UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

 

FORM 10-K

 

 

(Mark One)

 

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

 

For the fiscal year ended December 31, 2009

OR

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

 

For the transition period from            to           

 

Commission file number 033-43007

 

TERRA NITROGEN COMPANY, L.P.

(Exact name of registrant as specified in its charter)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

 

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. Yeso  Nox

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yeso  Nox

 

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

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso  Nox

 

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, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yeso  Nox

 

The aggregate market value of the voting and non-voting common units held by non-affiliates computed by reference to the price at which the common units were last sold, or the average bid and asked price of such common units, as of the last business day of the registrant’s most recently completed second fiscal quarter was $464,853,998.36.

 

The number of Common Units, without par value, outstanding as of March 3, 2010 was 18,501,576.

 

 

Forward-Looking Information is Subject to Risk and Uncertainty

 

Certain statements in this report may constitute “forward-looking” statements within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are based upon assumptions as to future events that may not prove to be accurate. Actual outcomes and results may differ materially from what is expressed or forecasted in these forward-looking statements. As a result, these statements speak only as of the date they were made and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as otherwise required by law. Words such as “expects,” “intends,” “plans,” “projects,” “believes,” “estimates,” and similar expressions are used to identify these forward-looking statements. The forward-looking statements contained herein include statements about the proposed business combination between Yara International ASA (Yara) and Terra Industries Inc. (Terra). Forward-looking statements are not guarantees of future performance and involve risks, uncertainties and assumptions that are difficult to predict. These risks, uncertainties and assumptions include, among others:

 

 

Additional information as to these factors can be found in the sections entitled “Business”, “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and in the Notes to our Consolidated Financial Statements included as part of this Annual Report on Form 10-K.

 

Table of Contents

 

Terra Nitrogen Company, L.P.
Form 10-K
Part I

 

General

 

Terra Nitrogen Company, L.P. (TNCLP, we, our or us) is a Delaware Limited Partnership that produces and distributes nitrogen fertilizer products. Our principal products are anhydrous ammonia (ammonia) and urea ammonium nitrate solutions (UAN), which we manufacture at our facility in Verdigris, Oklahoma (“Verdigris”).

 

Ownership of TNCLP is represented by the General Partner interest and the Limited Partner interest. The Limited Partner interest consists of 18,501,576 Common Units and 184,072 Class B Common Units. Terra Industries Inc. (Terra), a Maryland corporation, and its subsidiaries owned 13,889,014 Common Units and all of the Class B Common Units as of December 31, 2009. The balance of Common Units is traded on the New York Stock Exchange under the symbol “TNH”.

 

We conduct our operations through an operating partnership, Terra Nitrogen, Limited Partnership (TNLP or the Operating Partnership, and collectively with TNCLP, the Partnership). Terra Nitrogen GP Inc. (TNGP or General Partner), a Delaware corporation, is the general partner of both TNCLP and TNLP and owns a consolidated 0.05 percent general partner interest in the Partnership. The General Partner is an indirect, wholly-owned subsidiary of Terra, a leading North American producer and marketer of nitrogen products, serving agricultural, industrial and environmental customers. In the event of a change in control of Terra, the acquiring company would assume Terra’s role relative to our ownership and operation.

 

On February 12, 2010, Terra entered into an Agreement and Plan of Merger (the Yara Merger Agreement) with Yara International ASA (Yara) and Yukon Merger Sub, Inc. (Merger Sub), an indirect, wholly owned subsidiary of Yara. If the transactions contemplated by the Yara Merger Agreement are consummated, Merger Sub will merge with and into Terra (the Yara Merger), with the result that Terra and our General Partner will become indirect, wholly owned subsidiaries of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

On March 2, 2010, Terra received a proposal from CF Industries Holdings, Inc. (CF Industries) to acquire all of the outstanding common stock of Terra for $37.15 in cash and 0.0953 of a share of CF Industries common stock for each Terra share. The proposal from CF Industries is subject to the termination of the Yara Merger Agreement, the execution of a definitive agreement with CF Industries and other customary conditions.

 

2009 Overview

 

For the year 2009, we reported net income of $144.3 million on revenues of $507.7 million, compared to net income of $422.4 million on revenues of $903.0 million for the year 2008. Net income allocable to Common Units was $100.0 million ($5.40 per Common Unit) and $275.7 million ($14.90 per Common Unit) for the 2009 and 2008 full years, respectively.

 

We delivered this strong performance against a backdrop of lackluster nitrogen demand resulting from the global economic crisis and the psychological effect on buyers of having managed through high-priced inventory from the previous year. The sluggish nitrogen demand resulted in depressed selling prices and weaker sales volumes, which were partially offset by natural gas price reductions.

 

Business Overview

 

We produce and distribute nitrogen products, which are used primarily by farmers to improve the yield and quality of their crops. Our product sales are heavily weighted toward UAN, and all of our products are sold on a wholesale basis. Although ammonia and UAN are often interchangeable, each has its own characteristics, and customer product preferences vary according to the crop planted, soil and weather conditions, regional

farming practices, relative prices and the cost and availability of appropriate storage, handling and application equipment.

 

Financial information about our business is included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Our Products

 

Overview

 

One of the principal forms of globally traded nitrogen fertilizer is ammonia. UAN is used principally in North America and has only recently been traded in other countries. UAN’s high water content and need for transportation in tankers can cause transportation costs per unit of nitrogen to be higher than for other forms of internationally traded nitrogen products. The location of our sole production facility in Verdigris provides us an advantage in serving agricultural customers in the Central and Southern Plains and the Corn Belt regions of the U.S. We do not sell our products internationally. Our nitrogen products and 2009 product production are described in greater detail below.

 

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 (AN) and water. The nitrogen content of UAN ranges from 28 percent to 32 percent by weight (unless we state otherwise, all references to UAN assume a 32 percent nitrogen content). 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 may be used for no-till row crops where fertilizer is spread on the surface of the soil.

 

In 2009 we produced and sold approximately 1.8 million tons of UAN, which was sold primarily to U.S. fertilizer dealers and distributors.

 

Anhydrous Ammonia

 

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 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 percent 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 2009, we produced approximately 1.0 million tons of ammonia. We sold a total of 0.3 million tons of ammonia and consumed approximately 0.7 million tons of ammonia as a raw material to manufacture our other nitrogen products.

 

Marketing and Distribution

 

We sell our products primarily in the Central and Southern Plains and Corn Belt regions of the U.S. Our sole production facility in Verdigris is located near the major crop producing and consuming areas of the U.S., and has ready access to barge, truck and rail transportation. In addition, the Verdigris facility has an ammonia pipeline to transport product to high demand regions. Our products are marketed and distributed by Terra based in Sioux City, Iowa, which provides services to the Partnership. For further information on the combined organizations of the General Partner and our affiliates, see Note 11, Transactions with Affiliates, of the Notes to

the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data of this Annual Report on Form 10-K.

 

All of our sales are at the wholesale level. Our customers for fertilizer products are dealers, national farm retail chains, distributors and other fertilizer producers and traders. National farm retail chains have both distribution and application capabilities. Distributors operate as wholesalers and sell directly to dealers and national farm retail chains, which, in turn, sell directly to farmers. Many dealers maintain year-round storage capacity for inventory as well as application equipment. We sell a majority of our nitrogen fertilizer products to dealers. Our top five customers make up approximately 27 percent of our nitrogen sales, with Crop Production Services, Inc. being our largest customer with approximately 12 percent of our nitrogen sales.

 

Transportation

 

We use several modes of transportation to ship product to customers, including railcars, common carrier trucks, barges and common carrier pipelines. Railcars are the primary mode of transportation for shipments from our Verdigris facilities. We utilize railcars that are currently leased by Terra for all of its businesses. Terra currently leases approximately 3,000 railcars. We also use approximately 40 liquid and ammonia fertilizer terminal storage facilities in numerous states.

 

Nitrogen Industry Overview

 

Building Blocks for Growth

 

The three major nutrients required for plant growth are nitrogen, produced from natural gas; phosphorous, mined as phosphate rock; and potassium, mined as potash.

 

These three nutrients occur naturally in the soil, but must be replaced because as crops grow, they remove nutrients from the ground. 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-to-year, per-acre-planted basis than is demand for phosphate or potash fertilizer.

 

The major nitrogen consuming crops in North America are corn and wheat, although cotton, rice and sugar cane all require significant application rates of nitrogen per acre. Certain crops, such as soybeans and other legumes, can better absorb atmospheric nitrogen and do not require nitrogen fertilizers.

 

Demand: Stable Growth

 

Global demand for fertilizers generally—and nitrogen in particular—grows at predictable rates that tend to correspond to growth in grain production and expansion of industrial demand. Global fertilizer demand is driven in the long-term by population growth, rising use of biofuels, increases in disposable income and associated improvements in diet. Short-term fertilizer 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 and India.

 

Long-term global demand growth for nitrogen is a result of the industrial and environmental businesses. Industrial growth is tied to increasing demand for coal and the expansion of industries that use nitrogen as a raw material. Growth in the environmental business is tied to increased use of nitrogen products that reduce nitrogen oxide (NOx) emissions. In the short-term environmental growth is spurred by changes in legislation and regulations. When these changes become institutionalized, they form the foundation for organic long-term growth as the environmental business increases in size over time.

 

Supply: Influenced by Gas Costs and Capital/Construction Costs

 

Over the past seven years, global ammonia capacity has increased incrementally, growing at an average of approximately 2.5 percent per year. This result was attributable principally to the combination of new project

capacity being offset by permanent plant closings in the U.S. and in Europe. As global operating rates and prices have risen, so have plans for new capacity.

 

This anticipated new global capacity will come primarily from advantaged natural gas regions of the world, such as the Middle East and Africa. This expansion of capacity could be limited, however, by high capital and construction costs, lower nitrogen prices and increasing natural gas prices. Russia has increased domestic gas prices as well as prices paid by their export customers. This has increased production costs for new and existing plants in Russia and Europe.

 

Imports account for a significant portion of U.S. nitrogen product supply. Producers from Russia, Canada, the Middle East, Trinidad and Venezuela are major exporters to the U.S. These export producers are often most 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 points of entry. According to Fertecon, a leading fertilizer industry publication, world ammonia imports grew from 17.0 million tons in 2000 to 20.3 million tons by 2008 due to the exceptional increase in gas prices in the U.S. and Europe during this period and the resulting reduction in U.S. capacity.

 

Outlook: Broadly Positive

 

As of October 2009, Fertecon forecasted global nitrogen fertilizer demand to rise by around 2 percent per year from 2008 to 2020, increasing by 23.9 million tons or close to 23 percent over the period. In North America, nitrogen fertilizer consumption is expected to increase in the same period from 14.1 million tons to 16.0 million tons, a 14 percent increase.

 

The continued growth in nitrogen demand has helped stabilize global ammonia capacity utilization rates, which averaged 82 percent between 2007 and 2008. Fertecon forecasts global ammonia utilization rates to remain stable at approximately 80 percent, and North American ammonia utilization rates to remain stable at approximately 85 percent, through 2015.

