended December 31, 2005 and 2004 were:

(in thousands)		2005				2004
Revenues:
Nitrogen products		$	1,905,505			$	1,320,142
Methanol			31,347				186,823
Other revenues			2,213				2,145
		$	1,939,065			$	1,509,110
Operating Income (Loss):
Nitrogen products		$	131,474			$	138,745
Methanol			(14,089	)			1,479
Other expense—net			(3,689	)			(5,478	)
		$	113,696			$	134,746

Nitrogen Products

Volumes and prices for 2005 and 2004 were:

Volumes and Prices		2005								2004
(quantities in		Sales				Average				Sales				Average
thousands of tons)		Volumes				Unit Price*				Volumes				Unit Price*
Ammonia			1,898			$	303				1,391			$	266
Nitrogen solutions			4,368				151				3,869				120
Urea			151				262				376				195
Ammonium nitrate			1,581				202				988				178

Nitrogen products revenues increased by $585.4 million to $1,905.5 million for 2005 compared with $1,320.1 million for 2004 primarily as the result of the December 2004 acquisition of MCC and higher sales prices. Higher selling prices contributed $253.7 million to 2005 revenues as the result of increased demand and lower fertilizer supplies due to reduced production capacity in North America. Sales volumes in 2005 were higher than those of the previous year due primarily to the MCC acquisition.

Nitrogen products operating income decreased by $7.3 million to $131.5 million for 2005 from $138.7 million for 2004. Operating income in 2005 from the MCC business totaled $34.5 million, but was more than offset by lower nitrogen margins on other operations and the absence of the $17.9 million 2004 insurance recovery of product claim costs. Nitrogen margins declined principally as the result of increases to natural gas costs that outpaced selling price changes.

Natural gas costs increased $272.5 million from 2004 as unit costs, net of forward pricing gains and losses, and were $7.50 per million British thermal units (“MMBtu”) during 2005 compared to $5.37/MMBtu during 2004. As a result of forward price contracts, 2005 natural gas costs for the nitrogen products segment were $0.7 million lower than spot prices.

Methanol

Methanol revenues were $31.3 million and $186.8 million for the years ended December 31, 2005 and 2004, respectively. Sales volumes declined approximately 87% from the prior year primarily due to cessation of production from the Beaumont facility.

The methanol segment had an operating loss of $14.1 million during 2005 compared to operating income of $1.5 million in 2004. The 2005 operating loss reflected lower sales volumes and idle facility costs.

Other Operating Activities—Net

The Company had $3.7 million of charges from other operating activities in 2005 compared to $5.5 million in 2004. The decrease in expense relates primarily to administrative and legal fees for general corporate activities not allocable to any particular business segment.

Interest Expense—Net

Net interest expense was $45.4 million in 2005 compared with $49.8 million in 2004. The reduction in interest expense primarily related to higher cash balances during 2005 as compared to 2004, increased yields on the cash balances and a decrease in interest expense due to a 2004 fourth quarter $70.7 million redemption of Senior Notes due in 2010.

Minority Interest

Minority interest represents interest in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2005 minority interest charge of $13.7 million reflected nitrogen earnings for TNCLP, which were included in their entirety in consolidated operating results. Minority interest charge of $11.2 million was recorded in 2004, which were included in their entirety in consolidated operating results.

Income Taxes

Terra’s income tax expense was $14.2 million in 2005, or 39% of pretax income, based primarily on statutory rates in the jurisdictions where the earnings arise.

Terra’s income tax benefit of $5.0 million in 2004 included reductions to tax reserves totaling $27.9 million for a reduced assessment by a foreign taxing authority.

Results of Continuing Operations—2004 Compared with 2003

Consolidated Results

The Company reported 2004 net income of $67.6 million on revenues of $1,509 million compared with a 2003 net loss of $12.5 million on revenues of $1,351 million. Diluted income (loss) per share for 2004 was $0.85 compared with $(0.16) for 2003. Results for 2004 and 2003 were favorably affected by income tax benefits of $27.9 million and $36.4 million, respectively, for reduced assessments by a foreign taxing authority and reversals of tax reserves established in prior years.

The 2004 net income also included $11.6 million attributable to an insurance recovery of product claim costs (representing $17.9 million of operating income less $6.3 million of related income taxes) and a $11.1 million loss from the early retirement of long-term debt primarily related to the Company’s redemption of $70.7 million in Second Priority Senior Secured Notes due 2010 (there were no tax benefits associated with this loss.)

The 2003 net loss included a $27.0 million net charge for the impairment of the Company’s Blytheville facility (representing $53.1 million impairment charge to operating income less $9.9 million allocated to minority interest and $16.2 million income tax benefits).

The Company classifies its operations in two business segments: Nitrogen Products and Methanol. The Nitrogen Products segment represents the sale of nitrogen products including that produced at the Company’s ammonia manufacturing and upgrading facilities. The Methanol segment represents sales of methanol including that produced at the Company’s two methanol manufacturing facilities.

MCC revenues and expense are included from the December 21, 2004, acquisition date and are not significant for the year ended December 31, 2004 as compared to the year ended December 31, 2003.

Total revenues and operating income (loss) by segment for the years ended December 31, 2004 and 2003 were:

(in thousands)		2004				2003
Revenues:
Nitrogen products		$	1,320,142			$	1,139,379
Methanol			186,823				209,870
Other revenues			2,145				1,806
		$	1,509,110			$	1,351,055
Operating Income (Loss):
Nitrogen products		$	138,745			$	33,721
Impairment of long-lived assets (nitrogen products)			—				(53,091	)
Methanol			1,479				1,866
Other expense—net			(5,478	)			(6,056	)
		$	134,746			$	(23,560	)

Nitrogen Products

Volumes and prices for 2004 and 2003 were:

Volumes and Prices		2004								2003
(quantities in		Sales				Average				Sales				Average
thousands of tons)		Volumes				Unit Price*				Volumes				Unit Price*
Ammonia			1,391			$	266				1,400			$	229
Nitrogen solutions			3,869				120				3,840				99
Urea			376				195				545				173
Ammonium nitrate			988				178				934				142

*		After deducting outbound freight costs

Nitrogen products revenues increased by $181 million to $1,320 million for 2004 compared with $1,139 million for 2003 primarily as the result of higher sales prices. Selling prices were higher as the result of increased demand and lower fertilizer supplies caused by industry-wide production curtailments since mid-2003. Price increases also reflected higher imported product costs as the result of U.S. currency declines relative to other currencies and increased international freight rates. Sales volumes in 2004 were lower than those of the previous year due mostly to the Blytheville production facility’s permanent closure in May 2004.