 

To help meet the growing global demand for fertilizers, especially in high growth areas like China and India, new ammonia capacity is expected to come on stream globally in the next decade. According to Fertecon, global ammonia capacity is forecasted to increase by 17.5 million tons by 2015, a total increase of 12 percent. This projected capacity increase excludes Chinese plants, as any new volumes in China are not expected to reach global markets. There are a number of new capacity projects expected or underway in gas advantaged regions, however, increased construction costs and changes in market dynamics have delayed a number of such projects.

 

World trade in ammonia is expected to increase by 4.1 million tons or 22 percent from 2009 to 2015, according to Fertecon, representing more modest growth than 2000 to 2005. Fertecon projects that higher gas costs for Russian and Ukrainian exporters and the lower relative gas price outlook for the U.S. would appear to support continued operating rates at the remaining U.S. ammonia capacity, limiting the near-term growth in ammonia imports.

 

Global grain inventories are currently at levels significantly below the ten-year average, and corn prices, which have been volatile over the past several years, stand at $3.34 per bushel as of February 19, 2010 versus $3.40 per bushel one year prior and $4.98 per bushel two years prior. Both of these factors influence the outlook for demand for our products.

 

The emergence of ethanol as an alternative energy source has the potential to drive incremental fertilizer demand. Corn, the primary feedstock for U.S. ethanol production, represents approximately 46 percent of fertilizer demand in North America. New ethanol capacity is increasing the demand for corn and is expected to increase U.S. corn acreage for ethanol production from 20 million acres in 2008 to 29 million acres in 2012. The amount of corn used in the U.S. for ethanol production has more than doubled in the last five years. In 2007-2008, approximately 3.0 billion bushels of corn were used for ethanol production. This number is projected to rise to over 4.0 billion bushels by 2009-2010, equivalent to approximately 32 percent of the U.S. corn crop.

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 consumption periods, with prices normally reaching their highest point in the spring, decreasing in the summer, and increasing again in the late fall and 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:

 

 

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

 

Raw Materials

 

The sole purchased feedstock used to produce manufactured nitrogen products is natural gas. Natural gas costs in 2009 accounted for approximately 49 percent of our total 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 our business, financial condition and results of operations. We believe there will be a sufficient supply of natural gas for the foreseeable future and we 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. We use a combination of spot and term purchases of varied duration from a variety of suppliers to obtain natural gas supply.

 

Natural gas is delivered to our Verdigris facility via an intrastate pipeline. This pipeline is not an open-access carrier, but is nonetheless part of a widespread regional system through which our Verdigris facility can receive natural gas from any major Oklahoma source. We also have limited access to out-of-state natural gas supplies for this facility.

 

We use derivative instruments to hedge a portion of our natural gas purchases. Our policy is designed to hedge exposure to natural gas price fluctuations for production required for estimated forward product sales commitments. We hedge natural gas prices through the use of supply contracts, financial derivatives and other instruments.

 

The settlement dates of forward-pricing contracts coincide with gas purchase dates as well as shipment periods on forward committed sales. Forward-pricing contracts are based on a specified price referenced to spot market prices or appropriate New York Mercantile Exchange (NYMEX) futures contract prices.

 

Competition

 

The categories in which we operate are highly competitive. Competition for agricultural product sales takes place largely on the basis 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 the competitive position of our plants are the natural gas acquisition and transportation contracts we negotiate with our major suppliers, as well as proximity to natural gas sources and the end-users.

Our domestic competitors in nitrogen fertilizers are primarily other independent fertilizer companies. Nitrogen fertilizers imported into the U.S. compete with domestically produced nitrogen fertilizers, including those we produce. Imports of nitrogen products represent approximately 46 percent of nitrogen used in North America. Some foreign competitors in 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 in countries with favored natural gas costs.

 

Credit

 

Our credit terms are generally 15-30 days, but may be extended for longer periods during certain sales seasons, consistent with industry practices.

 

Environmental and Other Regulatory Matters

 

Our operations are subject to various federal, state and local environmental, health and safety laws and regulations, including laws relating to air emissions, hazardous or solid wastes and water discharges. Our facilities require operating permits that are subject to review by governmental agencies. We are 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 or other regulatory agencies. We take precautions to reduce the likelihood of accidents (including human exposure) 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, we may be responsible under the Comprehensive Environmental Response, Compensation and Liability Act of 1980 (CERCLA) or analogous state laws for all or part of the costs of such investigation and remediation, and damages to natural resources. Freeport-McMoRan Resource Partners, Limited Partnership (a former owner and operator of the Partnership’s production facilities) has retained liability for certain environmental matters originating prior to the Partnership’s acquisition of these facilities.

 

We endeavor to comply in all material respects with applicable environmental, health and safety regulations and we have incurred substantial costs in connection with this compliance. Because these laws and regulations are expected to continue to change and generally become more restrictive than current requirements, the costs of compliance will likely increase. We do not expect our compliance with these laws and regulations to have a material adverse effect on our results of operations, financial position or net cash flows, however, there can be no guarantee that new regulations will not result in material costs. We may be required to install additional air and water quality control equipment, such as low NOx burners, scrubbers, ammonia sensors and continuous emission monitors, at our facility to comply with applicable environmental requirements. Our capital expenditures related to environmental control in 2009 were approximately $5.6 million. Environmental capital expenditures are projected to be approximately $11.3 million in the aggregate for the three years 2010, 2011 and 2012. The majority of these expenditures are for voluntary pollution prevention projects.

 

We believe that our policies and procedures now in effect comply with applicable environmental laws and with the permits relating to our facility in all material respects. However, in the normal course of our business, we are exposed to risks relating to possible releases of hazardous substances, including anhydrous ammonia, into the environment. Such releases could cause substantial damage 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 accidental releases of hazardous substances from our facility. Such liabilities could have a material adverse impact on our results of operations, financial position and/or net cash flows.

 

Employees

 

TNGP, the General Partner, is responsible for managing our business. As of December 31, 2009, the General Partner had no employees. Terra Nitrogen Corporation (TNC), a Terra subsidiary and the prior general partner had 164 employees, who, along with Terra, provide services to us under the October 2007 Amended and Restated General and Administrative Services Agreement. TNCLP had no employees as of December 31, 2009.

Upon consummation of the transactions contemplated by the Yara Merger Agreement, our General Partner will become an indirect, wholly owned subsidiary of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

Available Information

 

TNCLP was formed as a limited partnership in Delaware in 1990 and is subject to the reporting requirements of the Securities Exchange Act of 1934, as amended (the Exchange Act) and its rules and regulations. The Exchange Act requires us to file reports, proxy statements and other information with the U.S. Securities and Exchange Commission (SEC). Copies of these reports, proxy statements and other information can be obtained through the SEC’s Web site at http://www.sec.gov, at the SEC’s Office of Public Reference, 100 F Street, NE Room 1580, Washington, D.C. 20549, or by calling (800) SEC-0330.

 

We make available, free of charge on our Web site at www.terraindustries.com, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to these reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file these documents with, or furnish them to, the SEC.

 

We also make available, free of charge on our Web site, the charters of the Audit Committee and the Nominating and Corporate Governance Committee, as well as the Corporate Governance Guidelines of our Board of Directors (the Board) and our Code of Ethics and Standards of Business Conduct (including any amendment to, or waiver from, a provision of our Code of Ethics and Standards of Business Conduct) adopted by our Board.

 

Copies of any of these documents are also made available, free of charge, upon written request to:

 

Terra Industries Inc.
Attention: Investor Relations
600 Fourth Street
P.O. Box 6000
Sioux City, Iowa 51102-6000

 

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

 

A substantial portion of our 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 2009 comprised approximately 49 percent of our total costs and expenses. A significant increase in the price of natural gas (which can be driven by, among other things, supply disruptions, governmental or regulatory actions, cold weather and oil price spikes) that is not hedged or recovered through an increase in the price of the related nitrogen products could result in reduced profit margins and lower production. We have reduced production rates for periods of time in response to high natural gas prices and may do so again in the future. Globally, a significant number of competitors’ nitrogen production facilities have access to fixed-priced natural gas supplies. Our offshore competitors’ natural gas costs have been and likely will continue to be substantially lower than ours. Governmental or regulatory actions may also adversely affect both the supply availability and price of natural gas which could have a material adverse affect on the Partnership’s business, financial condition and results of operations.

 

Declines in the prices of our products may reduce profit margins.

 

Prices for nitrogen products are influenced by the global supply and demand 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 Russia, Canada, the Middle East, Trinidad and Venezuela. When the industry is oversupplied, as is common in commodity businesses, the price at which we sell our nitrogen products typically declines, which results in reduced profit margins, lower production rates and plant closures. U.S. supply is also affected by trade regulatory measures, which restrict imports into that geographic region. Changes in those measures would likely adversely impact available supply and pricing.

 

Our products are subject to price volatility resulting from periodic imbalances of supply and demand, which may cause our results of operations to fluctuate.

 

Historically, our product 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. Product demand depends 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, demand for our 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 we sell our products may be depressed and this could have a material adverse effect on our business, financial condition and results of operations.

 

Our products are global commodities and we face intense competition from other producers.

 

Our products are global commodities and can be subject to intense price competition from both domestic and foreign sources. Fertilizers are global commodities, and customers, including end-users, dealers, other crop-nutrients producers and distributors, base their purchasing decisions principally on the delivered price and availability of the product. We compete with a number of U.S. and offshore producers, including state-owned and government-subsidized entities. The U.S. has 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 our sales and profitability of the particular products involved. Some of our 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 fixed-price natural gas contracts that have been, and could continue to be, substantially lower priced than our natural gas. Our inability to compete successfully could result in the loss of customers, which could adversely affect sales and profitability.

 

Our business is subject to risks related to weather conditions.

 

Adverse weather 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 of nitrogen fertilizer that we sell. 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 our customers.

 

Weather and weather forecasts can dramatically affect the price of natural gas, our main raw material. Colder than normal winters as well as warmer than normal summers increase the natural gas demand for residential use. Also, hurricanes affecting the gulf coastal states can severely impact the supply of natural gas and cause prices to rise sharply.

 

Our risk measurement and hedging activities might not prevent losses.

 

We manage commodity price risk for our businesses as a whole. Although we implemented risk measurement systems that use various methodologies to quantify the risk, these systems might not always be followed or might not always work as planned. Further, such risk measurement systems do not in themselves manage risk, and adverse changes involving volatility, adverse correlation of commodity prices and the liquidity of markets might still adversely affect earnings and cash flows, as well as the balance sheet under applicable accounting rules, even if risks have been identified. The ability to manage exposure to commodity price risk in the purchase of natural gas through the use of financial derivatives may be affected by limitations imposed by the covenants in the agreements governing our indebtedness.