Nitrogen products operating income, excluding 2003 charges for the impairment of long-lived assets, increased by $105.0 million to $138.7 million for 2004 from $33.7 million for 2003. Higher selling prices and recovery of product claim costs contributed $180.4 million and $17.9 million, respectively, to 2004 operating income. Theses factors were partly offset by higher natural gas costs and increased expenses.

Natural gas costs increased $76.1 million from 2004 as unit costs, net of forward pricing gains and losses, were $5.37 per million British thermal units during 2004 compared to $4.76/MMBtu during 2003. As a result of forward price contracts, 2004 natural gas costs for the nitrogen products segment were $14.6 million lower than spot prices.

Selling, general and administrative expenses assigned to the nitrogen products business segment totaled $41.9 million for 2004 compared to $30.2 million for 2003. The increase is primarily due to incentive pay accruals based on net income, professional fees associated with Sarbanes-Oxley compliance and changes in the allocation methods of centralized expense centers between the nitrogen products and methanol business segments. During 2003, $5.6 million of the Company’s selling, general and administrative expenses were allocated to the methanol business segment. Those allocations were discontinued in 2004 as a result of contracts transferring the marketing rights for our methanol production to Methanex.

Impairment of Long-Lived Assets

During 2003, the Company recorded a $53.1 million charge for the impairment of the Blytheville, Arkansas facility as it concluded that future market conditions may not justify ongoing investment in the maintenance and replacement capital required to operate the Blytheville facility for its established useful life. The Blytheville production capabilities were permanently closed in May 2004.

Methanol

Methanol revenues were $186 million for the year ended December 31, 2004. Approximately 85% of 2004 methanol revenues were realized under a contract providing Methanex with exclusive rights to all methanol production at our Beaumont, Texas facility. That contract was executed in December 2003 and requires the Company to sell the Beaumont production to Methanex at a price which will generally approximate cash production costs. In addition, Methanex pays the Company one-half of the cash margin attributable to Beaumont’s production based on realized methanol prices and actual natural gas costs. Other contract-related 2004 revenues include amounts received at signing that are deferred and recognized over the life of the contract on a straight-line basis.

During 2004, the Company realized $8.2 million of margin-sharing and deferred revenues under the Methanex contract. Methanol 2004 operating income also includes depreciation charges related to the

Beaumont facility and earnings realized on methanol sales from the Company’s Woodward, Oklahoma facility.

During 2003, methanol segment revenues were derived from market-based sales to third-party customers. Operating income was largely a function of revenues over production costs, including natural gas, and operating expenses.

Other Operating Activities—Net

The Company had $5.5 million of charges from other operating activities in 2004 compared to $6.1 million in 2003. These losses represent charges for amortization of deferred financing costs and legal fees related to general corporate activities not allocable to any particular business segment.

Interest Expense—Net

Net interest expense was $49.8 million in 2004 compared with $54.5 million in 2003. The reduction in interest expense primarily related to higher cash balances and the fourth quarter $70.7 million redemption of Senior Notes due in 2010.

Minority Interest

Minority interest represents interest in the earnings of the publicly held common units of Terra Nitrogen Company, L.P. (TNCLP). The 2004 minority interest charge of $11.2 million reflected nitrogen earnings for TNCLP, which were included in their entirety in consolidated operating results. Minority interest benefits of $8.6 million were recorded in 2003 as the result of TNCLP losses, which included an impairment charge for the Blytheville, Arkansas facility. These amounts are directly related to TNCLP losses and earnings.

Income Taxes

Terra’s income tax benefit was $5.0 million in 2004 and included reductions to tax reserves totaling $27.9 million for a reduced assessment by a foreign taxing authority. The 2004 benefit was net of a $2.5 million charge to eliminate tax benefits associated with U.S. losses.

Terra’s income tax benefit was $57.0 million in 2003 and also included reductions to tax reserves totaling $36.4 million for a reduced assessment by a foreign taxing authority and reversal of tax reserves provided in prior years. The 2003 benefit was reduced to $0.8 million to eliminate tax benefits associated with U.S. losses.

Liquidity and Capital Resources

The Company’s primary uses of cash and cash equivalents is to fund its working capital requirements, make payments on its debt and other obligations and make payments for plant turnarounds and capital expenditures. The principal sources of funds are cash flow from operations and borrowings under available bank facilities.

Unrestricted cash and cash equivalent balances at December 31, 2005, were $86.4 million. Restricted cash and cash equivalent balances of $8.6 million at December 31, 2005 are restricted until qualified capital expenditures at the Verdigris, Oklahoma facility have been performed.

During 2005, cash and cash equivalents decreased $147.4 million. Net cash provided by operating activities was $10.8 million. Cash used in financing activities was $144.6 million, primarily related to the early extinguishment of debt. Cash used for investing activities was $22.3 million, primarily for capital expenditures and plant turnaround costs, offset by distributions received from unconsolidated affiliates.

Net cash provided by 2005 operating activities of $10.8 million was composed of $174.2 million of cash provided from operating activities and $163.4 million used by higher net working capital balances. Net working capital balances increased $59.6 million and $45.6 million primarily as the result of higher prices and natural gas costs on accounts receivable and finished goods inventory values, respectively. Current liabilities also declined by $76.1 million during 2005 due to a reduction in customer prepayment arrangements. The Company had $52.9 million in customer prepayments at December 31, 2005 for the selling price and delivery costs of nitrogen products that it will deliver during the first half of 2006.

During 2005, the Company repaid $125 million of debt obligations related to the MCC acquisition during 2004.

During 2004, the Company issued 4.25% Cumulative Convertible Perpetual Series A Preferred Shares with a liquidation value of $120 million for net proceeds of $115.8 million. The Series A preferred shares are not redeemable by the Company, are convertible into common stock at a conversion price of $9.96 per common share at the option of the holder and may at the Company’s option be automatically converted to common shares after December 20, 2009 if the closing price for common shares exceeds 140% of the conversion price for any twenty days within a consecutive thirty day period prior to such conversion. Upon the occurrence of a fundamental change to the Company’s capital structure, including a change of control, merger, or sale of the Company, holders of the Series A preferred shares may require the Company to purchase any or all of their shares at a price equal to their liquidation value plus any accumulated, but unpaid, dividends. The Company also has the right, under certain conditions, to require holders of the Series A preferred shares to exchange their shares for convertible subordinated debentures with similar terms.