 

In an effort to manage financial exposure related to commodity price and market fluctuations, we have entered into contracts to hedge certain risks associated with our business, its assets and operations. In these hedging activities, we have used fixed-price, forward, physical purchase and sales contracts, futures, financial swaps and option contracts traded in the over-the-counter markets or on exchanges. Nevertheless, no single hedging arrangement can adequately address all risks present in a given contract or industry. Therefore, unhedged risks will always continue to exist. We may not be able to successfully manage all credit risk and as such, future cash flows could be impacted by counterparty default. As part of its policies and procedures with respect to swap counterparties, the Partnership performs credit analysis and maintains an approved counterparty listing with established individual counterparty credit exposure limits. Counterparty credit exposure limits did not exceed $20 million for any individual counterparty during the fiscal year ended December 31, 2009.

 

We are wholly dependent on our Verdigris manufacturing facility, and any operational disruption could result in a reduction of sales volumes and could cause us to incur substantial expenditures.

 

Our manufacturing operations may be subject to significant interruption if our Verdigris manufacturing facility were to experience a major accident or were damaged by severe weather or other natural disaster. In addition, our operations are subject to hazards inherent in nitrogen fertilizer manufacturing. Some of those hazards could cause personal injury and loss of life, severe damage to or destruction of property and equipment and environmental damage, and could result in suspension of operations and the imposition of civil or criminal penalties. We currently maintain property insurance, including business interruption insurance although there can be no assurance that we have sufficient coverage, or can in the future obtain and maintain sufficient coverage at reasonable costs.

We may incur costs or liabilities under environmental laws or regulations to which we are subject.

 

Our operations are subject to various federal, state and local environmental, safety and health laws and regulations, including laws relating to air emissions, the use and disposal of hazardous and solid materials and wastes, water discharges, investigation and remediation of contamination, transportation and worker health and safety. We could incur substantial costs, including capital expenditures for equipment upgrades, civil and criminal fines and penalties and third-party claims for damages, as a result of violations of or liabilities under environmental laws and regulations. In connection with the manufacturing, handling, transportation, storage and disposal of materials that are or may be classified as hazardous or toxic by foreign, federal, state, provincial or local agencies, we may be responsible under CERCLA or analogous state laws if such materials have been or are disposed of or released at sites that require investigation and/or remediation, including 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.

 

From time to time, our production of anhydrous ammonia has resulted in accidental releases that have temporarily disrupted our manufacturing operations and resulted in liability for administrative penalties and claims for personal injury. Although, to date, our costs to resolve these liabilities have not been material, we could incur significant costs if our liability coverage is not sufficient to pay for all or a large part of any judgments against us, or if our carrier refuses coverage for these losses.

 

We 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, including proposals to reduce emissions of carbon dioxide and other greenhouse gases, can be expected to result in increased future investments for environmental controls at ongoing operations. We may be required to install additional air and water quality control equipment, such as low NOx burners, scrubbers, ammonia sensors and continuous emission monitors, at our facilities in order to comply 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 previously unknown conditions may require significant expenditures in excess of our estimates and may have a material adverse effect on our results of operations, financial position or net cash flows.

 

Government regulation and agricultural policy may reduce the demand for our products.

 

Existing and future government regulations and laws may reduce the demand for our 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. Changes in U.S. energy policies may affect the demand for our nitrogen products. 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. 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 for and selling prices of our products. In addition, we manufacture and sell AN in the U.S. AN can be used as an explosive and was used in the Oklahoma City bombing in April 1995. It is possible the U.S. government could impose limitations on the use, sale or distribution of AN, thereby limiting our ability to manufacture or sell this product.

 

We are subject to risks associated with possible climate change legislation, regulation and international accords.

 

Greenhouse gas emissions have increasingly become the subject of a large amount of international, national, regional, state and local attention. Cap and trade initiatives to limit greenhouse gas emissions have been introduced in the EU. Similarly, numerous bills related to climate change have been introduced in the US Congress, which could adversely impact all industries. In addition, future regulation of greenhouse gas could occur pursuant to future US treaty obligations, statutory or regulatory changes under the Clean Air Act or new climate change legislation.

While not all are likely to become law, this is a strong indication that additional climate change related mandates may be forthcoming, and it is expected that they may adversely impact our costs by increasing energy costs and raw material prices and establishing costly emissions trading schemes and requiring modification of equipment.

 

A step toward potential federal restriction on greenhouse gas emissions was taken on December 7, 2009 when the EPA issued its Endangerment Finding in response to a decision of the Supreme Court of the United States. The EPA found that the emission of six greenhouse gases, including carbon dioxide (which is emitted from the combustion of fossil fuels), may reasonably be anticipated to endanger public health and welfare. Based on this finding, the EPA defined the mix of these six greenhouse gases to be air pollution subject to regulation under the Clean Air Act. Although the EPA has stated a preference that greenhouse gas regulation be based on new federal legislation rather than the existing Clean Air Act, many sources of greenhouse gas emissions may be regulated without the need for further legislation.

 

The US Congress is considering legislation that would create an economy-wide cap-and-trade system that would establish a limit (or cap) on overall greenhouse gas emissions and create a market for the purchase and sale of emissions permits or allowances. Under the leading cap-and-trade proposals before Congress, the fertilizer industry likely would be affected due to anticipated increases in the cost of natural gas fuel and feedstock, and the cost of emissions allowances, which the Company would be required to obtain. In addition, cap-and-trade proposals would likely increase the cost of electricity used by the Company. Other countries are also considering or have implemented cap-and-trade systems. Future environmental regulatory developments related to climate change are possible, which could materially increase operating costs in the fertilizer industry and thereby increase our manufacturing and delivery costs.

 

Terra and its affiliates may engage in competition with us.

 

The partnership agreement does not prohibit Terra and its affiliates, other than our General Partner TNGP, and, upon consummation of the Yara Merger, will not prohibit Yara and its affiliates, other than our General Partner TNGP, from owning and operating nitrogen fertilizer manufacturing plants and storage and distribution assets or engaging in businesses that otherwise compete directly or indirectly with us, which could harm our business. In addition, Terra, and upon the consummation of the Yara Merger, Yara, may acquire, construct or dispose of additional assets related to our business, without any obligation to offer us the opportunity to purchase or construct any of these assets.

 

We are dependent on Terra and its employees for the success of our business.

 

We are dependent on Terra, and, upon consummation of the Yara Merger, will be dependent on Yara, for our success in a number of respects. Terra, through its wholly-owned subsidiary TNGP (our General Partner), manages our business operations and, together with its affiliates, provides certain other services to us, including production, manufacturing, sales, customer service, distribution, accounting, legal, risk management, investor relations and other general and administrative services. Upon consummation of the Yara Merger, Yara will assume Terra’s role relative to our ownership and operations. Terra and its wholly-owned subsidiaries have, and, upon consummation of the Yara Merger, Yara and its wholly-owned subsidiaries may have, more debt and debt service requirements than we do. Although Terra and Yara are affected by most of the factors that affect us, a higher level of debt could put a greater risk on Terra or Yara, as the case may be, in the event business conditions deteriorate materially. Our results of operations and financial condition might be adversely affected by financial difficulties at Terra, and, upon consummation of the Yara Merger, Yara, default by them or their subsidiaries on their debt or their bankruptcy. Information regarding Terra can be obtained in the various filings with the Securities and Exchange Commission, including Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K.

 

We may be unable to refinance our indebtedness upon a change of control.

 

Under our revolving credit facility, a change of control will occur if, among other such things, an individual or group acquires more than 35 percent of the outstanding voting shares of Terra, such as is the case with the Yara Merger. Such a change of control would constitute an event of default under the credit facility. If such a

change of control was to occur, the Partnership may not have the ability to replace its current revolving credit facility on terms equal to or more favorable than current terms.

 

If the global economic downturn continues or worsens, our business could be adversely impacted.

 

In the latter part of 2008 and through 2009, the global economic downturn worsened and nitrogen demand continued to weaken. We have experienced declining demand and falling prices for some of our products due to the general economic slowdown and our customers’ reluctance to replenish inventories. In particular, industrial demand for ammonia has remained relatively weak as the economy has struggled to recover. At the same time, the economic downturn has also reduced demand and pricing for natural gas, the primary raw material used in the production of nitrogen products, which has helped to reduce our production costs. In light of these varied and sometimes offsetting effects, the overall impact of the global economic downturn is difficult to predict and our business could be adversely impacted.

 

Disruption in or increased costs of transportation services could have an adverse effect on our profitability.

 

We depend on rail, barge, truck and pipeline transportation services to deliver nitrogen products to our customers, and transportation costs are a significant component of the total cost of supplying nitrogen products. Disruptions of these transportation services could temporarily impair our ability to supply nitrogen products to our customers. In addition, increases in our transportation costs, or changes in such costs relative to transportation costs incurred by our competitors, could have an adverse effect on our revenues and results of operations.

 

None

 

Production Facility

 

			Annual Capacity in Tons1
Location			Ammonia2			UAN—32%
Verdigris, Oklahoma			1,050,000			1,925,000
1 The annual capacity contains an allowance for a planned maintenance shutdown.
2 Measured in gross tons of ammonia produced; net tons available for sale will vary with upgrading requirements.

UAN plants and a port terminal. The Partnership owns the plants, while the port terminal is leased from the Tulsa-Rogers County Port Authority. The Partnership’s leasehold interest on the port terminal was renewed for ten (10) years in April 2004, extending the term to April 2014, and the Partnership has an option to renew the lease for an additional five-year term. The Partnership’s Verdigris production facility produces all of the Partnership’s nitrogen fertilizer products. This facility’s production capacity is shown in the table above.

 

The Partnership’s Verdigris production facility is 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 Verdigris manufacturing facility was 93 percent in 2009, 107 percent in 2008 and 106 percent in 2007.

 

The Partnership owns all of its manufacturing and terminal facilities in fee, unless otherwise stated below.

 

Terminal Facilities

 

The Partnership owns and operates two terminals used to store and distribute its products to customers. The Partnership owns UAN terminals near Blair, Nebraska (Washington County) and Pekin, Illinois (Tazewell County). In addition, the Blair terminal stores and distributes ammonia.

 

From time to time, we may be involved in claims, disputes, administrative proceedings and litigation arising in the ordinary course of business. We do not believe that the matters in which the Partnership may be currently involved, either individually or in the aggregate, will have a material adverse effect on the business, results of operations, financial position or net cash flows of the Partnership.

 

No matters were submitted to a vote of unitholders of TNCLP during the fourth quarter of 2009.

 

		2009								2008
Quarter		High				Low				High				Low
1st		$	145.90			$	93.30			$	168.19			$	102.10
2nd			144.48				94.97				171.37				108.39
3rd			119.86				95.00				135.98				94.00
4th			115.62				99.37				111.17				65.20

right discloses the high and low sales prices of the common units for each quarterly period for 2009 and 2008, as reported on the NYSE Composite Price History.

 

Ownership of TNCLP is composed of the General Partner interest and the Limited Partner interests. The Limited Partner interests consist of 18,501,576 Common Units and 184,072 Class B Common Units. Terra and its subsidiaries owned 13,889,014 Common Units and 184,072 Class B Common Units as of December 31, 2009. Based on information received from TNCLP’s transfer and service agent, the number of registered unitholders as of March 3, 2010 is 140.

 

Under TNCLP’s limited partnership agreement, cash distributions to unitholders are based on Available Cash for the quarter as defined therein. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. For additional information regarding cash distributions, see the “Liquidity and Capital Resources” section of Item 7, Management’s Discussion and Analysis, of this Annual Report on Form 10-K.

 

The following table represents cash distributions paid to the holders of Common Units, Class B Common Units and the General Partner for the years ending December 31, 2009 and 2008:

 

 

The following table presents our selected financial data. The table should be read in conjunction with Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

 

 

Overview

 

As you read this management’s discussion and analysis of financial condition and results of operations, you should refer to our Consolidated Financial Statements and related Notes included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Introduction

 

 

 

Company Overview

 

Terra Nitrogen Company, L.P. (TNCLP, we our, or us) is a Delaware Limited Partnership that produces and distributes nitrogen products primarily to the agriculture industry. We conduct our business through an operating partnership, Terra Nitrogen, Limited Partnership (TNLP or the Operating Partnership, and collectively with TNCLP, the Partnership). Terra Nitrogen GP Inc. (TNGP or General Partner), is the general partner of both TNLCP and TNLP and owns a consolidated 0.05 percent general partner interest in the Partnership. The General Partner is an indirect, wholly-owned subsidiary of Terra Industries Inc. (Terra), a Maryland corporation. Terra is a leading pure play nitrogen producer in North America serving agricultural, industrial and environmental customers. TNLP is an integral part of the pure play nitrogen strategy by producing 1.0 million tons of ammonia annually, of which 0.7 million tons are upgraded.

 

On February 12, 2010, Terra entered into an Agreement and Plan of Merger (the Yara Merger Agreement) with Yara International ASA (Yara) and Yukon Merger Sub, Inc. (Merger Sub), an indirect, wholly owned subsidiary of Yara. If the transactions contemplated by the Yara Merger Agreement are consummated, Merger Sub will merge with and into Terra (the Yara Merger), with the result that Terra and our General Partner will become indirect, wholly owned subsidiaries of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

On March 2, 2010, Terra received a proposal from CF Industries Holdings, Inc. (CF Industries) to acquire all of the outstanding common stock of Terra for $37.15 in cash and 0.0953 of a share of CF Industries common stock for each Terra share. The proposal from CF Industries is subject to the termination of the Yara Merger Agreement, the execution of a definitive agreement with CF Industries and other customary conditions.

 

Upgraded Product Focus

 

Our principal products are anhydrous ammonia (ammonia) and urea ammonium nitrate solutions (UAN), which we manufacture at our Verdigris facility. We are the second largest UAN production facility in North America. Our location is well positioned to serve customers in the Cornbelt because our transportation costs are lower

than those of Gulf or offshore producers. In addition to lower transportation costs, our plant has a significant natural gas basis advantage as compared to the Henry Hub. The plant is served by the OneOK (Panhandle) gas pipeline.

 

The core of the nitrogen pure play strategy is meeting the nitrogen demand of the agriculture industry, specifically for corn production. In the latter half of this decade we have seen a shortage in world grain stocks as a result of the growing population, developing economies in India and China, and on a smaller scale, the influence of the ethanol fuel market. Nitrogen is vital to successful corn yields and unlike other fertilizers such as potash and phosphate which can be applied on a rotational basis, nitrogen must be applied annually.

 

2009 Executive Summary

 

Significant Results

 

 

Significant Developments

 

 

Significant Drivers

 

 

Business Strategy

 

We are a leading producer and marketer of wholesale nitrogen products, serving agricultural and industrial customers. The nitrogen products industry has periods of oversupply during industry downturns that lead to capacity shutdowns at the least cost-effective plants. These shutdowns are followed by supply shortages, which

result in higher selling prices and higher industry-wide production rates during industry upturns. The higher selling prices encourage capacity additions until we start to see an oversupply, and the cycle repeats itself.

 

To succeed in this business, a producer must have the financial strength to weather industry downturns and the ability to serve its customers cost-effectively during every phase of the cycle. A nitrogen producer will also benefit from having one or more nitrogen products that operate in non-agricultural industries to balance the cyclicality of agriculture demand.

 

We base our business strategies on these concepts. In practice, this means we:

 

 

In every case, we invest our capital judiciously to realize a return above the cost of capital over the industry cycle.

 

Recent Business Environment

 

The following factors are the key drivers of our profitability: nitrogen products selling prices, as determined primarily by the global nitrogen demand/supply balance, and natural gas costs, particularly in North America.

 

Demand

 

During 2009, the nitrogen business was affected by the decline in the global economy. Industrial customers curtailed production lessening the demand for our industrial based nitrogen products. In 2009, we saw a decrease in energy costs, which lessened demand for alternative fuels. As a result, some ethanol production was curtailed during the first half of the year. As energy prices have rebounded some of the production has since come back on line.

 

The agriculture business faced similar effects of the economic downturn, with volatile crop prices, escalating input costs and credit constraints impacting growers’ buying behavior. In 2009, farmers saw a $30 billion decrease in net farm income as compared to 2008 due primarily to a decrease in crop prices. This hampered demand and, coupled with the volatility present in fertilizer pricing in 2008, resulted in cautious buying behaviors among growers and retailers as they waited for firm orders from growers at the end of 2009.

 

Long term demand for nitrogen products is driven by a growing global population, its desire for a higher protein diet, and to a lesser degree, by the rise in demand of alternative bio-fuels in North America. In 2010, we expect to see a strong recovery in the fertilizer markets as the fundamentals for corn demand have improved. Corn pricing remains strong at $3.34 per bushel as of February 19, 2010, input costs have declined and the lending markets are improving.

 

An increase in ethanol demand is expected in the coming years due to the government mandated volumes of 15.0 billion gallons in 2015 and an anticipated increase in the ethanol blend rate by the EPA from 10 percent to 15 percent in 2010. In 2009, production exceeded the mandated volumes of 10.5 billion gallons by 2.5 billion gallons; therefore, the 2010 increase to 12.0 billion gallons is already covered by current production volumes. However, an increase in the blend rate would impact the immediate demand for corn in 2010. Energy prices and policy will have an impact on the magnitude of ethanol’s impact on nitrogen demand in the future.

 

The populations are growing and diets are improving in China, the Southeast Asian countries, and Russia. As the economies and population of these countries continue to grow, so does the demand for grain. For example, India, with a population in excess of 1 billion people, has seen its grain consumption grow 31 percent in the last two decades due to an increase in population of 35 percent.

 

We expect the demand for UAN to continue to grow over the long term. Weather and field conditions are variables present in every planting season. By using UAN, growers have greater application flexibility, which allows them to mitigate some of this risk. While upgraded products contain less nitrogen by weight, they are generally easier to ship, store and apply than ammonia and are safer to handle.

Supply

 

Over the past seven years, global ammonia capacity has increased incrementally, growing at an average of approximately 2.5 percent per year. This result was attributable principally to the combination of new project capacity offset by permanent plant closings in the U.S. and in Europe. As global operating rates and prices have risen, so have plans for new capacity.

 

This anticipated new global capacity is expected to come primarily from advantaged natural gas regions of the world, such as the Middle East and Africa. This expansion of capacity could be limited, however, by high capital and construction costs, lower nitrogen prices and increasing natural gas prices. Russia has increased domestic gas prices as well as prices paid by their export customers. This has increased production costs for new and existing plants in Russia and Europe.

 

Imports account for a significant portion of U.S. nitrogen product supply. Producers from Russia, Canada, the Middle East, Trinidad and Venezuela are major exporters to the U.S. These export producers are often most 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 points of entry.

 

To help meet the growing global demand for fertilizers, especially in high growth areas like China and India, new ammonia capacity is expected to come on stream globally in the next decade. This projected capacity increase excludes Chinese plants as any new volumes in China are not expected to reach global customers, but instead are expected to be consumed by China’s growing in-country demand. For ammonia, there are a number of new capacity projects expected or underway in gas advantaged regions; however, increased construction costs and changes in demand have delayed a number of such projects.

 

In 2009, the industry began the year with high inventories and weak demand. Demand strengthened in the second half of 2009 which allowed plant rates to return to planned production rates.

 

Natural Gas Costs

 

Natural gas in North America continues to be the most volatile commodity but the absolute price level for 2009 NYMEX settlements were less than half of the 2008 NYMEX settlement prices. The economic downturn of 2009 played a significant role in the price decline in 2009. Consumption dropped by 5-7 percent by analysts’ calculations. Natural gas production stayed steady and rose in some places in North America, adding fuel to the lagging prices. Based on projected net increases in natural gas supply for most of 2010, coupled with high storage volumes, we expect moderate North American natural gas prices to continue, enabling us to remain competitive with global producers. Although geographic basis has tightened, we believe that our geographic plant positions in Oklahoma provide us with a favorable delivered gas cost basis as compared to our Gulf Coast competitors.

 

The following is the average NYMEX forward natural gas price for the succeeding twelve-month period noted for the respective dates:

 

 

As shown in this table, natural gas prices in 2009 were not as volatile as in 2008. Some semblance of seasonal pricing patterns existed and the economy had a major impact on lowering prices. The first half of 2009 experienced slow price erosion and the fourth quarter of 2009 saw an increase as cooler weather caused heating demand to rise in the southern tier states.

 

Our strategy for natural gas procurement is to manage our exposure to price volatility by locking in our margin for known commitments. We execute our risk management approach by hedging natural gas prices through the use of supply contracts, financial derivatives and other instruments.

Results of Operations

 

Consolidated Results

 

We recorded 2009 net income of $144.3 million on revenues of $507.7 million compared with 2008 net income of $422.4 million on revenues of $903.0 million. The decrease in net income and revenue is due to the overall economic decline and an imbalance in the inventory channel for most of 2009, which drove pricing down.

 

The following table shows the results of operation for the three years ended December 31, 2009, 2008 and 2007:

 

 

Sales Volumes and Prices

 

 

 

Results of Operations—2009 Compared with 2008

 

Our net sales for 2009 decreased by 44 percent to $507.7 million from $903.0 million in 2008. The decrease in net sales was primarily attributable to a significant decline in nitrogen prices across all products and a moderate decrease in sales volumes as compared to 2008. Specifically, 2009 ammonia and UAN pricing were 39 percent and 42 percent, respectively, below 2008 price levels. 2009 sales volumes for UAN decreased 11 percent compared to 2008, while ammonia volumes increased slightly by 1 percent compared to 2008. The decline in nitrogen prices reflected the softening in demand due to imbalances that were present in the retail inventory channel. Despite the 86 million acres of corn planted in 2009 we did not see the typical seasonal demand due to inclement weather conditions and excess inventory carried over from 2008. Industry reports also indicate a decline of approximately 6 percent in overall fertilizer application during 2009 which contributed to the decline in volumes experienced in 2009.