During 2005 and 2004, the Company funded plant and equipment purchases of $30.8 million and $18.5 million, respectively, primarily for replacement or stay-in-business capital needs. The Company expects 2006 plant and equipment purchases to approximate $50 million consisting primarily of expenditures for replacement of equipment or to improve operating results at its manufacturing facilities.

Plant turnaround costs represent cash used for the periodic scheduled major maintenance of the Company’s continuous process production facilities that is performed at each plant, generally every two years. The Company funded $22.3 million and $28.9 million of plant turnaround costs in 2005 and 2004, respectively. The Company estimates 2006 plant turnaround costs will approximate $40 million.

On December 21, 2004, the Company entered into revolving credit facilities totaling $200 million that expire in June 2008. Borrowing availability under the credit facility is generally based on eligible cash balances, 85% of eligible accounts receivable and 60% of eligible inventory, less outstanding letters of

credit. These facilities include $50 million only available for the use of TNCLP, one of the Company’s consolidated subsidiaries. There were no outstanding revolving credit borrowings and there were $15.6 million in outstanding letters of credit, resulting in remaining borrowing availability of approximately $177.3 million under the facilities. The Company is required to maintain a combined minimum unused borrowing availability of $30 million. The credit facility also requires that the Company adhere to certain limitations on additional debt, capital expenditures, acquisitions, liens, asset sales, investments, prepayments of subordinated indebtedness, changes in lines of business and transactions with affiliates. In addition, if the Company’s borrowing availability falls below a combined $60 million, it is required to have generated $60 million of operating cash flows, or earnings before interest, income taxes, depreciation, amortization and other non-cash items (as defined in the credit facility) for the preceding four quarters.

The Company’s ability to meet credit facility covenants will depend on future operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to meet these covenants could result in additional costs and fees to amend the credit facility or could result in termination of the facility. Access to adequate bank facilities is critical to funding the Company’s operating cash needs. Based on our December 31, 2005 financial position and the current market conditions for the Company’s finished products and for natural gas, the Company anticipates that it will be able to comply with its covenants through 2006.

The Company’s ability to manage its exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by limitations imposed by its bank agreement covenants.

Contractual obligations and commitments to make future payments at December 31, 2005 were:

		Payments Due In
		Less than				One to				Three to
(in millions)		One Year				Three Years				Five Years				Thereafter
Long-term debt		$	—			$	200.0			$	131.3			$	—
Operating leases			21.1				34.2				24.8				11.7
Interest expense on fixed rate debt			40.8				78.5				21.4				—
Ammonia purchase contract (1)			112.6				225.2				225.2				900.8
Other purchase obligations			188.3				2.2				2.2				4.4
Total		$	362.8			$	540.1			$	404.9			$	916.9

(1)		The Company has a contractual obligation to purchase one-half of the ammonia produced by Point Lisas Nitrogen Limited. The purchase price is based on the average market price of ammonia, F.O.B. Caribbean, less a discount. Obligations in the above table are based on purchasing 360,000 short tons per year at the December 2005 average price paid. This contract expires in October 2018.

The Company’s pension projected benefit obligations were $454.5 million at December 31, 2005, which was $139.2 million higher than its pension plan assets. The pension projected benefit obligations were computed based on a 5.4% discount rate, which was based on yields for high-quality corporate bonds (Moody’s Investor Service “AA” rated or equivalent) with a maturity approximating the duration of the

Company’s pension obligation. Future declines in comparable bond yields would increase the Company’s pension obligation and future increases in bond yields would decrease the Company’s pension obligation. The Company’s pension obligation, net of plan assets, could increase or decrease depending on the extent that returns on pension plan assets are lower or higher than the discount rate. In addition, the pension obligation for the Company’s U.K. pension plan, which includes provisions to adjust benefit payments for general inflation rates, was estimated based on a 3.0% inflation rate. The Company’s pension obligation could increase or decrease based on actual U.K. inflation rates. The Company’s cash contributions to pension plans were $22.2 million in 2005 and are estimated at $8.3 million in 2006. Actual contributions could vary from these estimates depending on actual returns for plan assets, legislative changes to pension funding requirements and/or plan amendments.

Expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $15.7 million in 2005. Because environmental, health and safety regulations are expected to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. The Company does not expect compliance with such regulations will have a material adverse effect on the results of operations, financial position or net cash flows.

The Company incurred $2.0 million of 2005 capital expenditures to ensure compliance with environmental, health and safety regulations. The Company may be required to install additional air and water quality control equipment, such as low nitrous oxide burners, scrubbers, ammonia sensors and continuous emission monitors to continue to achieve compliance with the Clean Air Act and similar requirements. These equipment requirements typically apply to competitors as well. The Company estimates that the cost of complying with these existing requirements in 2006, 2007 and 2008 and beyond will be less than $20 million in the aggregate.

The Company owns 75.3% of the common units of TNCLP, which in accordance with the partnership agreement, permits it to call all common units that it does not own.

During 2005, 2004 and 2003, TNCLP distributed $13.6 million, $8.1 million and $1.2 million, respectively, to the minority TNCLP common unitholders. TNCLP distributions are based on “Available Cash” (as defined in the Partnership Agreement).

During 2005, the Company paid $6.0 million for preferred share dividends.

Cash balances at December 31, 2005 were $95.0 million, of which $8.6 million is restricted.

Recently Issued Accounting Standards

In October 2004, The American Jobs Creation Act of 2004 (the Jobs Act) was signed into law. The Act creates a temporary incentive for U.S. multinationals to repatriate accumulated income earned outside the U.S. at an effective tax rate of 5.25%. On December 21, 2004, the Financial Accounting Standards Board (“FASB”) issued their staff position, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” Statement of Financial Accounting Standards (“SFAS”) 109-2. SFAS 109-2 allows companies additional time to evaluate the impact of the law and to record the tax effect of repatriation over several interim periods as they complete

their assessment of repatriating all or a portion of these unremitted earnings. The Company does not plan to reinvest or repatriate any foreign earnings as a result of the Jobs Act.