The events of 2008 had a significant impact on the results of 2009. The 2008 record corn acres created a deviation in buying behavior with retailers buying more and earlier in fear of ever rising prices. However, the 2008 credit crisis led to the rapid decline of the economy. Nitrogen prices plummeted in the fourth quarter of 2008 leaving many retailers holding inventory priced higher than what the market would support. Even though growers had strong balance sheets, banks were reluctant to lend due to their evaluation of the risk at that time. Without credit, growers had limited working capital and were not willing to make advance purchases for their fertilizer needs. This trend has continued which is evident in our prepayment balances at year end. At December 31, 2008, we had $45.1 million in customer prepayments compared to $16.4 million at December 31, 2009.

 

The lower prices deterred imports which helped to correct the excess inventory issues. At the end of 2009, the inventory balances in the channel remained low due to low fall fill orders. Traditionally, growers apply nitrogen in the fall after harvest in order to be ready for the spring planting season. However, wet weather in the fall delayed farmers from accessing their fields. The situation worsened in December 2009 when several winter snow storms left approximately 5 percent of the 2009 harvest still standing in the fields. This will leave farmers with additional work in the spring to finish harvest and plant next season’s crops. The harvest issue in conjunction with the cautious buying behavior prevalent in the industry decreased our fall fill shipments during 2009. This has potential to increase pressure on logistics during the peak demand season in the spring of 2010 as there are limits to the amount of product that can be moved in the critical timeframe.

 

In order to effectively manage our inventory levels throughout the year, production was reduced to 93 percent. During 2009 certain production plants at the facility underwent turnaround. The period cost associated with production being offline during the turnaround was $5.2 million for the twelve months ended December 31, 2009.

 

Our gross profit was $160.9 million in 2009 compared to $432.2 in 2008 and decreased as a percentage of sales to 31.7 percent from 47.9 percent. For the year, natural gas unit costs, net of forward pricing gains and losses, decreased by 44 percent from $8.59 per MMBtu in 2008 to $4.83 per MMBtu in 2009. As a result of forward price contracts, 2009 natural gas costs were $52.9 million higher than spot prices, as compared to 2008 natural gas costs, which were $42.9 million higher than spot prices.

 

We enter into forward sales commitments by utilizing forward pricing and prepayment programs with customers. We use derivative instruments to hedge a portion of our natural gas requirements. The use of these derivative instruments is designed to hedge exposure to natural gas price fluctuations for production required for forward sales estimates. The net cost of derivatives for 2009 was $48.7 million, as compared to the net cost of $47.4 million for 2008. Excluding the impact of the hedge cost, natural gas cost was $3.55 per MMBtu and $7.45 per MMBtu for 2009 and 2008, respectively.

 

Operating expenses increased $1.3 million, primarily due to an increase in direct charges for the Partnership including Board of Director costs and K-1 reporting costs. Our increased 2009 selling, general and administrative (SG&A) allocation from Terra was primarily related to higher share-based compensation expense, resulting from a year over year appreciation of the Terra stock price.

 

Results of Operations—2008 Compared with 2007

 

Total revenues for 2008 were $903.0 million, compared to $636.3 million for 2007. The $266.7 million, or 42 percent increase in revenues was due to increased ammonia and UAN prices of 62 percent and 47 percent, respectively. The increased sales prices are due to the increased demand for nitrogen products driven by high commodity grain prices.

 

Income from operations for 2008 was $416.5 million as compared to $200.5 million for 2007. The $216.0 million increase was primarily due to $281.8 million increase in sales prices partially offset by $57.2 million related to an increase in natural gas costs and $7.4 million of sales volume decreases. Volumes for ammonia and UAN were down 13 percent and 2 percent, respectively, in comparison to 2007 due primarily to light nitrogen demand in the fourth quarter.

For the year, natural gas costs, including the effect of hedged settled natural gas position, increased 26 percent from $6.84 per British thermal unit (MMBtu) in 2007 to $8.59 per MMBtu in 2008. We enter into forward sales commitments by utilizing forward pricing and prepayment programs with customers. We use derivative instruments to hedge a portion of our natural gas requirements. The use of these derivative instruments is designed to hedge exposure to natural gas price fluctuations for production required for forward sales estimates. As a result of forward price contracts, 2008 natural gas costs were $42.9 million higher than spot prices, as compared to 2007 natural gas costs that were $25.1 million higher than spot prices.

 

Operating expenses decreased $5.4 million, primarily as a result of SG&A costs that are allocated to us from Terra. Our decreased 2008 SG&A allocation was primarily related to lower share-based compensation expense, resulting from a year over year reduction of the Terra stock price.

 

Liquidity and Capital Resources

 

Summary

 

Our principal funding needs are to support working capital requirements, make payments for plant turnaround and capital expenditures, and quarterly distributions. Cash and cash equivalent balances at December 31, 2009 were $24.8 million, a decrease of $129.9 million from 2008.

 

Our cash receipts are generally received by Terra. Cash receipts, net of cash payments made by Terra, are transferred to us from Terra weekly. Because of this cash collection and distribution arrangement, Terra is a creditor to us.

 

Cash Flows

 

The following table summarizes our cash flows from operating, investing and financing activities for each of the past three fiscal years ($ in thousands):

 

 

Operating Activities

 

Net cash provided by operating activities for 2009 represented $161.1 million from operations offset by $7.6 million from working capital changes. The $161.1 million includes $144.3 million of net income, adjusted for non-cash expenses of $16.4 million of depreciation of plant, property and equipment and amortization of deferred plant turnaround costs and $0.4 million of loss on derivatives.

 

Investing Activities

 

During 2009, we spent $21.1 million on capital expenditures for replacement additions to plant and equipment and $9.4 million for plant turnaround costs. The plant turnaround costs represent periodic scheduled maintenance costs and occur generally every two years.

 

Financing Activities

 

During 2009, we paid distributions of approximately $264.2 million to our unitholders. The distributions paid are based on the available cash, as defined our Agreement of Limited Partnership. See Partnership Distributions on page 22 and Note 3, Agreement of Limited Partnership, of the Notes to the Consolidated Financial Statements, included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K for further detail regarding distributions.

Revolving Credit Facility

 

We have a $50 million revolving credit facility extended through January 2012. A portion of this facility is available for swing loans and for the issuance of letters of credit. At December 31, 2009, there were no revolving credit borrowings, and there were no outstanding letters of credit. The facility requires us to maintain certain financial ratio covenants relating to minimum earnings, maximum capital expenditures and minimum liquidity. We must also adhere to certain limitations on additional indebtedness, capital expenditures, acquisitions, liens, investments, asset sales, prepayments or subordinated indebtedness, changes in lines of business, restricted payments and transactions with affiliates, among others. Terra and its other domestic subsidiaries have guaranteed our obligations on an unsecured basis. For additional information regarding our facility, see Note 9, Revolving Bank Credit Facility, of the Notes to the Consolidated Financial Statements included in Item 8, Financial Statements and Supplementary Data, of this Annual Report on Form 10-K.

 

Under the facility, we may borrow an amount generally based on eligible cash balances, 85 percent of eligible accounts receivable and 60 percent of eligible finished goods inventory, less outstanding letters of credit. Our borrowings under the credit facility are secured by substantially all of our working capital.

 

In addition, if our aggregate borrowing availability falls below $10 million, we are required to have generated $25 million of operating cash flows or earnings before interest, income taxes, depreciation, amortization and other non-cash items as defined in the facility for the preceding four quarters. We are also required to maintain a minimum aggregate unused borrowing availability of $5 million at all times.

 

Our ability to continue to comply with the covenants under the facility in the future will depend on market conditions, operating cash flows, working capital needs, receipt of customer prepayments and trade credit terms. Failure to comply with these covenants, or to obtain a waiver from the lenders, would result in our default such that all outstanding amounts could become immediately due and payable and we would be unable to borrow additional amounts under the facility. Access to adequate bank facilities may be required to fund operating cash needs. Therefore, any default or termination of the facility could have a material adverse effect on our business.

 

The facility requires that there be no change of control related to Terra, such that no individual or group acquires more than 35 percent of the outstanding voting shares of Terra, such as is the case with the Yara Merger. Such a change of control would constitute an event of default under the facility. We expect the facility to be adequate to meet our operating needs.

 

Debt

 

The General Partner is an indirect, wholly-owned subsidiary of Terra. Under the General Partner’s governing documents, neither we nor the General Partner may make any bankruptcy filing (or take similar action) without the approval of the General Partner’s independent directors. Upon consummation of the transactions contemplated by the Yara Merger Agreement, our General Partner will become an indirect, wholly owned subsidiary of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

Capital Expenditures

 

We had $21.1 million of capital expenditures in 2009, used primarily for replacing operating plant and equipment. Plant turnaround costs represent cash used for the periodic scheduled maintenance of our continuous process production facilities, generally every two years. We funded $9.4 million of plant turnaround costs during 2009. We expect 2010 capital expenditures to be approximately $21.4 million for operating plant and equipment and $10.8 million for turnaround costs.

 

We incurred $5.6 million, $2.0 million and $0.5 million of capital expenditures in 2009, 2008 and 2007, respectively, related to capital improvements to ensure compliance with environmental, health and safety regulations. We 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. We estimate that the cost of complying with these existing requirements in 2010, 2011 and

2012 will be approximately $11.3 million. The majority of these expenditures are for voluntary pollution prevention projects.

 

In addition, expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $1.7 million, $2.0 million and $1.7 million in 2009, 2008 and 2007, respectively. Because we expect environmental, health and safety regulations to continue to change and generally to be more restrictive than current requirements, the costs of compliance will likely increase. However, we do not expect that our compliance with these regulations will have a material adverse effect on our results of operations, financial position or net cash flows.

 

Partnership Distributions

 

We make quarterly distributions to our unitholders based on available cash for the quarter as defined in our Agreement of Limited Partnership. Available cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. We paid distributions of $264.2 million, $376.1 million and $144.2 million to our unitholders in 2009, 2008 and 2007, respectively.

 

We receive 99 percent of the Available Cash from Terra Nitrogen, Limited Partnership (the Operating Partnership) and 1 percent is distributed to its General Partner. Cash distributions from the Operating Partnership generally represent the Operating Partnership’s Available Cash from operations. Our cash distributions are made 99.975 percent to Common and Class B Common Unitholders and 0.025 percent to our General Partner except when cumulative distributions of Available Cash exceed specified target levels above the Minimum Quarterly Distributions (MQD) of $0.605 per unit. Under such circumstances, our General Partner is entitled to receive Incentive Distribution Rights (IDR’s). During 2009, we exceeded the MQD for the quarterly distributions for the first, second, and third quarter. Available Cash reserves were reviewed in the fourth quarter and no distribution was declared. The Partnership reserves of cash for anticipated working capital needs and fixed asset expenditures. Based upon the liquidity needs of the business these reserve requirements did not allow for a quarterly distribution.

 

In future periods when Available Cash is sufficient for declaration of a distribution the MQD in arrears must be paid before the Incentive Distribution Rights of the General Partner apply. Pursuant to our Agreement of Limited Partnership, income allocable to the Limited Partner and General Partner is based upon the distributions of Available Cash for the year. Therefore, earnings per unit reflect an annualized allocation rate.

 

When we exceed the cumulative MQD amounts and the Available Cash is distributed as summarized in the following table:

 

 

The General Partner is required to remit the majority of cash distributions it receives from the Partnership, in excess of its 1 percent Partnership equity interest, to an affiliated company.

 

General Partner Option to Effect Mandatory Redemption of Partnership Units

 

At December 31, 2009, the General Partner and its affiliates owned 75.3 percent of our outstanding common units. When less than 25 percent of the issued and outstanding common units are held by non-affiliates of the General Partner, as was the case at December 31, 2009, we, at the General Partner’s sole discretion, may

call, or assign to the General Partner or its affiliates the right to acquire all of the outstanding common units held by non-affiliated persons. If the General Partner elects to acquire all outstanding common units, we are required to give common unitholders at least 30 but not more than 60 days’ notice of its decision to purchase the outstanding common units. The purchase price per unit will be the greater of (1) the average of the daily closing prices per unit for the previous 20 trading days as of the date five days before a notice of such election is mailed and (2) the highest price paid by the General Partner or any of its affiliates for any common unit within the 90 days preceding the date the notice of such election is mailed. Additional purchases of common units by the General Partner may be restricted under the terms of Terra’s bank credit agreement as described therein.

 

Upon consummation of the transactions contemplated by the Yara Merger Agreement, our General Partner will become an indirect, wholly owned subsidiary of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

Off-balance Sheet Arrangements and Contractual Obligations

 

We have operating leases that are off-balance sheet arrangements. Contractual obligations and commitments to make future payments were as follows at December 31, 2009:

 

 

Environmental, Health and Safety

 

Expenditures related to environmental, health and safety regulation compliance are primarily composed of operating costs that totaled $1.7 million in 2009. Environmental health and safety regulations are expected to continue to change and generally to become more restrictive than current requirements, thus the cost of compliance likely will increase. We do not expect compliance with such regulations to have a material adverse effect on the results of operations, financial position or net cash flows.

 

We incurred $5.6 million of 2009 capital expenditures to ensure compliance with environmental, health and safety regulations. We 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. We estimate that the cost of complying with existing requirements in 2010, 2011, 2012 and beyond will be approximately $11.3 million in the aggregate.

 

Application of Critical Accounting Policies and estimates

 

The preparation of financial statements and related disclosures in conformity with accounting principles generally accepted in the United States requires us to make judgments, assumptions and estimates that affect the amounts reported in our Consolidated Financial Statements and accompanying notes. Note 1, Summary of Significant Accounting Policies, of the Notes to the Consolidated Financial Statements in Item 8, Financial Statements and Supplementary Data, of this Form 10-K describes the significant accounting policies and methods used in preparing the Consolidated Financial Statements. We consider the accounting policies described below to be our most critical accounting policies because they are impacted significantly by estimates that management makes. We based our estimates on historical experience or various assumptions that we believe to be reasonable under the circumstances, and the results form the basis for making judgments about the reported values of assets, liabilities, revenues and expenses. We have discussed the development and selection of our critical accounting estimates, and the disclosure regarding them, with the audit committee of the Board of Directors of our General Partner, and do so on a regular basis. Actual results may differ materially from these estimates.

Derivatives and Financial Instruments

 

We account for derivatives in accordance with the Derivative and Hedging topic of the Codification, which requires that derivatives be reported on the balance sheet at fair value and, if the derivative is not designated as a hedging instrument, changes in fair value must be recognized in earnings in the period of change. If the derivative is designated as a hedge and to the extent such hedge is determined effective, changes in fair value are either (a) offset by the change in fair value of the hedged asset or liability (if applicable) 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 that the offsetting hedged transaction occurs. We may also use similar derivative instruments to fix or set floor prices for a portion of our nitrogen sales volumes.

 

Until our derivatives settle, we test the derivatives for ineffectiveness. This includes assessing the correlation of NYMEX pricing, which is commonly used as an index in natural gas derivatives, to the natural gas pipelines’ pricing at our manufacturing facilities. This assessment requires management judgment to determine the statistically- and industry-appropriate analysis of prior operating relationships between the NYMEX prices and the natural gas pipelines’ prices at our facilities.

 

To the extent possible, we base our market value calculations on third party data. Due to multiple types of settlement methods available, not all settlement methods for future period trades are available from third party sources. In the event that a derivative is measured for fair value based on a settlement method that is not readily available, we estimate the fair value based on forward pricing information for similar types of settlement methods.

 

Inventory Valuation

 

Inventories are stated at the lower of cost or market. Market is defined as current replacement cost, except that market should not exceed the net realizable value and market should not be less than net realizable value reduced by an allowance for an approximately normal profit margin. The cost of inventories is determined by using the first-in, first out method. We perform a monthly analysis of our inventory balances to determine if the carrying amount of inventories exceeds their net realizable value. Our determination of estimated net realizable value is based on customer orders, market trends and historical pricing. If the carrying amount exceeds the estimated net realizable value, we reduce the carrying amount to the estimated net realizable value. We estimate a reserve for obsolescence and excess of our materials and supplies inventory. Inventory is stated net of the reserve.

 

Plant Turnaround Costs

 

Plant turnarounds are periodically performed to extend the useful life, increase output and/or efficiency and ensure the long-term reliability and safety of integrated plant machinery at our continuous process production facilities. The nature of a turnaround is such that it occurs on less than an annual basis and requires a multi-week shutdown of plant operations. Specific procedures performed during the turnaround include the disassembly, inspection and replacement or overhaul of plant machinery (boilers, pressure vessels, piping, heat exchangers, etc.) and rotating equipment (compressors, pumps, turbines, etc.), equipment recalibration and internal equipment efficiency assessments.

 

Preceding a turnaround, plants experience decreased efficiency in resource conversion to finished products. Replacement or overhaul of equipment and items such as compressors, turbines, pumps, motors, valves, piping and other parts that have an estimated useful life of at least two years, the internal assessment of production equipment, replacement of aged catalysts, and new installation/recalibration of measurement and control devices result in increased production output and/or improved plant efficiency after the turnaround. Turnaround activities are betterments that meet at least one of the following criteria: 1) extend the equipment useful life, or 2) increase the output and/or efficiency of the equipment. As a result, we follow the deferral method of accounting for these turnaround costs and thus they are capitalized and amortized over the period benefited, which is generally the two-year period until the next turnaround. The turnaround activities may extend the useful life of the assets since the overhaul of heat exchangers, pressure vessels, compressors, turbines, pumps, motors, etc. allow the continued use beyond the original design. If criteria for betterment or useful life extension

are not met, we expense the turnaround expenditures as repair and maintenance activities in the period performed.

 

Revenue Recognition

 

We recognize revenue when persuasive evidence of a transaction exists, delivery has occurred, the price is fixed or determinable, no obligations remain and collectability is probable. We classify any discounts and trade allowances as a reduction in revenue. Gains or losses associated with settled nitrogen derivative contracts are classified as revenue. We classify amounts directly or indirectly billed to our customers for shipping and handling as revenue. Rail and barge shipments usually take approximately 7 and 10 days, respectively, to arrive at customer locations.

 

New Accounting Pronouncements

 

In June 2009, the FASB issued new guidance on Generally Accepted Accounting Principles (GAAP) relating to the Codification. This guidance establishes the Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force (EITF) Abstracts; instead the FASB will issue Accounting Standard Updates. Accounting Standard Updates will not be authoritative in their own right as they will only serve to update the Codification. This guidance was effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In December 2007, the FASB issued new guidance on business combinations, which was effective for us for business combinations with the acquisition date on or after January 1, 2009. This guidance requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction and establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed in a business combination. Certain provisions of this guidance will, among other things, impact the determination of acquisition-date fair value of consideration paid in a business combination (including contingent consideration); exclude transaction costs from acquisition accounting; and change accounting practices for acquired contingencies, acquisition-related restructuring costs, in-process research and development, indemnification assets and tax benefits. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In March 2009, the FASB issued new guidance on derivatives and hedging, which requires entities to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. We adopted this guidance on January 1, 2009 and these disclosures are included in Note 6 herein.

 

In March 2008, the FASB issued new guidance on earnings per share for Master Limited Partnerships. This guidance specifies the treatment of earnings per unit calculations when incentive distribution rights exist. We adopted this guidance on January 2, 1009 and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance on fair value measurements and disclosures, which provides additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity. This also provides additional guidance on circumstances that may indicate that a transaction is not orderly and requires additional disclosures. We adopted this guidance on April 1, 2009, and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance relating to investments, which amends the other-than-temporary recognition guidance for debt securities and requires additional interim and annual disclosures of other-than-temporary impairments on debt and equity securities. Pursuant to the new guidance, an other-than-temporary

impairment has occurred if a company does not expect to recover the entire amortized cost basis of the security. In this situation, if the company does not intend to sell the impaired security, and it is not more likely than not it will be required to sell the security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings is limited to the portion attributed to the credit loss. The remaining portion of the other-than-temporary impairment is then recorded in other comprehensive income. We adopted this guidance on April 1, 2009 and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance relating to interim disclosures about the fair value of financial instruments. This guidance required disclosures about fair value of all financial instruments for interim reporting periods. This guidance relates to fair value disclosures for any financial instruments that are not currently reflected in a company’s balance sheet at fair value. Prior to the effective date of this guidance, fair values for these assets and liabilities were only disclosed once a year. This guidance now requires these disclosures to be made on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. We adopted this guidance on April 1, 2009 and included the additional interim disclosure information in our quarterly SEC filings.

 

In June 2009, the FASB issued new guidance on subsequent events. This guidance provides authoritative accounting literature and disclosure requirements for material events occurring subsequent to the balance sheet date and prior to the issuance of the financial statements. This guidance is effective for us for the periods ended on and after June 30, 2009. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows. We have reviewed and disclosed all material subsequent events in Note 15 herein.

 

In June 2009, the FASB issued new guidance on transfers and servicing, an amendment of previous authoritative guidance. The most significant amendments resulting from this guidance consist of the removal of the concept of a qualifying special-purpose entity (SPE) from previous authoritative guidance, and the elimination of the exception for the qualifying SPEs from the consolidation guidance regarding variable interest entities. This guidance is effective for us January 1, 2010 and we are currently assessing the impact this guidance will have on our financial statements.

 

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. This guidance affects the overall consolidation analysis and requires enhanced disclosures on involvement with variable interest entities. This guidance is effective for us January 1, 2010 and we are currently assessing the impact this guidance will have on our financial statements.

 

In September 2009, the FASB issued amendments to the accounting and disclosure for revenue recognition. This guidance will change the accounting for revenue recognition for arrangements with multiple deliverables and will enable entities to separately account for individual deliverables for many more revenue arrangements. This guidance eliminates the requirement that all undelivered elements must have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. As a result, the new guidance may allow some companies to recognize revenue on transactions that involve multiple deliverables earlier than under current requirements. This guidance is effective for us January 1, 2011 and we are currently assessing the impact this guidance will have on our financial statements.

 

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements. The Update provides amendments to FASB ASC 820-10 that require entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition the Update requires entities to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The disclosures related to Level 1 and Level 2 fair value measurements are effective for us in 2010 and the disclosures related to Level 3 fair value measurements are effective for us in 2011. The Update requires new disclosures only, and will have no impact on our consolidated financial position, results of operations or cash flows.