In December 2004, the FASB issued SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair-value method and the recording of such expense in the consolidated financial statements. In addition, the adoption of SFAS 123R requires additional accounting related to the income tax effects and disclosure regarding the cash flow effects resulting from share-based payment arrangements. In January 2005, the United States Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidance for SFAS 123R. SFAS 123R is effective for the Company’s first quarter of fiscal 2006. The Company has selected the Black-Scholes option-pricing model as the most appropriate fair-value method for its awards and will recognize compensation cost on a straight-line basis over its awards’ vesting periods. The adoption of SFAS 123R will not have a material impact on the Company’s results of operation. However, uncertainties, including the Company’s future stock-based compensation strategy, stock price volatility, estimated forfeitures and employee stock option exercise behavior, make it difficult to determine whether the stock-based compensation expense that the Company will incur in future periods will be similar to the SFAS 123 pro forma disclosed in the notes to Consolidated Financial Statements.

In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets,” (SFAS 153) an amendment of APB Opinion No. 29. SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effective for nonmonetary asset exchanges beginning in the Company’s first quarter of fiscal 2006. The Company does not expect the adoption of SFAS 153 to have a material impact on results of operation or financial condition.

In March 2005, the FASB issued FASB Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations” (FIN 47). FIN 47 is an interpretation of SFAS 143, “Accounting for Asset Retirement Obligations.” FIN 47 addresses the recognition of an unconditional retirement obligation when uncertainty exists about the timing and (or) method of settlement. The Company adopted FIN 47 during 2005. The effect of the adoption of FIN 47 was not material to the Company’s financial statements.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections,” (SFAS 154) which replaces Accounting Principles Board Opinions No. 20 “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements — An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the earliest practicable date, as the required method for reporting a change in accounting principle and restatement with respect to the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2007.

In June 2005, the EITF reached a consensus on Issue No. 05-06, “Determining the Amortization Period for Leasehold Improvements” (EITF 05-06). EITF 05-06 provides guidance for determining the amortization period used for leasehold improvements acquired in a business combination or purchased

after the inception (of a lease, collectively referred to as subsequently acquired leasehold improvement). EITF 05-06 provides that the amortization period used for the subsequently acquired leasehold improvements to be the lesser of (a) the subsequently acquired leasehold improvements’ useful lives, or (b) a period that reflects renewals that are reasonably assured upon the acquisition or the purchase. EITF 05-06 is effective on a prospective basis for subsequently acquired leasehold improvements purchased or acquired in periods beginning after the date of the FASB’s ratification, which was on June 29, 2005. The Company does not believe the adoption of EITF 05-06 will affect its results of operations and financial condition in fiscal 2006.

In March 2005, the FASB issued SFAS Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”, which requires conditional asset retirement obligations to be recognized if a legal obligation exists to perform asset retirement activities and a reasonable estimate of the fair value of the obligation can be made. FIN 47 also provides guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company adopted the provisions of FIN 47 on December 31, 2005 and the adoption has not had a material affect on the Company’s financial statements.

In July 2005, the FASB issued proposed guidance concerning the accounting for uncertain tax positions. The proposal would require that an uncertain tax position meet a probable recognition threshold based on the merits of the position in order for the benefit to be recognized in the financial statements. The proposal also addresses the accrual of interest and penalties related to tax uncertainties and the classification of liabilities on the balance sheet. If implemented in its present form, the Company does not expect the adoption to have a material impact on the results of operations or financial condition.

Forward-Looking Precautions

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

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Risk Management and Financial Instruments

Market risk represents the risk of loss that may impact the Company’s financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. The Company uses derivative financial instruments to manage risk in the areas of (a) foreign currency fluctuations, (b) changes in natural gas prices and (c) changes in nitrogen prices and (d) changes in interest rates. See Note 13 to the Consolidated Financial Statements for additional information on the use of derivative financial instruments.

The Company’s policy is to avoid unnecessary risk and to limit, to the extent practical, risks associated with operating activities. The Company’s management may not engage in activities that expose the Company to speculative or non-operating risks and is expected to limit risks to acceptable levels. The use of derivative financial instruments is consistent with the Company’s overall business objectives. Derivatives are used to manage operating risk within the limits established by our Board of Directors, and in response to identified exposures, provided they qualify as hedge activities. As such, derivative financial instruments are used to manage exposure to interest rate fluctuations, to hedge specific assets and liabilities denominated in foreign currency, to hedge firm commitments and forecasted natural gas purchase transactions, to set a floor for nitrogen selling prices and to protect against foreign exchange rate movements between different currencies that impact revenue and earnings expressed in U.S. dollars.

The use of derivative financial instruments subjects the Company to some inherent risks associated with future contractual commitments, including market and operational risks, credit risk associated with counterparties, product location (basis) differentials and market liquidity. The Company continuously monitors the valuation of identified risks and adjusts the portfolio based on current market conditions.

Foreign Currency Fluctuations

The Company’s policy is to manage risk associated with foreign currency fluctuations by entering into forward exchange and option contracts covering specific currency obligations or net foreign currency operating requirements, as appropriate. Such hedging is limited to the amounts and duration of the specific obligations being hedged and, in the case of operating requirements, no more than 75% of the forecasted requirements. The primary currencies to which the Company is exposed are the Canadian dollar and the British pound. At December 31, 2005, the Company had nominal forward currency positions that were matched with committed capital expenditures.

Natural Gas Prices—North American Operations

Natural gas is the principal raw material used to manufacture nitrogen and methanol. Natural gas prices are volatile and the Company mitigates some of this volatility through the use of derivative commodity instruments. The Company’s current policy is to hedge natural gas provided that such arrangements would not result in costs greater than expected selling prices for its finished products. North American natural gas requirements for 2006 are approximately 100 million MMBtu. The Company has hedged 18% of its expected 2006 North American requirements and none of its requirements beyond December 31, 2006. The fair value of these instruments is estimated based, in part, on quoted market prices from brokers, realized gains or losses and the Company’s computations. These instruments and other natural gas positions fixed natural gas prices at $14.1 million more than published prices for December 31, 2005 forward markets. Market risk is estimated as the potential loss in fair value resulting from a hypothetical 10% adverse change in price. As of December 31, 2005 the Company’s market risk exposure related to future natural gas requirements being hedged was $9.5 million based on a sensitivity analysis. Changes in the market value of these derivative instruments have a high correlation to changes in the spot price of natural gas. Since the Company enters into forward pricing agreements for only a portion of its natural gas requirements, this hypothetical adverse impact on natural gas derivative instruments could be more than offset by lower costs for all natural gas it purchases.

Natural Gas Prices—Trinidad Operation

The natural gas requirements of Point Lisas Nitrogen Limited are supplied under contract with the Natural Gas Company of Trinidad and Tobago. The cost of natural gas to the joint venture fluctuates based on changes in the market price of ammonia.

Natural Gas Prices—United Kingdom Operations

To meet natural gas production requirements at the Company’s United Kingdom production facilities, the Company generally enters into one- or two-year gas supply contracts and fixes prices for approximately 20% to 80% of total volume requirements. Procurement requirements for 2006 U.K. natural gas are approximately 26 million MMBtu. As of December 31, 2005, the Company had fixed-price contracts for 8% of its expected 2006 U.K. natural gas requirements and none of its 2007 natural gas requirements. The Company’s U.K. fixed-price derivative contracts for 2006 natural gas purchases were at prices $2.0 million lower than published prices for December 31, 2005 forward markets.

Nitrogen Prices

The prices for nitrogen products can be volatile and the Company mitigates some of this volatility through the use of derivative commodity instruments. The Company’s current policy is to hedge no more than 20% of its expected production for the upcoming 12 months and no more than 50% of any single month’s expected production. Deviation from this policy requires Board of Director approval. The Company has not hedged any of its 2006 North American sales of nitrogen solutions.

Interest Rate Fluctuations

The table below provides information about the Company’s financial instruments that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The Company had no interest rate financial derivatives outstanding at December 31, 2005.

Interest Rate Sensitivity

(in millions)		Expected Maturity Date
		2006				2007				2008				2009				2010				Thereafter				Total				Fair Value
Long-Term Debt
Senior Secured Notes, fixed rate of 12.88% ($US)		$	—			$	—			$	200.0			$	—			$	—			$	—			$	200.0			$	204.3
Senior Second Priority Secured Notes, fixed rate 11.50% ($US)			—				—				—				—				131.3				—				131.3				125.7
Total Long-Term Debt		$	—			$	—			$	200.0			$	—			$	131.3			$	—			$	331.3			$	455.4
Short-Term Borrowings
Revolving credit facility, notional amount ($US)		$	150.0			$	150.0			$	150.0			$	—			$	—			$	—			$	—			$	—
Variable interest rate, LIBOR based			4.34	%			4.34	%			4.34	%			—				—				—				—				—
TNLP revolving credit facility, notional amount ($US)		$	50.0			$	50.0			$	50.0				—			$	—				—				—				—
Variable interest rate, LIBOR based			4.34	%			4.34	%			4.34	%			—				—				—				—				—

Item 8. Financial Statements and Supplementary Data

Consolidated Statements of Financial Position

		At December 31,
(in thousands)		2005				2004
Assets
Cash and cash equivalents		$	86,366			$	233,798
Restricted cash			8,595				—
Accounts receivable, less allowance for doubtful accounts of $234 and $262			206,407				150,271
Inventories			190,314				148,808
Income tax receivable			—				11,500
Other current assets			54,578				46,606
Total current assets			546,260				590,983
Property, plant and equipment, net			733,536				797,978
Deferred plant turnaround costs			27,447				33,897
Equity investments			183,884				215,939
Intangible assets			7,526				24,884
Other assets			24,972				21,827
Total assets		$	1,523,625			$	1,685,508
Liabilities
Debt due within one year		$	38			$	167
Accounts payable			125,863				119,571
Customer prepayments			52,913				115,347
Accrued and other current liabilities			84,996				104,848
Total current liabilities			263,810				339,933
Long-term debt and capital lease obligations			331,300				435,238
Deferred income taxes			65,998				58,224
Pension liabilities			120,236				119,570
Other liabilities			41,320				47,872
Minority interest			92,258				92,197
Total liabilities and minority interest			914,922				1,093,034
Commitments and contingencies (Note 11)			—				—
Preferred Shares - liquidation value of $120,000 and $137,269			115,800				133,069
Common Stockholders’ Equity
Capital stock
Common Shares, authorized 133,500 shares; 95,171 and 92,994 shares outstanding			146,994				144,531
Paid-in capital			712,671				681,639
Accumulated other comprehensive loss			(70,143	)			(55,994	)
Unearned compensation			(5,369	)			(2,568	)
Accumulated deficit			(291,250	)			(308,203	)
Total stockholders’ equity			492,903				459,405
Total liabilities and stockholders’ equity		$	1,523,625			$	1,685,508

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Operations

		Year ended December 31,
(in thousands, except per-share amounts)		2005				2004				2003
Revenues		$	1,930,583			$	1,506,965			$	1,349,249
Other income, net			8,482				2,145				1,806
Total Revenue			1,939,065				1,509,110				1,351,055
Cost and Expenses
Cost of sales			1,800,236				1,348,077				1,281,663
Selling, general and administrative expense			46,548				44,190				39,861
Equity in earnings of unconsolidated affiliates			(21,415	)			—				—
Impairment of long-lived assets			—				—				53,091
Recovery of product claim costs			—				(17,903	)			—
			1,825,369				1,374,364				1,374,615
Income (loss) from operations			113,696				134,746				(23,560	)
Interest income			8,086				3,307				534
Interest expense			(53,478	)			(53,134	)			(55,072	)
Loss on early retirement of debt			(27,193	)			(11,116	)			—
Change in fair value of warrant liability			8,860				—				—
Income (loss) before income taxes and minority interest			49,971				73,803				(78,098	)
Income tax benefit (provision)			(14,217	)			5,000				57,000
Minority interest			(13,667	)			(11,207	)			8,617
Net income (loss)			22,087				67,596				(12,481	)
Preferred share dividends			(5,134	)			(1,029	)			—
Income (Loss) Available to Common Stockholders		$	16,953			$	66,567			$	(12,481	)
Basic and Diluted Income (Loss) Per Share:
Basic		$	0.18			$	0.87			$	(0.16	)
Diluted			0.18				0.85				(0.16	)
Basic and Diluted Weighted Average Shares Outstanding:
Basic			92,537				76,478				75,676
Diluted			94,935				79,859				75,676