 

Risk Management and Financial Instruments

 

Market risk represents the risk of loss that may impact our financial position, results of operations or cash flows due to adverse changes in financial and commodity market prices and rates. We use derivative financial instruments to manage risk in the area of changes in natural gas prices. We have no foreign currency exchange rate risk.

 

The General Partner’s current policy is, and historically has been, to avoid unnecessary risk and to limit, to the extent practical, risks associated with operating activities. The General Partner may not engage in activities that expose the Partnership to speculative or non-operating risks. Management is expected to limit risks to acceptable levels. The use of derivative financial instruments is consistent with the overall business objectives of the Partnership. Derivatives are used to manage operating risk within the limits established by the General Partner’s Board of Directors, and in response to identified exposures, provided they qualify as hedge activities. As such, derivative financial instruments are used to hedge firm commitments and forecasted commodity purchase transactions. The use of derivative financial instruments subjects the Partnership 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 General Partner continuously monitors the valuation of identified risks and adjusts the portfolio based on current market conditions.

 

Upon consummation of the transactions contemplated by the Yara Merger Agreement, our General Partner will become an indirect, wholly owned subsidiary of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

Natural Gas Prices

 

Natural gas is the principal raw material used to manufacture nitrogen. Natural gas prices are volatile and the General Partner manages some of this volatility through the use of derivative commodity instruments. We have hedged approximately 16 percent of anticipated 2010 requirements and none of our requirements beyond December 31, 2010. The fair value of these instruments is estimated based on published referenced prices and quoted market prices from brokers. These instruments and other natural gas positions fixed natural gas prices at $3.2 million less than published prices for December 31, 2009 forward markets. Market risk is estimated as the potential loss in fair value resulting from a hypothetical price change. Changes in the market value of these derivative instruments have a high correlation to changes in the spot price of natural gas. Based on the Partnership’s derivatives outstanding at December 31, 2009 and 2008, which included swaps and basis swaps, a $1 per MMBtu increase in NYMEX pricing would result in a $6.1 million and $3.1 million, respectively, fluctuation in our natural gas costs.

 

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 consumption 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:

 

 

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

 

Our management is responsible for the preparation, integrity and objectivity of the accompanying consolidated financial statements and the related financial information. The consolidated financial statements have been prepared in conformity with accounting principles generally accepted in the United States of America and necessarily include certain amounts that are based on estimates and informed judgments. Our management also prepared the related financial information included in this Annual Report on Form 10-K and is responsible for its accuracy and consistency with the consolidated financial statements.

 

The accompanying consolidated financial statements have been audited by Deloitte & Touche LLP, an independent registered public accounting firm, who conducted its audits in accordance with the standards of the Public Company Accounting Oversight Board. The independent registered public accounting firm’s responsibility is to express an opinion as to the fairness with which such financial statements present our financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

Report of Independent Registered Public Accounting Firm

 

To the Partners of Terra Nitrogen Company, L.P.

 

We have audited the accompanying consolidated balance sheets of Terra Nitrogen Company, L.P. (a Limited Partnership) (the Partnership) as of December 31, 2009 and 2008 and the related consolidated statements of operations, partners’ capital, and cash flows for each of the three years in the period ended December 31, 2009. These financial statements are the responsibility of the Partnership’s management. Our responsibility is to express an opinion on these financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Terra Nitrogen Company, L.P. at December 31, 2009 and 2008 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2009, in conformity with accounting principles generally accepted in the United States of America.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Partnership’s internal control over financial reporting as of December 31, 2009 based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 3, 2010 expressed an unqualified opinion the Partnership’s internal control over financial reporting.

 

 

Omaha, Nebraska

March 3, 2010

 

Consolidated Balance Sheets

 

See accompanying Notes to the Consolidated Financial Statements

 

Consolidated Statements of Operations

 

See accompanying Notes to the Consolidated Financial Statements

 

Consolidated Statements of Partners’ Capital

 

See accompanying Notes to the Consolidated Financial Statements

 

Consolidated Statements of Cash Flows

 

See accompanying Notes to the Consolidated Financial Statements

 

Notes to the Consolidated Financial Statements

 

 

 

Terra Nitrogen Company, L.P. (TNCLP, we, our or us) is a Delaware Limited Partnership that owns a 99 percent limited partner interest as the sole limited partner in Terra Nitrogen, Limited Partnership (the “Operating Partnership”; collectively with TNCLP, the “Partnership,” unless the context otherwise requires).

 

Ownership of TNCLP is represented by the General Partner interest and the Limited Partner interest. The Limited Partner interest consists of 18,501,576 Common Units and 184,072 Class B Common Units. Terra Industries Inc. (Terra) and its subsidiaries owned 13,889,014 Common Units and 184,072 Class B Common Units as of December 31, 2009. The balance of Common Units is traded on the New York Stock Exchange under the symbol “TNH”.

 

We manufacture and sell nitrogen products, including ammonia and urea ammonium nitrate solution (UAN), which are principally used by farmers to improve the yield and quality of their crops. We sell products primarily throughout the U.S. on a wholesale basis. Our customers vary in size and are primarily related to the agriculture industry and to a lesser extent to the chemical industry.

 

 

 

Basis of Presentation—The consolidated financial statements and the accompanying notes are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP) and the rules of the U.S. Securities and Exchange Commission. They include the accounts of the Partnership. All intercompany accounts and transactions have been eliminated. Income is allocated to the General Partner and the Limited Partners in accordance with the provisions of the TNCLP Agreement of Limited Partnership that provides for allocations of income between the Limited Partners and the General Partner in the same proportion as cash distributions declared during the year.

 

Cash and Cash Equivalents—We classify cash and short-term investments with an original maturity of three months or less as cash and cash equivalents. Demand deposits with affiliate are not classified in cash and cash equivalents.

 

Demand Deposits with Affiliate—Our cash receipts are generally received by Terra. Cash receipts, net of cash payments made by Terra, are transferred to us from Terra weekly. As a result of this cash collection and distribution arrangement, Terra is a creditor to us.

 

Receivables—Account receivables and other receivable balances are reported at outstanding principal amounts, net of an allowance for doubtful accounts. Management evaluates the collectability of receivable account balances to determine the allowance, if any. Management considers the other party’s credit risk and financial condition, as well as current and projected economic and market conditions in determination of an allowance amount. As of December 31, 2009 and 2008, we have an allowance against our receivables of $760 and $0, respectively.

 

Inventories—Production costs include the cost of direct labor and materials, depreciation and amortization, and overhead costs related to manufacturing activities. We allocate fixed production overhead costs based on the normal capacity of our production facilities and unallocated overhead costs are recognized as expense in the period incurred. The cost of inventories is determined using the first-in, first-out method.

 

Inventories are stated at the lower of cost or market. Market is defined as current replacement cost, except that market should not exceed the net realizable value and should not be less than net realizable value reduced by an allowance for an approximately normal profit margin. We perform a monthly analysis of our inventory balances to determine if the carrying amount of inventories exceeds their net realizable value. Our determination of estimated net 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 reliable value.

 

We estimate a reserve for obsolescence and excess of materials and supplies inventory. Inventory is stated net of the reserve.

 

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 the buildings and 3 to 18 years for plants and equipment. Maintenance and repair costs, other than plant turnaround and catalyst replacement, are expensed as incurred.

 

Plant Turnaround Costs—Plant turnarounds are periodically performed to extend the useful life, increase output and/or efficiency and ensure the long-term reliability and safety of integrated plant machinery at our continuous process production facilities. The nature of a turnaround is such that it occurs on less than an annual basis and requires a multi-week shutdown of plant operations. Specific procedures performed during the turnaround include the disassembly, inspection and replacement or overhaul of plant machinery (boilers, pressure vessels, piping, heat exchangers, etc.) and rotating equipment (compressors, pumps, turbines, etc.), equipment recalibration and internal equipment efficiency assessments.

 

Preceding a turnaround, plants experience decreased efficiency in resource conversion to finished products. Replacement or overhaul of equipment and items such as compressors, turbines, pumps, motors, valves, piping and other parts that have an estimated useful life of at least two years, the internal assessment of production equipment, replacement of aged catalysts, and new installation/recalibration of measurement and control devices result in increased production output and/or improved plant efficiency after the turnaround. Turnaround activities are betterments that meet at least one of the following criteria: 1) extend the equipment useful life, or 2) increase the output and/or efficiency of the equipment. As a result, we follow the deferral method of accounting for these turnaround costs and thus they are capitalized and amortized over the period benefited, which is generally the two-year period until the next turnaround. The turnaround activities may extend the useful life of the assets since the overhaul of heat exchangers, pressure vessels, compressors, turbines, pumps, motors, etc. allow the continued use beyond the original design. If criteria for betterment or useful life extension are not met, we expense the turnaround expenditures as repair and maintenance activities in the period performed.

 

In addition, state and certain other regulatory agencies require a scheduled biennial safety inspection of plant components, such as steam boilers and registered pressure vessels and piping, which can only be performed during the period of shut down. A full shutdown and dismantling of components of the plant is generally mandatory to facilitate the inspection and certification. We defer costs associated with regulatory safety inspection mandates that are incurred during the turnaround. These costs are amortized over the period benefited, which is generally the two-year period until the next turnaround.

 

During a turnaround event, there will also be routine repairs and maintenance activities performed for normal operating purposes. The routine repairs and maintenance costs are expensed as incurred. We do not classify routine repair and maintenance activities as part of the turnaround costs capitalization since they are not considered betterments.

 

The installation of major equipment items can occur at any time, but frequently occur during scheduled plant outages, such as a turnaround. During a plant turnaround, expenditures for replacing major equipment items are capitalized as separate fixed assets.

 

TNCLP classifies capitalized turnaround costs as an investing activity under the caption “Capital expenditures and plant turnaround expenditures” in the Statement of Cash Flows, since this cash outflow relates to expenditures related to productive assets. Repair and maintenance costs are expensed as incurred and are included in the operating cash flow.

 

There are three acceptable methods of accounting for turnaround costs: 1) direct expensing method, 2) built-in overhaul method and 3) deferral method. Terra utilizes the deferral method and recognizes turnaround expense over the period benefited since these expenditures are asset betterments. If the direct expense method was utilized, all turnaround expenditures would be recognized in the income statement as a period cost when incurred and reflected in cash flows from operating activities in the statement of cash flows.

 

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

 

Derivatives and Financial Instruments—We account for derivatives in accordance with the Derivative and Hedging topic of the Codification, which requires that derivatives be reported on the balance sheet at fair value and, if the derivative is not designated as a hedging instrument, changes in fair value must be recognized in earnings in the period of change. If the derivative is designated as a hedge and to the extent such hedge is determined effective, changes in fair value are either (a) offset by the change in fair value of the hedged asset or liability (if applicable) 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 that the offsetting hedged transaction occurs.