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Cash Flows

		Year ended December 31,
(in thousands)		2005				2004				2003
Operating Activities
Net income (loss)		$	22,087			$	67,596			$	(12,481	)
Adjustments to reconcile net income (loss) to net cash flows from operating activities:
Depreciation and amortization			110,342				102,230				107,370
Non-cash loss on early retirement of debt			22,543				2,985				—
Change in fair value of warrant liability			(8,860	)			—				—
Deferred income taxes			13,538				(6,058	)			(57,398	)
Non-cash loss on derivatives			4,091				—				—
Minority interest in earnings (loss)			13,667				11,207				(8,617	)
Equity in undistributed earnings			(6,941	)			—				—
Amortization of unearned compensation			1,997				1,513				—
Term loan discount accretion			1,773				—				—
Recovery of product claim costs			—				(12,874	)			—
Impairment of long-lived assets			—				—				53,091
Change in current assets and liabilities, net of acquisition:
Accounts receivable			(59,591	)			27,647				(27,569	)
Inventories			(45,579	)			(11,352	)			(354	)
Accounts payable and customer prepayments			(60,136	)			48,394				11,501
Other assets and liabilities, net			1,944				(19,782	)			16,879
Net Cash Flows from Operating Activities			10,875				211,506				82,422
Investing Activities
Purchase of property, plant and equipment			(30,820	)			(18,472	)			(8,639	)
Plant turnaround costs			(22,331	)			(28,878	)			(28,080	)
Acquisition, net of cash acquired			—				(54,168	)			—
Distributions received from unconsolidated affiliates			31,901				—				—
Restricted cash			(8,595	)			—				—
Proceeds from the sale of property, plant and equipment			7,560				—				1,755
Other			—				966				(11,358	)
Net Cash Flows used in Investing Activities			(22,285	)			(100,552	)			(46,322	)
Financing Activities
Payments under borrowing arrangements			(125,167	)			(70,854	)			(200,142	)
Preferred share dividends paid			(5,950	)			—				—
Distributions to minority interests			(13,607	)			(8,072	)			(1,153	)
Proceeds from exercise of stock options			142				447				68
Preferred share issuance, net of $4,200 issuance costs			—				115,800				—
Deferred financing costs			—				(2,598	)			(8,581	)
Issuance of long-term debt			—				—				202,000
Net Cash Flows used in Financing Activities			(144,582	)			34,723				(7,808	)
Effect of Exchange Rate Changes on Cash			8,560				787				563
Increase (Decrease) in Cash and Cash Equivalents			(147,432	)			146,464				28,855
Cash and Cash Equivalents at Beginning of Year			233,798				87,334				58,479
Cash and Cash Equivalents at End of Year		$	86,366			$	233,798			$	87,334

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Cash Flows (continued)

						Year ended December 31,
		2005				2004				2003
Supplemental cash flow information:
Interest paid		$	42,110			$	50,455			$	50,983
Income tax refunds received			11,933				—				—
Income taxes paid			1,526				1,123				4,297
Supplemental schedule of non-cash investing and financing activities:
Conversion of Series B preferred stock to common stock:
Common Stock		$	2,066			$	—			$	—
Paid in Capital		$	14,646			$	—			$	—
Consideration to fund acquisitions:
Common shares		$	—			$	135,750			$	—
Series B preferred shares		$	—			$	17,269			$	—
Assumed debt		$	—			$	125,000			$	—
Stock Incentive Plan		$	5,020			$	2,908			$	608

See accompanying Notes to the Consolidated Financial Statements

Consolidated Statements of Changes in Common Stockholders’ Equity

														Accumulated
														Other
		Common Stock								Paid-In				Comprehensive				Unearned				Accumulated								Comprehensive
(in thousands)		Shares				Amount				Capital				Loss				Compensation				Deficit				Total				Income
January 1, 2003			76,920			$	128,654			$	555,167			$	(63,668	)		$	—			$	(362,289	)		$	257,864
Comprehensive Income (Loss):
Net loss			—				—				—				—				—				(12,481	)			(12,481	)		$	(12,481	)
Foreign currency translation adjustments			—				—				—				27,631				—				—				27,631				27,631
Change in fair value of derivatives, net of taxes of $614			—				—				—				1				—				—				1				1
Minimum pension liability, net of taxes of $1,806			—				—				—				(8,560	)			—				—				(8,560	)			(8,560	)
Comprehensive income																														$	6,591
Exercise of stock options, net			48				48				20				—				—				—				68
Stock Incentive Plan			595				266				342				—				—				—				608
December 31, 2003			77,563				128,968				555,529				(44,596	)			—				(374,770	)			265,131
Comprehensive Income (Loss):
Net income			—				—				—				—				—				67,596				67,596			$	67,956
Foreign currency translation adjustments			—				—				—				25,216				—				—				25,216				25,216
Change in fair value of derivatives, net of taxes of $690			—				—				—				(23,286	)			—				—				(23,286	)			(23,286	)
Minimum pension liability, net of taxes of $3,149			—				—				—				(13,328	)			—				—				(13,328	)			(13,328	)
Comprehensive income																														$	56,198
Preferred share dividends			—				—				—				—				—				(1,029	)			(1,029	)
Issuance of common stock			14,995				14,995				120,755				—				—				—				135,750
Exercise of stock options			198				198				249				—				—				—				447
Restricted stock			238				370				5,106				—				(4,081	)			—				1,395
Amortization of unearned compensation			—				—				—				—				1,513				—				1,513
December 31, 2004			92,994				144,531				681,639				(55,994	)			(2,568	)			(308,203	)			459,405
Comprehensive Income (Loss):
Net income			—				—				—				—				—				22,087				22,087			$	22,087
Foreign currency translation adjustments			—				—				—				(23,387	)			—				—				(23,387	)			(23,387	)
Change in fair value of derivatives, net of taxes of $2,861			—				—				—				14,198				—				—				14,198				14,198
Minimum pension liability, net of taxes of $5,015			—				—				—				(4,960	)			—				—				(4,960	)			(4,960	)
Comprehensive income																														$	7,938
Preferred share dividends			—				—				—				—				—				(5,134	)			(5,134	)
Conversion of preferred shares			2,066				2,066				14,646				—				—				—				16,712
Reclassification of warrant liability			—				—				12,240				—				—				—				12,240
Exercise of stock options			39				39				103				—				—				—				142
Restricted stock			72				358				4,043				—				(4,798	)			—				(397	)
Amortization of unearned compensation			—				—				—				—				1,997				—				1,997
December 31, 2005			95,171			$	146,994			$	712,671			$	(70,143	)		$	(5,369	)		$	(291,250	)		$	492,903

See accompanying Notes to the Consolidated Financial Statements

Notes to the Consolidated Financial Statements

1. Summary of Significant Accounting Policies

Basis of presentation: The Consolidated Financial Statements include the accounts of Terra Industries Inc. and all majority owned subsidiaries (Terra). All significant intercompany accounts and transactions have been eliminated. Minority interest in earnings and ownership has been recorded for the percentage of limited partnership common units not owned by Terra Industries Inc. for each respective period presented.

Description of business: Terra produces nitrogen products for agricultural dealers and industrial users, and methanol for industrial users.

Foreign exchange: Results of operations for the foreign subsidiaries are translated using average currency exchange rates during the period; assets and liabilities are translated using period-end rates. Resulting translation adjustments are recorded as foreign currency translation adjustments in accumulated other comprehensive income (loss) in stockholders’ equity.

Cash and cash equivalents: Cash and cash equivalents consist of all cash balances and all highly liquid investments purchased with an original maturity of three months or less.

Restricted cash: Restricted cash consists of cash and cash equivalents that have been pledged as collateral on outstanding debt. The restrictions on the balances lapse with the payments for qualified expenditures at the Verdigris, Oklahoma facility.

Inventories: Inventories are stated at the lower of cost or estimated net realizable value. The cost of inventories is determined using the first-in, first-out method. The Company performs a monthly analysis of its inventory balances to determine if the carrying amount of inventories exceeds their 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.

The Company allocates fixed production overhead costs based on the normal capacity of its production facilities and unallocated overhead costs are recognized as expense in the period incurred.

Property, plant and equipment: Expenditures for plant and equipment additions, replacements and major improvements are capitalized. Related depreciation is charged to expense on a straight-line basis over estimated useful lives ranging from 15 to 22 years for buildings and 3 to 18 years for plants and equipment. Equipment under capital leases is recorded in property with the corresponding obligations in long-term debt. The amount capitalized is the present value at the beginning of the lease term of the aggregate future minimum lease payments. Maintenance and repair costs are expensed as incurred.

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.

Amortization expense related to plant turnarounds of $27.6 million, $24.1 million and $29.0 million was recorded for the years ended December 31, 2005, 2004 and 2003, respectively.

Equity investments: Equity investments are carried at original cost adjusted for the Company’s proportionate share of the investees’ income, losses and distributions. The Company periodically assesses the carrying value of its equity investments and records a loss in value of the investment when the assessment indicates that an other-than-temporary decline in the investment exists.

Intangible assets: The Company’s intangible asset has a finite useful life and is amortized using the straight-line method over the estimated useful life of five years. The Company monitors its intangible asset and records an impairment loss on the intangible asset when circumstances indicate that the carrying amount is not recoverable and that the carrying amount exceeds its fair value.

During 2005, the Company recorded $1.9 million of amortization expense. The estimated intangible asset amortization expense is $1.9 million annually for 2006 through 2009.

Debt issuance costs: Costs associated with the issuance of debt are included in other noncurrent assets and are amortized over the term of the related debt using the straight-line method.

Impairment of long-lived assets: The Company reviews and evaluates its long-lived assets for impairment when events and changes in circumstances indicate that the carrying amount of its asset may not be recoverable. Impairment is considered to exist if the total estimated future cash flows on an undiscounted basis are less than the carrying value of the asset. Future cash flows include estimates of production levels, pricing of the Company’s products, costs of natural gas and capital expenditures. If the assets are impaired, a calculation of fair value is performed; if the fair value is less than the carrying value of the assets, the assets are reduced to their fair value.

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.

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 and hedging transactions: 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. Costs of sales include amounts related to shipping and handling charges to the Company’s customers.

Share-based compensation: The Company accounts for stock options using the intrinsic value method. No compensation cost has been recognized for options granted under any of the Company’s share-based compensation plans. The Company accounts for certain nonvested restricted grants as fixed-plan awards since both the aggregate number of awards issued and the aggregate amount to be paid by the participants for the common stock is known. The Company accounts for certain nonvested restricted grants as variable-plan awards since the aggregate number of awards to be issued is not known. The Company evaluates these awards each period for determining compensation cost. Compensation cost related to all nonvested restricted stock grants is measured as the difference between the market price of the Company’s common stock at the grant date and the amount to be paid by the participants for the common stock. Compensation costs associated with each restricted stock grant are amortized on a straight-line basis to expense over the grant’s vesting period. The pro forma impact on basic income and diluted income per share of accounting for share-based compensation using the fair value method required by Statement of Financial Accounting Standards (SFAS) No. 123 was:

(in thousands, except per-share data)		2005				2004				2003
Income (loss) available to common shareholders, as reported		$	16,953			$	66,567			$	(12,481	)
Add: Share based employee compensation expense included in reported income, net of related tax effects			1,218				1,205				1,224
Deduct: Share based employee compensation expense determined under fair-value based method for all awards, net of related tax effects			(1,218	)			(1,205	)			(1,224	)
Pro forma income (loss) available to common shareholders		$	16,953			$	66,567			$	(12,481	)
Earnings (loss) per share:
Basic – as reported		$	0.18			$	0.87			$	(0.16	)
Basic – pro forma			0.18				0.87				(0.16	)
Diluted – as reported		$	0.18			$	0.85			$	(0.16	)
Diluted – pro forma			0.18				0.85				(0.16	)

Per share results: Basic earnings per share data are based on the weighted-average number of common shares outstanding during the period. Diluted earnings per share data are based on the weighted-average number of common shares outstanding and the effect of all dilutive potential common shares including convertible preferred shares, common stock options, restricted stock and common stock warrants.

Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 the reported amounts of revenues and expenses during the reporting

period. The significant areas requiring the use of management’s estimates relate to assumptions used to calculate pension and other post-retirement benefits costs, valuation allowance for deferred tax assets, future cash flows from long-lived assets and the useful lives utilized for depreciation, amortization and accretion calculations. Actual results could differ from those estimates.

Recently issued accounting standards: In October 2004, The American Jobs Creation Act of 2004 (the Job Act) was signed into law. The Act creates a temporary incentive for U.S. multinationals to repatriate accumulated income earned outside the U.S. at an effective tax rate of 5.25%. On December 21, 2004, the Financial Accounting Standards Board (“FASB”) issued their staff position, "Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” Statement of Financial Accounting Standards (“SFAS”) 109-2. SFAS 109-2 allows companies additional time to evaluate the impact of the law and to record the tax effect of repatriation over several interim periods as they complete their assessment of repatriating all or a portion of these unremitted earnings. The Company does not plan to reinvest or repatriate any foreign earnings as a result of the Job Act.

In December 2004, the FASB issued SFAS 123 (revised 2004), “Share-Based Payment” (SFAS 123R). SFAS 123R requires measurement of all employee stock-based compensation awards using a fair-value method and the recording of such expense in the consolidated financial statements. In addition, the adoption of SFAS 123R requires additional accounting related to the income tax effects and disclosure regarding the cash flow effects resulting from share-based payment arrangements. In January 2005, the United States Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107, which provides supplemental implementation guidance for SFAS 123R. SFAS 123R is effective for the Company’s first quarter of fiscal 2006. The Company has selected the Black-Scholes option-pricing model as the most appropriate fair-value method for its awards and will recognize compensation cost on a straight-line basis over its awards’ vesting periods. The adoption of SFAS 123R will not have a material impact on the Company’s results of operation. However, uncertainties, including the Company’s future stock-based compensation strategy, stock price volatility, estimated forfeitures and employee stock option exercise behavior, make it difficult to determine whether the stock-based compensation expense that the Company will incur in future periods will be similar to the SFAS 123 pro forma disclosed in the notes to Consolidated Financial Statements.

In December 2004, the FASB issued SFAS 153, “Exchanges of Nonmonetary Assets,” (SFAS 153) an amendment of APB Opinion No. 29. SFAS 153 addresses the measurement of exchanges of nonmonetary assets and redefines the scope of transactions that should be measured based on the fair value of the assets exchanged. SFAS 153 is effective for nonmonetary asset exchanges beginning in the Company’s first quarter of fiscal 2006. The Company does not expect the adoption of SFAS 153 to have a material impact on results of operation or financial condition.

In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections,” (SFAS 154) which replaces Accounting Principles Board Opinions No. 20 “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements – An Amendment of APB Opinion No. 28.” SFAS 154 provides guidance on the accounting for and reporting of accounting changes and error corrections. It establishes retrospective application, or the earliest practicable date, as the required method for reporting a change in accounting principle and restatement with respect to the reporting of a correction of an error. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years

51

beginning after December 15, 2005 and is required to be adopted by the Company in the first quarter of fiscal 2007.

In June 2005, the EITF reached a consensus on Issue No. 05-06, “Determining the Amortization Period for Leasehold Improvements” (EITF 05-06). EITF 05-06 provides guidance for determining the amortization period used for leasehold improvements acquired in a business combination or purchased after the inception (of a lease, collectively referred to as subsequently acquired leasehold improvement). EITF 05-06 provides that the amortization period used for the subsequently acquired leasehold improvements to be the lesser of (a) the subsequently acquired leasehold improvements’ useful lives, or (b) a period that reflects renewals that are reasonably assured upon the acquisition or the purchase. EITF 05-06 is effective on a prospective basis for subsequently acquired leasehold improvements purchased or acquired in periods beginning after the date of the FASB’s ratification, which was on June 29, 2005. The Company does not believe the adoption of EITF 05-06 will affect its results of operations and financial conditions in fiscal 2006.

In March 2005, the FASB issued SFAS Interpretation No. 47, “Accounting for Conditional Asset Retirement Obligations”, which requires conditional asset retirement obligations to be recognized if a legal obligation exists to perform asset retirement activities and a reasonable estimate of the fair value of the obligation can be made. FIN 47 also provides guidance as to when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. The Company adopted the provisions of FIN 47 on December 31, 2005 and the adoption has not had a material affect on the Company’s financial statements.

In July 2005, the FASB issued proposed guidance concerning the accounting for uncertain tax positions. The proposal would require that an uncertain tax position meet a probable recognition threshold based on the merits of the position in order for the benefit to be recognized in the financial statements. The proposal also addresses the accrual of interest and penalties related to tax uncertainties and the classification of liabilities on the balance sheet. If implemented in its present form, the Company does not expect the adoption to have a material impact on the results of operations or financial condition.

2. Acquisition

On December 21, 2004, Terra acquired Mississippi Chemical Corporation (“MCC”) for a purchase price valued at $213.5 million consisting of 15 million common shares, 172,690 Series B preferred shares and cash of $54.2 million, including costs directly related to the acquisition. MCC manufactured nitrogen-based fertilizers and industrial use products; had a 50% ownership interest in Point Lisas Nitrogen Limited (PLNL), an ammonia production plant in Trinidad; and had a 50% interest in an ammonia storage joint venture located in Houston, Texas. These equity investments were acquired by the Company with the purchase of MCC. In connection with the acquisition, Terra assumed $125.0 million of MCC long-term debt and $34.1 million of unfunded pension liabilities.

The following table summarizes the fair market values of the assets acquired and the liabilities assumed at the acquisition date and subsequently adjusted to the final purchase price allocation:

		Preliminary Purchase Price								Final
		Allocation as Reported								Purchase
		in December 31, 2004								Price
(in thousands)		Annual Report				Adjustments				Allocation
Current assets		$	97,278			$	1,899			$	99,177
Property, plant and equipment			124,528				16,427				140,955
Equity investments			213,300				(11,780	)			201,520
Other assets			—				3,464				3,464
Intangible assets			15,550				(6,142	)			9,408
Total assets acquired			450,656				3,868				454,524
Current liabilities			37,169				—				37,169
Long-term debt and warrants			125,000				—				125,000
Pension and other long-term liabilities			36,314				—				36,314
Deferred income taxes			41,574				953				42,527
Total liabilities assumed			240,057				953				241,010
Net Assets acquired		$	210,599			$	2,915			$	213,514