 

Until our derivatives settle, we test the derivatives for ineffectiveness. This includes assessing the correlation of NYMEX pricing, which is commonly used as an index in natural gas derivatives, to the natural gas pipelines’ pricing at our manufacturing facilities. This assessment requires management judgment to determine the statistically- and industry-appropriate analysis of prior operating relationships between the NYMEX prices and the natural gas pipelines’ prices at our facilities.

 

To the extent possible, we base our market value calculations on third party data. Due to multiple types of settlement methods available, not all settlement methods for future period trades are available from third party sources. In the event that a derivative is measured for fair value based on a settlement method that is not readily available, we estimate the fair value based on forward pricing information for similar types of settlement methods.

 

Terra Industries Inc. and its subsidiaries (Terra) enter into derivative instruments with counterparties for our operations. When Terra enters into a derivative instrument for our operations, we simultaneously enter into a derivative instrument with Terra as the counterparty. The terms of the derivative instruments between Terra and us are identical to the terms of the derivative instruments between Terra and Terra’s counterparty. The types of derivative instruments entered into include futures contracts, swap agreements, put and call options to cap or fix prices for a portion of our natural gas production requirements. Terra may also enter into similar derivative instruments to fix or set floor prices for a portion of our nitrogen sales volumes.

 

Revenue Recognition—Revenue is recognized when persuasive evidence of a transaction exists, delivery has occurred, the price is fixed or determinable, and no obligations remain and collectability is probable. We classify any discounts and trade allowances as a reduction in revenue. Gains or losses associated with settled nitrogen derivative contracts are classified as revenue. We classify amounts directly or indirectly billed to our customers for shipping and handling as revenue. Rail and barge shipments usually take approximately 7 and 10 days, respectively, to arrive at customer locations.

 

Cost of Sales—The cost of manufacturing fertilizer products is recorded when the fertilizer products are sold and revenue is recognized. We classify shipping and handling costs incurred as cost of sales. Premiums paid for option contracts are deferred and recognized in cost of sales in the month to which the related derivative transactions are settled. Realized gains and losses on derivatives activities are recognized in cost of sales.

 

Income Taxes—We are not subject to income taxes. The income tax liability of the individual partners is not reflected in our consolidated financial statements.

 

Estimates—The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (GAAP) 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 revenue and expenses during the reporting period. Actual results could differ from these estimates.

 

New Accounting Pronouncements—In June 2009, the FASB issued new guidance on Generally Accepted Accounting Principles (GAAP) relating to the Codification. This guidance establishes the Codification as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with GAAP. Rules and interpretive releases of the SEC under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The FASB will no longer issue new standards in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force (EITF) Abstracts; instead the FASB will issue Accounting Standard Updates. Accounting Standard Updates will not be authoritative in their own right as they will only serve to update the Codification. This guidance was effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In December 2007, the FASB issued new guidance on business combinations, which was effective for us for business combinations with the acquisition date on or after January 1, 2009. This guidance requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction and establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed in a business combination. Certain provisions of this guidance will, among other things, impact the determination of acquisition-date fair value of consideration paid in a business combination (including contingent consideration); exclude transaction costs from acquisition accounting; and change accounting practices for acquired contingencies, acquisition-related restructuring costs, in-process research and development, indemnification assets and tax benefits. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In March 2009, the FASB issued new guidance on derivatives and hedging, which requires entities to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted, and how derivative instruments and related hedged items affect an entity’s financial position, results of operations, and cash flows. We adopted this guidance on January 1, 2009 and these disclosures are included in Note 6 herein.

 

In March 2008, the FASB issued new guidance on earnings per share for Master Limited Partnerships. This guidance specifies the treatment of earnings per unit calculations when incentive distribution rights exist. We adopted this guidance on January 2, 1009 and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance on fair value measurements and disclosures, which provides additional guidance on estimating fair value when the volume and level of activity for an asset or liability have significantly decreased in relation to normal market activity. This also provides additional guidance on circumstances that may indicate that a transaction is not orderly and requires additional disclosures. We adopted this guidance on April 1, 2009, and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance relating to investments, which amends the other-than-temporary recognition guidance for debt securities and requires additional interim and annual disclosures of other-than-temporary impairments on debt and equity securities. Pursuant to the new guidance, an other-than-temporary impairment has occurred if a company does not expect to recover the entire amortized cost basis of the security. In this situation, if the company does not intend to sell the impaired security, and it is not more likely than not it will be required to sell the security before the recovery of its amortized cost basis, the amount of the other-than-temporary impairment recognized in earnings is limited to the portion attributed to the credit loss. The remaining portion of the other-than-temporary impairment is then recorded in other comprehensive income. We adopted this guidance on April 1, 2009 and the adoption did not have an impact on our consolidated financial position, results of operations or cash flows.

 

In April 2009, the FASB issued new guidance relating to interim disclosures about the fair value of financial instruments. This guidance required disclosures about fair value of all financial instruments for interim reporting periods. This guidance relates to fair value disclosures for any financial instruments that are not currently reflected in a company’s balance sheet at fair value. Prior to the effective date of this guidance, fair values for

 

these assets and liabilities were only disclosed once a year. This guidance now requires these disclosures to be made on a quarterly basis, providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. We adopted this guidance on April 1, 2009 and included the additional interim disclosure information in our quarterly SEC filings.

 

In June 2009, the FASB issued new guidance on subsequent events. This guidance provides authoritative accounting literature and disclosure requirements for material events occurring subsequent to the balance sheet date and prior to the issuance of the financial statements. This guidance is effective for us for the periods ended on and after June 30, 2009. The adoption did not have an impact on our consolidated financial position, results of operations or cash flows. We have reviewed and disclosed all material subsequent events in Note 15 herein.

 

In June 2009, the FASB issued new guidance on transfers and servicing, an amendment of previous authoritative guidance. The most significant amendments resulting from this guidance consist of the removal of the concept of a qualifying special-purpose entity (SPE) from previous authoritative guidance, and the elimination of the exception for the qualifying SPEs from the consolidation guidance regarding variable interest entities. This guidance is effective for us January 1, 2010 and we are currently assessing the impact this guidance will have on our financial statements.

 

In June 2009, the FASB issued an amendment to the accounting and disclosure requirements for transfers of financial assets. This guidance affects the overall consolidation analysis and requires enhanced disclosures on involvement with variable interest entities. This guidance is effective for us January 1, 2010 and we are currently assessing the impact this guidance will have on our financial statements.

 

In September 2009, the FASB issued amendments to the accounting and disclosure for revenue recognition. This guidance will change the accounting for revenue recognition for arrangements with multiple deliverables and will enable entities to separately account for individual deliverables for many more revenue arrangements. This guidance eliminates the requirement that all undelivered elements must have objective and reliable evidence of fair value before a company can recognize the portion of the overall arrangement fee that is attributable to items that already have been delivered. As a result, the new guidance may allow some companies to recognize revenue on transactions that involve multiple deliverables earlier than under current requirements. This guidance is effective for us January 1, 2011 and we are currently assessing the impact this guidance will have on our financial statements.

 

In January 2010, the FASB issued Accounting Standards Update No. 2010-06, Improving Disclosures about Fair Value Measurements. The Update provides amendments to FASB ASC 820-10 that require entities to disclose separately the amounts of significant transfers in and out of Level 1 and Level 2 fair value measurements and describe the reasons for the transfers. In addition the Update requires entities to present separately information about purchases, sales, issuances, and settlements in the reconciliation for fair value measurements using significant unobservable inputs (Level 3). The disclosures related to Level 1 and Level 2 fair value measurements are effective for us in 2010 and the disclosures related to Level 3 fair value measurements are effective for us in 2011. The Update requires new disclosures only, and will have no impact on our consolidated financial position, results of operations or cash flows.

 

 

 

We make quarterly distributions to our partners based on available cash for the quarter as defined in our Agreement of Limited Partnership. Available Cash is defined generally as all cash receipts less all cash disbursements, adjusted for changes in certain reserves established as the General Partner determines in its reasonable discretion to be necessary. We paid distributions of $264.2 million, $376.1 million and $144.2 million to our partners in 2009, 2008 and 2007, respectively.

 

We receive 99 percent of the Available Cash from Terra Nitrogen, Limited Partnership (the Operating Partnership) and 1 percent is distributed to its General Partner. Cash distributions from the Operating Partnership generally represent the Operating Partnership’s Available Cash from operations. Our cash distributions are made 99.975 percent to Common and Class B Common Unitholders and 0.025 percent to our

 

General Partner except when cumulative distributions of Available Cash exceed specified target levels above the Minimum Quarterly Distributions (MQD) of $0.605 per unit. Under such circumstances, our General Partner is entitled to receive Incentive Distribution Rights (IDR’s). During 2009, we exceeded the MQD for the quarterly distributions for the first, second, and third quarter. Available Cash reserves were reviewed in the fourth quarter and no distribution was declared. The Partnership reserves of cash for anticipated working capital needs and fixed asset expenditures. Based upon the liquidity needs of the business these reserve requirements did not allow for a quarterly distribution.

 

In future periods when Available Cash is sufficient for declaration of a distribution the MQD in arrears must be paid before the Incentive Distribution Rights of the General Partner apply. Pursuant to our Agreement of Limited Partnership, income allocable to the Limited Partner and General Partner is based upon the distributions of Available Cash for the year. Therefore, earnings per unit reflect an annualized allocation rate.

 

When we exceed the cumulative MQD amounts and the Available Cash is distributed as summarized in the following table:

 

 

The General Partner is required to remit the majority of cash distributions it receives from the Partnership, in excess of its 1 percent Partnership equity interest, to an affiliated company.

 

The quarterly cash distributions paid to the Unitholders and the General Partner in 2009 and 2008 follow:

 

 

At December 31, 2009, the General Partner and its affiliates owned 75.3 percent of our outstanding common units. When less than 25 percent of the issued and outstanding common units are held by non-affiliates of the General Partner, as was the case at December 31, 2009, we, at the General Partnerships’ sole discretion may call, or assign to the General Partner or its affiliates the right to acquire all outstanding common units held by non-affiliated persons. If the General Partner elects to acquire all outstanding common units, we are required to

 

give common unitholders at least 30 but not more than 60 days’ notice of its decision to purchase the outstanding common units. The purchase price per unit will be the greater of (1) the average of the daily closing prices per unit for the previous 20 trading days as of the date five days before a notice of such election is mailed and (2) the highest price paid by the General Partner or any of its affiliates for any common unit within the 90 days preceding the date the notice of such election is mailed. Additional purchases of common units by the General Partner may be restricted under the terms of Terra’s bank credit agreement as described therein.

 

Upon consummation of the transactions contemplated by the Yara Merger Agreement, our General Partner will become an indirect, wholly owned subsidiary of Yara and Yara would assume Terra’s role relative to our ownership and operation.

 

 

Basic income per unit data is based on the weighted-average number of Partnership Units outstanding during the period. Diluted income per unit data is based on the weighted-average number of Partnership Units outstanding and the effect of all dilutive potential common units.

 

The following table provides a reconciliation between basic and diluted income per unit for the years ended December 31, 2009, 2008 and 2007: