UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
| [X] |
Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003 OR |
| [ ] |
Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from . . . . to . . . . Commission file number 1-7627 |
FRONTIER OIL CORPORATION
(Exact name of registrant as specified in its charter)
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Wyoming (State or other jurisdiction of incorporation or organization) 10000 Memorial Drive, Suite 600 Houston, Texas (Address of principal executive offices) |
74-1895085 (I.R.S. Employer Identification No.) 77024-3411 (Zip Code) |
Registrant’s telephone number, including area code: (713) 688-9600
Former name, former address and former fiscal year, if changed since last report.
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Indicate by check mark
whether the registrant (1) has filed all reports required to be filed by Section
13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes [x] No . . . |
| Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) |
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Yes [x] No . . . Registrant’s number of common shares outstanding as of October 24, 2003: 26,162,514 |
FRONTIER OIL CORPORATION
QUARTERLY REPORT ON FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
INDEX
Part I - Financial Information
Part II - Other Information
This Form 10-Q contains “forward-looking statements,” as defined by the Securities and Exchange Commission. Such statements are those concerning contemplated transactions and strategic plans, expectations and objectives for future operations. These include, without limitation:
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statements, other than statements of historical facts, that address activities,
events or developments that we expect, believe or anticipate will or may occur
in the future;
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statements relating to future financial performance, future equity issuances and other matters; and
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any other statements preceded by, followed by or that include the words
“anticipates,” “believes,” “expects,”
“plans,” “intends,” “estimates,”
“projects,” “could,” “should,” “may,” or
similar expressions.
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Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Form 10-Q are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. These statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate in the circumstances. Such statements are subject to a number of risks and uncertainties, many of which are beyond our control. You are cautioned that any such statements are not guarantees of future performance and that actual results or developments may differ materially from those projected in the forward-looking statements.
We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.
Definitions of Terms
bbl(s) = barrel(s)
bpd = barrel(s) per day
PART I - FINANCIAL INFORMATION
FRONTIER OIL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited, in thousands except per share amounts)
Nine Months Ended Three Months Ended
September 30 September 30
2003 2002 2003 2002
----------- ----------- ----------- -----------
Revenues:
Refined products $ 1,625,441 $ 1,282,818 $ 594,292 $ 488,476
Other 2,119 (626) 471 (1,796)
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1,627,560 1,282,192 594,763 486,680
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Costs and Expenses:
Raw material, freight and other costs 1,401,401 1,101,305 502,723 424,161
Refining operating expenses, excluding
depreciation 149,059 130,924 48,495 42,236
Selling and general expenses, excluding
depreciation 14,926 12,821 5,132 4,817
Merger termination and legal costs (Note 6) 3,953 - 3,953 -
Depreciation 21,187 20,353 7,156 6,979
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1,590,526 1,265,403 567,459 478,193
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Operating Income 37,034 16,789 27,304 8,487
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Interest expense and other financing costs 20,749 20,739 6,590 7,009
Interest income (907) (1,387) (260) (471)
Merger financing termination costs, net (Note 6) 17,632 - 14,212 -
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37,474 19,352 20,542 6,538
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Income (Loss) Before Income Taxes (440) (2,563) 6,762 1,949
Provision (Benefit) for Income Taxes 430 (626) 2,940 1,140
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Net Income (Loss) $ (870) $ (1,937) $ 3,822 $ 809
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Basic Income (Loss) Per Share
of Common Stock: $ (.03) $ (.08) $ .15 $ .03
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Diluted Income (Loss) Per Share
of Common Stock: $ (.03) $ (.08) $ .14 $ .03
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FRONTIER OIL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited, in thousands)
Nine Months Ended Three Months Ended
September 30 September 30
2003 2002 2003 2002
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Net Income (Loss) $ (870) $ (1,937) $ 3,822 $ 809
Other Comprehensive Income, Net of Income Tax:
Change in fair value of cash flow hedges - 263 - -
Derivative value reclassed to income - (168) - (129)
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Comprehensive Income (Loss) $ (870) $ (1,842) $ 3,822 $ 680
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FRONTIER OIL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited, in thousands except share data)
September 30, 2003 and December 31, 2002 2003 2002
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ASSETS
Current Assets:
Cash, including cash equivalents of
$105,040 in 2003 and $109,825 in 2002 $ 106,616 $ 112,364
Restricted cash 232,066 -
Trade receivables, net of allowance of $500 in both years 74,255 81,154
Note receivable, net of allowance of $800 in both years 1,449 1,449
Other receivables 3,166 987
Inventory of crude oil, products and other 125,048 105,160
Deferred tax current assets 5,110 5,346
Other current assets 1,206 2,510
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Total current assets 548,916 308,970
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Property, Plant and Equipment, at cost:
Refineries and pipeline 474,473 447,948
Furniture, fixtures and other equipment 5,248 5,119
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479,721 453,067
Less - Accumulated depreciation 165,314 144,127
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314,407 308,940
Asset Held for Sale - 472
Deferred Financing Costs, Net 4,650 5,460
Other Assets 5,877 5,035
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TOTAL ASSETS $ 873,850 $ 628,877
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LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Accounts payable $ 172,204 $ 174,917
Current portion of long-term debt (Note 7) 220,000 -
Revolving credit facility 16,750 -
Accrued turnaround cost 8,480 12,849
Accrued liabilities and other 12,588 9,095
Accrued interest 15,995 3,856
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Total current liabilities 446,017 200,717
Long-Term Debt 208,112 207,966
Long-Term Accrued Turnaround Cost 16,514 14,013
Post-Retirement Employee Liabilities 19,325 18,784
Deferred Credits and Other 4,167 3,963
Deferred Income Taxes 14,984 15,176
Commitments and Contingencies
Shareholders' Equity:
Preferred stock, $100 par value, 500,000 shares authorized,
no shares issued - -
Common stock, no par, 50,000,000 shares authorized,
30,338,549 and 30,290,324 shares issued in 2003 and 2002 57,474 57,469
Paid-in capital 103,234 102,557
Retained earnings 44,831 49,621
Accumulated other comprehensive income (loss) (598) (598)
Treasury stock, 4,176,035 shares and 4,151,210 shares
in 2003 and 2002 (38,387) (37,959)
Deferred employee compensation (1,823) (2,832)
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Total Shareholders' Equity 164,731 168,258
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TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 873,850 $ 628,877
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FRONTIER OIL CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited, in thousands)
For the nine months ended September 30, 2003 2002
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OPERATING ACTIVITIES
Net loss $ (870) $ (1,937)
Depreciation 21,187 20,353
Deferred income taxes 131 (486)
Finance costs and discount on 8% senior notes (Note 7) 8,114 -
Amortization of deferred finance costs and discount 1,833 1,611
Deferred employee compensation amortization 1,009 652
Net loss on sales of assets 189 363
Deferred credits and other (604) (497)
Change in working capital from operations (1,672) (12,986)
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Net cash provided by operating activities 29,317 7,073
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INVESTING ACTIVITIES
Additions to property, plant and equipment and other (27,026) (22,488)
Proceeds from sale of assets 304 -
Other investments (34) (400)
El Dorado refinery acquisition - contingent earn-out payment - (7,500)
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Net cash used in investing activities (26,756) (30,388)
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FINANCING ACTIVITIES
Revolving credit facility borrowings 16,750 30,100
Repayments of 9-1/8% Senior Notes - (1,090)
Proceeds from issuance of 8% Senior Notes (Note 7) 218,143 -
Fund restricted cash (escrow account) (Note 7) (232,066) -
Finance costs on 8% Senior Notes (Note 7) (6,257) -
Deferred finance costs (877) -
Issuance of common stock 316 1,650
Purchase of treasury stock (428) (787)
Dividends (3,890) (3,870)
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Net cash (used in) provided by financing activities (8,309) 26,003
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(Decrease) Increase in cash and cash equivalents (5,748) 2,688
Cash and cash equivalents, beginning of period 112,364 103,995
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Cash and cash equivalents, end of period $ 106,616 $ 106,683
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The accompanying notes are an integral part of these condensed consolidated financial statements.
FRONTIER OIL
CORPORATION AND SUBSIDIARIES
CONDENSED NOTES TO INTERIM CONSOLIDATED
FINANCIAL STATEMENTS
September 30, 2003
(Unaudited)
The consolidated financial statements include the accounts of Frontier Oil Corporation, a Wyoming corporation, and its wholly owned subsidiaries, collectively referred to as Frontier or the Company. The Company is an energy company engaged in crude oil refining and wholesale marketing of refined petroleum products (the “refining operations”). The Company operates refineries (“the Refineries”) in Cheyenne, Wyoming and El Dorado, Kansas with a combined crude oil capacity of over 156,000 barrels per day. All of the operations of the Company are in the United States with its marketing efforts focused in the Rocky Mountain and Plains States regions of the United States. The Company purchases the crude oil to be refined and markets the refined petroleum products produced, including various grades of gasoline, diesel fuel, jet fuel, asphalt, chemicals and petroleum coke. The operations of refining and marketing of petroleum products are considered part of one reporting segment.
These financial statements have been prepared by the Company without audit, pursuant to the rules and regulations of the Securities and Exchange Commission and include all adjustments (comprised of only normal recurring adjustments) which are, in the opinion of management, necessary for a fair presentation. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures are adequate to make the information presented not misleading. It is suggested that the financial statements included herein be read in conjunction with the financial statements and the notes thereto included in the Company’s annual report on Form 10-K/A for the year ended December 31, 2002.
Basic earnings per share (“EPS”) has been computed based on the weighted average number of common shares outstanding. Basic and diluted shares were the same for the nine months ended September 30, 2003 and 2002 because losses were incurred. Diluted earnings per share for the three months ended September 30, 2003 and 2002 assumes the additional dilution for the exercise of in-the-money stock options. No adjustments to income are used in the calculation of earnings per share. The basic and diluted average shares outstanding are as follows:
Nine Months Ended Three Months Ended
September 30, September 30,
2003 2002 2003 2002
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Basic 25,910,470 25,759,114 25,937,842 25,834,717
Diluted 25,910,470 25,759,114 26,956,658 26,806,285
The number of shares of the Company’s restricted stock that could potentially dilute basic EPS in the future but were not included in the computation of diluted EPS for the three months ended September 30, 2003 and 2002 were 160,608 and 255,306 shares, respectively, because to do so would have been antidilutive for the periods presented.
In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations”. This statement provides accounting and disclosure requirements for retirement obligations associated with long-lived assets and became effective January 1, 2003. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred with the associated asset retirement costs being capitalized as a part of the carrying amount of the long-lived asset. SFAS No. 143 also includes disclosure requirements that provide a description of asset retirement obligations and reconciliation of changes in the components of those obligations. The Company has potential asset retirement obligation (“ARO”) liabilities related to its Refineries as a result of environmental and other legal requirements. Any ARO liability is not currently estimatable as to amount and timing, but the Company will continue to monitor and evaluate its potential AROs. In the event that the Company decides to cease the use of a particular refinery, an ARO liability would be recorded at that time. The adoption of SFAS No. 143 on January 1, 2003 did not have any impact on the Company’s current financial condition or results of operations.
In 2001, the American Institute of Certified Public Accountants (“AICPA”) issued an Exposure Draft for a Proposed Statement of Position, “Accounting for Certain Costs and Activities Related to Property, Plant and Equipment”. The proposed Statement of Position (“SOP”), as originally written, would require major maintenance activities, such as refinery turnarounds, to be expensed as costs are incurred. At its September 2003 meeting, the Accounting Standards Executive Committee of the AICPA approved the SOP for issuance; however, it still must be cleared by the FASB before it becomes a generally accepted accounting principle (“GAAP”). As drafted, the SOP would become effective for fiscal years beginning after December 15, 2004, although any issues raised by the FASB during the clearance process could delay the release date and/or the effective date. Adoption of the proposed SOP would require that any existing turnaround accruals be reversed to income immediately and the costs of future turnarounds expensed as incurred. If this proposed change were in effect at September 30, 2003, the Company would have been required to reverse the turnaround accruals and recognize pretax income totaling $25.0 million. The total accrued turnaround costs will change throughout the year as turnarounds are incurred and accruals are made for future turnarounds. If adopted in its present form, income related to this proposed change would be reported as a cumulative effect of an accounting change, net of tax, in the consolidated statements of operations.
In April 2002, the FASB issued SFAS No. 145, “Rescission of FASB Statements No. 4, 44 and 64, Amendment of FASB Statement No. 13, and Technical Corrections.” The rescission of SFAS No. 4 is the only portion of SFAS No. 145 that may have an impact on the Company in the future. Under SFAS No. 4, all gains and losses from extinguishment of debt were required to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. SFAS No. 145 eliminates SFAS No. 4. As a result, gains and losses from extinguishment of debt should be classified as extraordinary items only if they meet the criteria in Accounting Principles Board Opinion No. 30. The Company adopted SFAS No. 145 effective January 1, 2003, and it did not have any impact on the Company’s financial condition or results of operations.
In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”. This statement amends FASB Statement No. 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation. The Company is currently evaluating the various provisions of SFAS No. 148, and if it decides to change to the fair value based method of accounting as allowed under SFAS No. 148, the adoption is not expected to have a material impact on the Company’s financial condition or results of operations.
In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities”. This statement amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other activities. SFAS No. 149 is to be applied prospectively for contracts entered into or modified after June 30, 2003 and is not expected to have any impact on the Company’s financial condition or results of operations.
In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”. This statement established standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument within its scope as a liability (or asset in some circumstances). This statement was effective for financial instruments entered into or modified after May 31, 2003 and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The Company adopted SFAS No. 150 on July 1, 2003, and it did not have any impact on the Company’s financial condition or results of operations.
2. Schedule of major components of inventory
September 30, December 31,
2003 2002
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(in thousands)
Crude oil $ 34,801 $ 33,765
Unfinished products 40,465 24,806
Finished products 31,292 29,836
Process chemicals 5,131 3,308
Repairs and maintenance supplies and other 13,359 13,445
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$ 125,048 $ 105,160
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Inventories of crude oil, unfinished products and all finished products are recorded at the lower of cost on a first in, first out (“FIFO”) basis or market. Crude oil includes both domestic and foreign crude oil volumes at its cost and associated freight and other cost. Unfinished products (work in process) include any crude oil which has entered into the refining process, and other feedstocks that are not finished as far as refining operations are concerned. These include unfinished gasoline and diesel, blendstocks and other feedstocks. Finished product inventory includes saleable gasoline, diesel, jet fuel, chemicals, asphalt and other finished products. Unfinished and finished products inventory values have both components of raw material, the associated raw material freight and other costs, and direct refinery operating expense allocated when refining begins relative to their proportionate market values. Refined product exchange transactions are considered asset exchanges with deliveries offset against receipts. The net exchange balance is included in inventory. Inventories of materials and supplies and process chemicals are recorded at the lower of average cost or market.
Stock-based compensation is measured in accordance with Accounting Principles Board (“APB”) Opinion No. 25. Under this intrinsic value method, compensation cost is the excess, if any, of the quoted market value of the Company’s common stock at the grant date over the amount the employee must pay to acquire the stock.
On March 13, 2001 the Company established the Frontier Oil Corporation Restricted Stock Plan (the “Plan”) which reserved 1,000,000 shares of common stock held as treasury stock by the Company for restricted stock grants to be made under an incentive compensation program. Restricted shares, when granted, are recorded at the market value on the date of issuance as deferred employee compensation (equity account) and amortized to compensation expense over the respective vesting periods of the stock. Compensation costs of $1.0 million and $652,000 related to restricted stock awards were recognized for the nine months ended September 30, 2003 and 2002, respectively. Compensation costs of $377,000 and $252,000 related to restricted stock awards were recognized for the three months ended September 30, 2003 and 2002, respectively. As of September 30, 2003, there were 205,629 shares of unvested restricted stock, which represents the total of grants made in 2001 and 2002 less the vested portion of the grants and shares forfeited from employee departures prior to vesting. The remaining 123,054 shares from the 2001 grants vest in March 2004. Of the remaining 82,575 shares from the 2002 grants, approximately 27,527 shares will vest in March 2004 with the remaining vesting in March 2005. No grants were made in the nine months ended September 30, 2003.
The Company has a stock option plan which authorizes the granting of options to employees to purchase shares of the Company’s common stock. The plan through September 30, 2003, had reserved for issuance a total of 8,001,575 shares of common stock of which 4,483,400 shares were granted and exercised, 3,376,525 shares were granted and outstanding and 141,650 shares were available to be granted. Options under the plans are granted at fair market value on the date of grant. No entries are made in the accounts until the options are exercised, at which time the proceeds are credited to common stock and paid-in capital. Generally, the options vest ratably throughout their one- to five-year terms.
Had compensation costs been determined based on the fair value at the grant dates for awards, consistent with SFAS No. 123, “Accounting for Stock-Based Compensation, the Company’s net income (loss) and EPS would have been the pro forma amounts indicated in the following table for the nine months and three months ended September 30, 2003 and 2002:
Nine Months Ended Three Months Ended
September 30 September 30,
2003 2002 2003 2002
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(in thousands, except per share amounts)
Net income (loss) as reported $ (870) $ (1,937) $ 3,822 $ 809
Deduct: Pro forma compensation
expense, net of tax 3,609 4,002 - -
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Pro forma net income (loss) $ (4,479) $ (5,939) $ 3,822 $ 809
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Basic Income (Loss) per Share:
As reported $ (.03) $ (.08) $ .15 $ .03
Pro forma (.17) (.23) .15 .03
Diluted Income (Loss) per Share:
As reported $ (.03) $ (.08) $ .14 $ .03
Pro forma (.17) (.23) .14 .03
The Company, at times, enters into commodity derivative contracts to manage its price exposure to its inventory positions, purchases of foreign crude oil and consumption of natural gas in the refining process or to fix margins on certain future production. The commodity derivative contracts used by the Company may take the form of futures contracts, collars or price swaps and are entered into with counterparties believed to be credit-worthy. The Company uses futures transactions to price foreign crude oil cargos at the price at the time the crude oil is processed by the El Dorado refinery instead of the price when purchased. Foreign crude oil delivery times can exceed one month from when the purchase is made. The Company accounts for its commodity derivative contracts under 1) the hedge (or deferral) method of accounting when the derivative contracts are designated as hedges for accounting purposes, or 2) mark-to-market accounting if the Company elects not to designate derivative contracts as accounting hedges or if such derivative contracts do not qualify for hedge accounting. As such, gains or losses on commodity derivative contracts accounted for as hedges are recognized in refining operating expenses when the associated transactions are consummated while gains and losses on transactions accounted for using mark-to-market accounting are reflected in other revenues at each period end.
Other revenues for the nine months ended September 30, 2003 include $1.2 million realized and unrealized net gains on derivative contracts accounted for using mark-to-market accounting and $20,000 net realized gains for the ineffective portion of crude oil hedges. Other revenues for the nine months ended September 30, 2002 included $1.2 million realized net gains on the ineffective portion of fair value hedges on crude oil cargos and $2.6 million realized and unrealized net losses on derivative contracts accounted for using mark-to-market accounting. Other revenues for the three months ended September 30, 2003 includes $186,000 realized and unrealized net gains on derivative contracts accounted for using mark-to-market accounting while other revenues for the three months ended September 30, 2002 included $2.1 million realized and unrealized net losses on derivative contracts accounted for using mark-to-market accounting. The ineffective portion of foreign crude oil hedges arises primarily from changes in the shape of the forward futures price curve.
At September 30, 2003 the Company had the following open commodity derivative contracts which, while economic hedges, did not qualify for hedge accounting treatment and whose gains or losses are being reflected in other revenues:
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Derivative contracts on 398,000 barrels of crude oil to hedge normal butane
inventory expected to be utilized at the El Dorado refinery between October 2003
and December 2003. These open contracts have total net unrealized gains at
September 30, 2003 of approximately $58,000. During the nine months ended
September 30, 2003 the Company realized net losses of approximately $524,000 on
closed out contracts to hedge butane inventory.
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| • | Derivative contracts on 15,000 barrels of crude oil to hedge gas oil inventory at the Cheyenne refinery. These open contracts have unrealized gains at September 30, 2003 of approximately $17,000. During the nine months ended September 30, 2003 the Company realized net losses of approximately $26,000 on closed out contracts to hedge gas oil inventory at Cheyenne. |
The Company had no open derivative contracts at September 30, 2003 being accounted for as hedges. During the nine months ended September 30, 2003, the Company had the following derivatives that were appropriately designated and accounted for as hedges:
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Natural Gas Collars. Price swaps on natural gas for the purpose of
hedging against natural gas price increases for February and March 2003 for
approximately 100% of the El Dorado refinery’s anticipated usage and which
are accounted for as cash flow hedges. The February group of contracts to hedge
natural gas costs were for 700,000 MMBTU and expired with no gain or loss. The
March group of contracts to hedge natural gas totaled 720,000 MMBTU and the
Company realized a $1.7 million gain which reduced refining operating expenses
in March.
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| • | Crude Contracts. In January 2003, the Company had derivative contracts on 200,000 barrels of crude oil to hedge Canadian crude costs for the Cheyenne refinery which were accounted as fair value hedges. A $13,000 loss was realized on these positions, of which $31,000 increased crude costs and $18,000 income was reflected in other revenues for the ineffective portion of this hedge. In May 2003, the Company closed out derivative contracts it had purchased in April 2003 on 675,000 barrels of crude oil to hedge two foreign crude cargos purchased for the El Dorado refinery. A $13,000 gain was realized on these positions, of which $11,000 reduced crude costs and $2,000 was reflected in other revenues for the ineffective portion of these hedges. |
The Company’s refining and marketing operations are subject to a variety of federal, state and local health and environmental laws and regulations governing product specifications, the discharge of materials into the environment, and the generation, treatment, storage, transportation and disposal of solid and hazardous waste and materials. Numerous permits with varying terms of duration are required for the operation of the Refineries, and these permits are subject to revocation, expiration, modification and renewal. Timely application for new permits and/or renewal of existing permits is undertaken as necessary to maintain compliance with applicable permitting requirements. Governmental authorities have the power to enforce compliance with these regulations and permits, and violators are subject to injunctions, civil fines and even criminal penalties. The Company believes that each of our Refineries has obtained all necessary permits and is in substantial compliance with such permits, and other applicable existing environmental laws and regulations.
The Company’s operations and many of the products manufactured are specifically subject to certain requirements of the Clean Air Act (“CAA”) and related state and local regulations. The 1990 amendments to the CAA contain provisions that will require capital expenditures for the installation of certain air pollution control devices at our refineries during the next several years. The EPA recently embarked on a Petroleum Refining Initiative (“Initiative”) alleging industry-wide noncompliance with certain CAA rules. The Initiative has resulted in many refiners entering into consent decrees typically requiring substantial expenditures for penalties and additional pollution control equipment. Frontier has been contacted by the EPA and invited to meet with them to hear more about the Initiative. At this time, the Company does not know how or if the Initiative will affect Frontier. The Company has, however, recently determined through the Company’s practice of routine self audits, that over the next three years, expenditures totaling approximately $10 million will likely be necessary to further reduce emissions from the Refineries’ flare systems. This determination resulted from internal compliance audits initiated by the Company and subsequently shared with the corresponding state regulatory agencies under the provisions of state audit privilege statutes. The Wyoming Department of Environmental Quality (“WDEQ”) has expressed its intent to enter into a Consent Decree with the Company to settle this and certain other compliance matters. The WDEQ has informally suggested that they will be seeking injunctive relief and a penalty in the $600,000 range, an amount that is subject to potential negotiation and off-set by Supplemental Environmental Projects. The Kansas Department of Health and Environment has not yet responded to the submittal of the compliance audit. Because other refineries will be required to make similar expenditures, Frontier does not expect such expenditures to materially adversely impact the Company’s competitive position.
On December 21, 1999, the EPA promulgated national regulations limiting the amount of sulfur that is to be allowed in gasoline. The total capital expenditures estimated, as of September 30, 2003, to achieve the final gasoline sulfur standard, are approximately $35.8 million at the Cheyenne Refinery and approximately $44 million at the El Dorado Refinery. Approximately $20.7 million of the Cheyenne Refinery expenditures had been incurred as of September 30, 2003; an additional $8.1 million is expected to be incurred by early 2004 with the remaining $7 million in 2009 and 2010. The expenditures for the El Dorado Refinery are expected to be incurred beginning in 2008 and completed in 2010.
The EPA recently promulgated regulations that will limit the sulfur content of highway diesel fuel beginning in 2006 to 15 parts-per-million from the current standard of 500 parts-per-million. As of September 30, 2003, capital costs for diesel desulfurization are estimated to be approximately $12.5 million for Cheyenne and $56 million for El Dorado. The Cheyenne Refinery expenditures are currently expected to be committed beginning with approximately $2.0 million in 2004, $7.0 million anticipated to be committed in 2005 and the final $3.5 million in 2006. Approximately $6 million of the El Dorado Refinery expenditures are currently expected to be committed in 2004 with the remaining $50 million in 2005 and 2006.
The Front Range of Colorado (including the Denver metro area) is a major market for the products manufactured by the Company’s refineries in Cheyenne, Wyoming and El Dorado, Kansas. Until the summer of 2003, this area had been in compliance with all of the Environmental Protection Agency’s National Ambient Air Quality Standards (“NAAQS”), and in recognition of that compliance had been granted annual waivers from federal gasoline vapor pressure standards that pre-date that compliance. The combination of a new, lower NAAQS for ozone and unusual summertime meteorological conditions in the area resulted in numerous and unforeseen exceedences of the new standard. The State of Colorado has recently undertaken an effort to develop and implement controls necessary to ensure the area will regain compliance with the NAAQS for ozone during the three year averaging period of 2005 through 2007. These controls will likely include a requirement to reduce the current allowable summertime gasoline vapor pressure from 9.0 pounds to either 8.1 pounds or the current federal standard of 7.8 pounds. These controls will most likely be initiated for the summertime gasoline to be sold in the area beginning in May of 2005. The Company is currently evaluating what modifications may be required to the Cheyenne Refinery to allow manufacture of the lower vapor pressure product. At this time, the Company does not believe that any capital investment will be required at El Dorado to meet the anticipated new standard.
On April 15, 2003, the EPA proposed regulations to reduce emissions from diesel engines used in off-road activities such as agriculture, mining and railroads and also to limit the allowable amount of sulfur in the diesel fuel used in those engines. If promulgated, the EPA’s proposal would require a reduction in off-road diesel fuel sulfur by June 1, 2007 from the currently allowable 5,000 parts per million to 500 parts per million and by June 1, 2010 further limit the concentration of diesel fuel used in off-road applications other than railroads and marine engines to 15 parts per million of sulfur. The EPA is also proposing to allow small business refiners, such as Frontier, to continue to produce off-road diesel at the current sulfur limit of 5,000 parts per million through May 31, 2010 and to meet a limit of 500 parts per million sulfur from June 1, 2010 until May 31, 2014. Frontier has historically provided a minor amount of diesel fuel to the off-road markets from both of the Company’s refineries. The Company is monitoring these regulatory developments and is evaluating its compliance options. The costs that the Company will eventually incur to comply with these regulations, when final, are currently unknown.
As is the case with all companies engaged in similar industries, the Company faces potential exposure from claims and lawsuits involving environmental matters. The matters include soil and water contamination, air pollution, personal injury and property damage allegedly caused by substances which the Company manufactured, handled, used, released or disposed of.
Beverly Hills Lawsuits. A Frontier subsidiary, Wainoco Oil & Gas Company, owned and operated an interest in an oil field in the Los Angeles, California metropolitan area from 1985 to 1995. The production facilities for that interest in the oil field are located at the campus of the Beverly Hills High School. In April 2003, a law firm began filing claims with the Beverly Hills Unified School District and the City of Beverly Hills on behalf of former students, school employees, area residents and others alleging that emissions from the oil field or the production facilities caused cancers or various other health problems in those individuals. Wainoco Oil & Gas Company and Frontier are defendants in three pending lawsuits relating to some of those claims; other defendants include the Beverly Hills Unified School District, the City of Beverly Hills, ten other oil and gas companies, two additional companies involved in owning or operating a power plant adjacent to the Beverly Hills High School and three of their related parent companies. The lawsuits include claims for personal injury, wrongful death, loss of consortium and/or fear of contracting diseases, and also ask for punitive damages. No dollar amounts of damages have been specified in any of the lawsuits. The three pending lawsuits have been formally related to one another and have been transferred to a judge on the complex civil litigation panel in the Superior Court of the State of California for the County of Los Angeles.
The oil production site operated by Frontier’s subsidiary was a modern facility and was operated with a high level of safety and responsibility. Frontier believes that its subsidiary’s activities did not cause any health problems for anyone, including former Beverly Hills high school students, school employees or area residents. Nevertheless, as a matter of prudent risk management, Frontier has recently purchased insurance from an insurance company with an A.M. Best rating of A++ (Superior) covering the existing claims described above and any similar claims for bodily injury or property damage asserted during the five-year period following the policy’s September 30, 2003 commencement date. The claims are covered, whether asserted directly against the insured parties or as a result of contractual indemnity. The policy covers defense costs, and any payments made to claimants, up to an aggregate limit of $120 million, including coinsurance by Frontier of up to $3.9 million in the coverage between $40 million and $120 million. In October 2003, the Company paid $6.25 million to the insurance company (which includes indemnity premium of $5.75 million and a $500,000 administration fee) and have funded with the insurance company a Commutation Account of approximately $19.5 million, from which the insurance company will fund the first costs under the policy including, but not limited to, the costs of defense of the claims. Frontier has the right to terminate the policy at any time after the first year and prior to September 30, 2008, receive back up to $4.3 million of return premium, the dollar amount which declines over time, plus, any unspent balance in the Commutation Account plus accumulated interest. While the policy is in effect, the insurance company will manage the defense of the claims. The Company is also seeking coverage with respect to the Beverly Hills, California claims from the insurance companies that provided policies to Frontier during the 1985 to 1995 period.
The Company believes that neither the claims that have been made, the three pending lawsuits, nor other potential future litigation by which similar or related claims may be asserted against Frontier or its subsidiary will result in any material liability or have any material adverse effect upon Frontier.
Cheyenne Refinery. The Company is party to an agreement with the State of Wyoming requiring the investigation and possible eventual remediation of certain areas of the Cheyenne Refinery’s property which may have been impacted by past operational activities. This action primarily addressed the threat of groundwater and surface water contamination. Based upon the results of the investigation, substantial capital expenditures and remediation of conditions found to exist have already taken place or are in progress, including the completion of surface impoundment closures, waste stabilization activities and other site remediation projects totaling approximately $4 million and an ongoing groundwater remediation program averaging $150,000 in annual operation and maintenance costs. Additional remedial action could be required by a subsequent administrative order or permit.
El Dorado Refinery. The El Dorado Refinery is subject to a 1988 consent order with the Kansas Department of Health and Environment (“KDHE”). This order, including various subsequent modifications, requires the Refinery to continue the implementation of a groundwater management program with oversight provided by the KDHE Bureau of Environmental Remediation. The order requires that remediation activities continue until KDHE-established groundwater criteria or other criteria agreed to by the KDHE and the Refinery are met. Frontier acquired the El Dorado refinery in November 1999 from Equilon Enterprises LLC, now known as Shell Oil Products US (“Shell”). Subject to the terms of the purchase and sale agreement, Shell will be responsible for the costs of continued compliance with this order.
The most recent National Pollutant Discharge Elimination System permit issued to the El Dorado Refinery requires, in part, the preparation and submittal of an engineering report identifying certain refinery wastewater treatment plant upgrades necessary to allow routine compliance with applicable discharge permit limits. In accordance with the provisions of the purchase and sale agreement, Shell will be responsible for the first $2 million of any required wastewater treatment system upgrades. If required system upgrade costs exceed this amount, Shell and Frontier will share, based on a sliding scale percentage, up to another $3 million in upgrade costs. Subject to the terms of the purchase and sale agreement, Shell will be responsible for up to $5 million in costs, in addition to Shell’s obligation for the wastewater treatment system upgrade, relating to safety, health and environmental conditions after closing arising from Shell’s operation of the El Dorado Refinery that are not covered under a ten-year insurance policy. This insurance policy has $25 million coverage through November 17, 2009 for environmental liabilities, with a $500,000 deductible, and will reimburse the Company for losses related to all unknown and some known conditions existing prior to our acquisition of the El Dorado Refinery. The first phase of wastewater treatment system upgrades was completed in 2001 at a cost of $2.6 million with payment apportioned as described above.
On August 18, 2000, the Company entered into a Consent Agreement and Final Order of the Secretary (“Agreement”) with the KDHE that required the initiation of a wastewater toxicity testing program to commence upon the completion of the wastewater treatment upgrades described above. Progress has been made toward satisfying the provisions of the Agreement, and Frontier expects to meet all applicable requirements. The costs associated with compliance with this Order are the subject of an indemnity claim against Shell under the wastewater treatment plant upgrade coverage in the purchase and sale agreement as described in the preceding paragraph.
On March 31, 2003 the Company announced that it had entered into an agreement with Holly Corporation (“Holly”) pursuant to which the two companies would merge. On August 20, 2003, Frontier announced that Holly had advised the Company that Holly was not willing to proceed with our previously announced March 30, 2003 merger agreement on the agreed terms. As a result, the Company filed suit for damages in the Delaware Court of Chancery. On September 2, 2003, Holly filed an answer and counterclaims, denying our claims, asserting that Frontier repudiated the merger agreement by filing the Delaware lawsuit, and claiming among other things that the Beverly Hills, California litigation caused the Company to be in breach of its representations and warranties in the merger agreement. Frontier has denied all of Holly’s counterclaims. The Delaware Court of Chancery has scheduled the suit and Holly’s counterclaims for trial in early December 2003.
The operating results for the nine months ended September 30, 2003 were negatively impacted by costs related to the Holly merger transaction in the aggregate amount of $13.3 million after tax expenses ($21.6 million pretax, comprised of $4.0 million under the heading “Merger termination and legal costs” in the statements of operations and $17.6 million under the heading “Merger financing termination costs” in the statements of operations.) The operating results for the three months ended September 30, 2003 were negatively impacted by costs related to the Holly merger transaction in the aggregate amount of $11.2 million after tax expenses ($18.2 million pretax, comprised of $4.0 million under the heading “Merger termination and legal costs” in the statements of operations and $14.2 million under the heading “Merger financing termination costs”). The $4.0 million of “Merger termination and legal costs” for the nine months and three months ended September 30, 2003 included $2.8 million in transaction related costs and $1.2 million in legal expenses incurred on the Holly lawsuit. The $17.6 million of “Merger financing termination costs, net” for the nine months ended September 30, 2003, includes interest expense since issuance, issue discount, finance issue costs and redemption premium on the 8% Senior Notes, net of $718,000 interest income earned on the senior notes escrow account. The $14.2 million of “Merger financing termination costs, net” for the three months ended September 30, 2003, includes interest expense for the three months, issue discount, finance issue costs and redemption premium on the 8% Senior Notes, net of $351,000 interest income earned on the senior notes escrow account for the three months ended September 30 (see Note 7 below).
On April 17, 2003, the Company received the net proceeds (net of issue discount and underwriting fees) from a private placement of $220 million of 8% senior notes (“Senior Notes”) due April 15, 2013. The net proceeds of the Senior Notes were to be used, together with other available funds, to finance the cash portion of the merger with Holly, to pay related fees and expenses and to refinance or pay off existing Holly indebtedness. Pending consummation of the merger with Holly, the net proceeds of the notes offering, along with other amounts contributed by the Company, were placed in an escrow account. As provided for in the escrow agreement, since the merger with Holly will not occur by October 31, 2003, on October 10, 2003 Frontier closed the escrow account and redeemed the notes at a price equal to 101% of the aggregate principal amount of the notes plus accrued interest. The redemption premium, financing costs and issue discount of the notes were all reflected as expenses as of September 30, 2003 and included under the heading “Merger financing termination costs, net” on the statements of operations. At September 30, 2003 the Senior Notes are reflected as a current liability on the consolidated balance sheet.
Effective June 1, 2003, one of the Company’s subsidiaries, Frontier Oil and Refining Company, entered into a new three year transportation agreement with a pipeline operator to transport up to 50,000 barrels per day of either West Texas Sour crude oil and/or West Texas Intermediate crude oil from Midland, Texas to Cushing, Oklahoma. If Frontier transports less than an average of 50,000 barrels per day over a contract year, Frontier is obligated to pay the pipeline operator a deficiency fee per barrel between the actual average barrels transported and 50,000 barrels. This agreement replaces previous similar agreements with pipeline operators.
In May 2003, the Company entered into an amended and restated revolving credit facility with a group of banks led by Union Bank of California and BNP Paribas. The revolving credit facility has a current expiration date of June 15, 2006. Commitments under the new working capital facility are $175 million with cash advances limited to a maximum of $125 million. The facility includes reduced interest rate spreads and letter of credit fees. In addition, the credit facility has a new financial covenant package that is based on consolidated parent financials (as opposed to subsidiary level financials), which facilitates intra-company funds flows. The Company is in compliance at September 30, 2003 with the financial covenants of the revolving credit facility.
Holly Lawsuit. On August 20, 2003, Frontier announced that Holly Corporation had advised the Company that Holly was not willing to proceed with our previously announced March 30, 2003 merger agreement on the agreed terms. As a result, the Company filed suit for damages in the Delaware Court of Chancery. On September 2, 2003, Holly Corporation filed an answer and counterclaims, denying our claims, asserting that Frontier repudiated the merger agreement by filing the Delaware lawsuit, and claiming among other things that the Beverly Hills, California litigation caused the Company to be in breach of its representations and warranties in the merger agreement. Frontier has denied all of Holly’s counterclaims. The Delaware Court of Chancery has scheduled the suit and Holly’s counterclaims for trial in early December 2003.
| ITEM 2. |
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
The terms “Frontier” and “we” refer to Frontier Oil Corporation and its subsidiaries.
Nine months ended September 30, 2003 compared with the same period in 2002
We had a net loss for the nine months ended September 30, 2003 of $870,000, or ($.03) per share, compared to a net loss of $1.9 million, or ($.08) per share, for the same period in 2002. Although operating income improved substantially in 2003 as compared to 2002, the resulting net loss included approximately $13.3 million after tax expenses relating to the Holly merger transaction, legal and financing costs. The most significant factors contributing to the improved operating income for the nine months ended September 30, 2003 were higher light product margins offset by higher crude oil prices and negative FIFO inventory valuation impacts.
Operating income increased $20.2 million in the first nine months of 2003 versus 2002 due to an increase in refined products revenues of $342.6 million and an increase in other revenues of $2.7 million offset by increases in raw material, freight and other costs of $300.1 million, refinery operating expenses, excluding depreciation, of $18.1 million (which included $10.1 million more in natural gas costs), selling and general costs, excluding depreciation, of $2.1 million, merger termination and legal costs of $4.0 million and depreciation of $834,000. The major economic and operating factors which affected operating income were higher light product margins in 2003 compared to 2002 and increases in both the light/heavy (the discount at which heavy crude oil sells compared to the sales price of light crude oil) and WTI/WTS (the difference between West Texas Intermediate and West Texas Sour crude oil prices) crude spreads, offset by negative impacts of the 18 day planned major turnaround in March 2003 at our El Dorado refinery and a negative inventory valuation impact during the nine months ended September 30, 2003 compared to a large positive inventory valuation impact for the same period in 2002.
Refined product revenues increased by $342.6 million or 27% from $1.3 billion to $1.6 billion due to increased sales prices. Refined product revenues are impacted by changes in the price of crude oil as product sales prices generally change accordingly. The average price of crude oil has been substantially higher during the first nine months of 2003 than during the same period in 2002. Average gasoline prices increased from $32.38 per sales barrel for the first nine months of 2002 to $40.46 per sales barrel during the first nine months of 2003. Gasoline sales volumes decreased 457 barrels per day during the nine months ended September 30, 2003 compared to the comparable nine months in 2002. Average diesel and jet fuel prices for the first nine months of 2003 increased from $28.83 per sales barrel for the first nine months of 2002 to $36.72 per sales barrel for the first nine months of 2003. Diesel sales volumes increased 597 barrels per day during the nine months ended September 30, 2003 compared to the comparable nine months in 2002. Manufactured product yields (“yields”) are the volumes of specification materials that are obtained through the distilling of crude oil and operations of other refinery process units. Yields of gasoline increased 633 barrels per day or 1%, from 81,303 barrels per day during the nine months ended September 30, 2002 to 81,936 barrels per day during the 2003 comparable period. Yields of diesel and jet fuel increased 327 barrels per day or 1%, from 52,861 barrels per day during the nine months ended September 30, 2002 to 53,188 barrels per day during the 2003 comparable period. Sales and yield volumes for the first nine months of 2003 for the El Dorado refinery were lower than during the same period in 2002 primarily because of the turnaround at the El Dorado refinery which commenced on March 18, 2003 and was completed on March 30. The Cheyenne refinery reflected increased sales and yields volumes to result in the small total overall increase.
Other revenues increased $2.7 million to $2.1 million in the nine months ended September 30, 2003 compared to a $626,000 loss in the comparable period in 2002 due to $1.2 million income in 2003 from realized and unrealized futures trading net gains, primarily on positions purchased to hedge inventories, compared to $1.4 million in net losses in 2002 from the ineffective portion of foreign crude oil hedges and realized and unrealized futures trading net losses on positions to hedge inventories in 2002.
Raw material, freight and other costs include crude oil and other raw materials utilized in the refining process, purchased products and blendstocks, freight costs for FOB destination sales, as well as the impact of changes in inventory under FIFO inventory accounting. Refined product revenues and raw material costs are impacted by changes in the price of crude oil. The average price of crude oil has been substantially higher in 2003 than in 2002. Raw material, freight and other costs of $1.4 billion ($31.21 per sales barrel) during the nine months ending September 30, 2003 increased 27% (26% on a per sales barrel basis) or $300.1 million ($6.52 per sales barrel) when compared to the same period in 2002 primarily due to higher crude oil prices. For the nine months ended September 30, 2003, we realized an increase in raw material, freight and other costs as a result of inventory losses of approximately $3.6 million pretax ($2.3 million after tax), comprised of a $4.6 million loss for the El Dorado refinery, offset by a $1.0 million gain for the Cheyenne refinery. For the nine months ended September 30, 2002 we realized a decrease in raw material, freight and other costs from inventory gains of approximately $35.5 million pretax ($22.0 million after tax), (comprised of $12.0 million from the Cheyenne refinery and $23.5 million from the El Dorado refinery) because of increasing crude prices during the period. The Cheyenne refinery raw material, freight and other costs of $29.68 per sales barrel increased 21% from $24.44 per sales barrel in 2002 due to higher crude oil prices. Our profitability at our Cheyenne refinery is impacted by the light/heavy crude spread. We benefited from the light/heavy spread averaging $5.92 per barrel in the first nine months of 2003 compared to only $3.74 per barrel in the first nine months of 2002. The heavy crude oil utilization rate for the nine month period at the Cheyenne refinery expressed as a percentage of total crude oil was 88.5% in 2003 compared to 90.5% in 2002. The El Dorado refinery raw material, freight and other costs of $31.96 per sales barrel increased 29% from $24.80 per sales barrel in 2002 due to higher crude oil prices. Our profitability at our El Dorado refinery is impacted by the WTI/WTS crude spread. The WTI/WTS spread increased from an average of $1.24 per barrel in the first nine months of 2002 to $2.67 per barrel in the first nine months of 2003.
Refinery operating expenses, excluding depreciation, include both the variable costs (including energy and utilities) and the fixed costs (salaries, taxes, maintenance costs and other) of operating the refineries. Refinery operating expense, excluding depreciation, increased by $18.1 million (to $3.32 per sales barrel from $2.94 per sales barrel) during the nine months ended September 30, 2003, when compared to the same period in 2002. Higher natural gas costs comprised approximately 60% of the per sales barrel refinery operating expense increase with another 26% of the per sales barrel increase due to increased salaries and benefits. The Cheyenne refinery operating expense, excluding depreciation, for the nine months ended September 30, 2003 increased $2.8 million from the same period in 2002, due to a $2.2 million increase in natural gas costs; however, refinery operating expense on a per sales barrel basis at Cheyenne decreased $0.12 to $2.99 per sales barrel in 2003 due to increased sales volumes. The El Dorado refinery operating expense, excluding depreciation, increased $15.3 million for the nine months ended September 30, 2003 from the same period in 2002 due primarily to a $7.9 million increase in natural gas cost, an increase of $2.9 million in salaries resulting from overtime incurred in connection with the turnaround and overall increased benefit costs, and the $2.4 million turnaround expense in excess of accrual. Refinery operating expense on a per sales barrel basis at El Dorado increased to $3.48 per sales barrel for the nine months ended September 30, 2003, compared to $2.86 per sales barrel in 2002, resulting from a combination of both the higher refinery operating expenses and decreased sales volumes in 2003 due to the turnaround.
Selling and general expenses, excluding depreciation, increased $2.1 million or 16% for the nine months ended September 30, 2003 compared to the same period in 2002 because of $866,000 incurred in the nine months ended September 30, 2003 for legal costs related to the Beverly Hills lawsuits and increased salaries, travel costs and engineering, and other consulting services relating to evaluating potential acquisitions.
“Merger termination and legal costs” of $4.0 million for the nine months ended September 30, 2003 include transaction and legal costs associated with the termination of the anticipated merger and resulting lawsuit with Holly.
Depreciation expense increased $834,000 or 4% in the 2003 nine-month period as compared to the same period in 2002 because of increases in capital investments.
The operating interest expense (excluding costs relating to the 8% Senior Notes issued and redeemed in connection with the merger) of $20.7 million for the nine months ended September 30, 2003 decreased minimally compared to the same period in 2002. Interest income (excluding interest income earned on the 8% Senior Notes escrow account) decreased $480,000 from $1.4 million for the nine months ended September 30, 2002 to $907,000 in the nine months ended September 30, 2003. Average debt outstanding (excluding the 8% Senior Notes) during the nine months ended September 30, decreased from $253 million in 2002 to $241 million in 2003. The 2003 “Merger financing termination costs, net” were $17.6 million and included interest expense, issue discount, financing issue costs and redemption premium, net of $718,000 interest income earned on the escrow account, related to the 8% Senior Notes.
The income tax provision for the nine months ended September 30, 2003 was $430,000 on a pretax net loss of $440,000 due to one-time adjustments for permanent book versus tax differences related to 2002 and 2003 expenses and an increase of $280,000 in the income tax provision for the nine months ended September 30, 2003 resulting from a correction of the 2002 tax provision. Our current estimated effective tax rate is 38.27%. Our effective income tax rate for the benefit of income taxes for the nine months ended September 30, 2002, of 24.4% was less than our then current estimated statutory rate of 38.24% primarily due to one-time adjustments for permanent book versus tax differences and an increase in the state deferred income tax provision due to a revised estimate of state apportionment factors during the third quarter of 2002. An $83,000 Canadian income tax payment for an audit settlement related to our Canadian oil and gas operations (sold in June 1997) also reduced our income tax benefit in 2002.
Three months ended September 30, 2003 compared with the same period in 2002
We had net income for the three months ended September 30, 2003 of $3.8 million, or $0.14 per diluted share, compared to net income of $809,000, or $.03 per diluted share, for the same period in 2002. Although operating income improved substantially in 2003 as compared to 2002, the results for the three months ended September 30, 2003 were reduced by approximately $11.2 million, after tax, from expenses related to the Holly merger transaction, legal and financing costs. The major economic and operating factors contributing to the increase in operating income in 2003 from 2002 were higher light product margins in 2003 as compared to 2002 and increases in both the light/heavy and WTI/WTS crude spreads, offset by higher crude oil prices and a negative FIFO inventory valuation impact in 2003 compared to a positive inventory valuation impact during the same period in 2002.
Operating income increased $18.8 million in 2003 versus 2002 due to an increase in refined product revenues of $105.8 million and an increase in other revenues of $2.3 million offset by increases in raw material, freight and other costs of $78.6 million, refinery operating expenses, excluding depreciation, of $6.3 million (which included $2.6 million in higher natural gas costs), selling and general costs, excluding depreciation, of $315,000, merger termination and legal costs of $4.0 million and depreciation expense of $177,000.
Refined product revenues increased by $105.8 million or 22% from $488.5 million to $594.3 million due to increased sales prices and increased overall sales volumes. Refined product revenues are impacted by changes in the price of crude oil as product sales prices generally change accordingly. The average price of crude oil was substantially higher in 2003 than in 2002. Average gasoline prices increased from $35.84 per sales barrel for the third quarter of 2002 to $41.67 per sales barrel during the same period of 2003. Gasoline sales volumes increased 4,119 barrels per day during the three months ended September 30, 2003 compared to the comparable three months in 2002. Average diesel and jet fuel prices increased from $32.52 per sales barrel for the three months ended September 30, 2002 to $36.10 per sales barrel for the comparable period of 2003. Diesel sales volumes increased 5,697 barrels per day during the three months ended September 30, 2003 compared to the comparable three months in 2002. Yields of gasoline increased 6,235 barrels per day or 8%, from 79,779 barrels per day during the three months ended September 30, 2002 to 86,014 barrels per day during the 2003 comparable period. Yields of diesel and jet fuel increased 4,220 barrels per day or 8%, from 53,101 barrels per day during the three months ended September 30, 2002 to 57,321 barrels per day during the 2003 comparable period.
Other revenues increased $2.3 million to a $471,000 profit in 2003 from a $1.8 million loss in 2002 due to a $186,000 profit from realized and unrealized futures trading net gains from positions to hedge inventory in 2003 compared to $2.1 million future trading net losses in 2002.
Raw material, freight and other costs include crude oil and other raw materials utilized in the refining process, purchased products and blendstocks, freight costs for free-on-board (“FOB”) destination sales, as well as the impact of changes in inventory under FIFO inventory accounting. Raw material costs are impacted by changes in the price of crude oil. The average price of crude oil was higher in the three months ended September 30, 2003 than in the same period in 2002. For the three months ended September 30, 2003, we realized an increase in raw material, freight and other costs as a result of inventory losses of approximately $6.3 million pretax ($3.9 million after tax), comprised of a $4.5 million loss for the El Dorado refinery and a $1.8 million loss for the Cheyenne refinery). For the three months ended September 30, 2002 we realized a decrease in raw material, freight and other costs from inventory gains of approximately $9.4 million pretax ($5.8 million after tax), comprised of $3.1 million from the Cheyenne refinery and $6.3 million from the El Dorado refinery) because of increasing crude prices during the period. Raw material, freight and other costs of $502.7 million during the three months ending September 30, 2003 increased 19% (12% on a per sales barrel basis) or $78.6 million ($3.24 per sales barrel) when compared to the same period in 2002 primarily due to higher crude oil prices. The Cheyenne refinery raw material, freight and other costs of $28.93 per sales barrel increased 7% from $26.95 per sales barrel in 2002 due to higher crude oil prices. Our profitability at our Cheyenne refinery is impacted by the light/heavy crude spread. We benefited from the light/heavy spread averaging $6.00 per barrel in the third quarter of 2003 compared to only $3.95 per barrel in the comparable quarter of 2002. The heavy crude oil utilization rate at the Cheyenne refinery expressed as a percentage of total crude oil was 87% in 2003 compared to 91% in 2002. The El Dorado refinery raw material, freight and other costs of $31.85 per sales barrel increased 14% from $27.99 per sales barrel in 2002 due to higher crude oil prices. Our profitability at our El Dorado refinery is impacted by the WTI/WTS crude spread. The WTI/WTS spread increased from an average of $.97 per barrel in the third quarter of 2002 to $2.44 per barrel in the third quarter of 2003.
Refinery operating expenses, excluding depreciation, include both the variable costs (including energy and utilities) and the fixed costs (salaries, taxes, maintenance costs and other) of operating the refineries. Refinery operating expense, excluding depreciation, increased by $6.3 million (to $2.98 per sales barrel from $2.75 per sales barrel) during the three months ended September 30, 2003, when compared to the same period in 2002. Higher natural gas costs comprised approximately 74% of the per sales barrel refinery operating expense increase. The Cheyenne refinery operating expense, excluding depreciation, for the three months ended September 30, 2003 increased $2.0 million from the same period in 2002, and included a $755,000 increase in natural gas costs and a $863,000 increase in salaries and benefits from 2002 to 2003. The refinery operating expense, on a per sales barrel basis, at Cheyenne increased $0.23 to $2.76 per sales barrel in 2003. The El Dorado refinery operating expense, excluding depreciation, increased $4.2 million for the three months ended September 30, 2003 from the same period in 2002 due primarily to a $1.9 million increase in natural gas cost, a $824,000 million increase in salaries and benefits and a $548,000 increase in consulting and legal. Refinery operating expense at El Dorado increased to $3.09 per sales barrel for the three months ended September 30, 2003, compared to $2.86 per sales barrel in the same period in 2002.
Selling and general expenses, excluding depreciation, increased $315,000 or 7% for the three months ended September 30, 2003 compared to the same period in 2002 because of $611,000 incurred for legal costs related to the Beverly Hills lawsuits and increased salaries offset by a $363,000 impairment loss in 2002 on an airplane to be sold, which sale was completed in the second quarter of 2003.
“Merger termination and legal costs” of $4.0 million for the three months ended September 30, 2003 include transaction and legal costs associated with the termination of the anticipated merger and resulting lawsuit with Holly.
Depreciation expense increased $177,000 or 3% in the 2003 three-month period as compared to the same period in 2002 because of increases in capital investments.
The operating interest expense (excluding costs relating to the 8% Senior Notes issued and redeemed in connection with the merger) decreased by $419,000 for the three months ended September 30, 2003 compared to the same period in 2002 due to $229,000 less amortization of deferred finance costs and $156,000 more interest capitalized. Normal operating interest income decreased $211,000 from $471,000 for the three months ended September 30, 2002 to $260,000 in the three months ended September 30, 2003 due to less cash available to invest and lower interest rates. Average debt outstanding (excluding the 8% Senior Notes) during the three months ended September 30, decreased from $247 million in 2002 to $239 million in 2003. The 2003 “Merger financing termination costs, net,” was $14.2 million and included interest expense for the three months ended September 30, 2003, issue discount, financing issue costs and redemption premium, net of interest income of $351,000 earned on the escrow account, related to the 8% Senior Notes.
The income tax provision for the three months ended September 30, 2003 was $2.9 million on pretax net income of $6.8 million (43.4% effective rate) due to one-time adjustments for permanent book versus tax differences related to 2002 and 2003 expenses and an increase in the income tax provision for the three months ended September 30, 2003 resulting from a correction of the 2002 tax provision. Our current estimated effective tax rate is 38.27%. Our effective income tax rate for the provision of income taxes for the three months ended September 30, 2002, of 58.5% was greater than our then current estimated statutory rate of 38.24% primarily due to one-time adjustments for permanent book versus tax differences and an increase in the state deferred income tax provision due to a revised estimate of state income tax apportionment factors during the third quarter of 2002.
Net cash provided by operating activities for the nine months ended September 30, 2003 was $29.3 million compared to $7.1 million cash provided by operating activities for the nine months ended September 30, 2002. Working capital changes required net $1.7 million and $13.0 million of cash flows for the first nine months of 2003 and 2002, respectively. The major use of working capital during the nine months ended September 30, 2003 was an increase in inventory of $19.9 million due to an increase in inventory volumes and higher inventory values resulting from higher crude prices. The major source of working capital during the nine months ended September 30, 2003 was an increase in accrued liabilities of $14.6 million primarily due to accrued interest on the 8% Senior Notes.
Cash spent on additions to property, plant and equipment in the first nine months of 2003 of $27.0 million increased $4.5 million from the first nine months in 2002. Capital expenditures of approximately $40 million are planned in 2003, which includes nearly $16.1 million for the low sulfur gasoline project at Cheyenne. The additional $23.9 million of capital expenditures includes approximately $12.1 million of sustaining capital (including safety, environmental and operational projects), $4.2 million of growth, strategic and profitability projects, $2.4 million of information technology projects and $2.9 million of small capital and other projects at both the Cheyenne and El Dorado refineries. During the first nine months of 2002, we also paid the $7.5 million El Dorado earn-out payment based on 2001 results of operations. No El Dorado earn-out payment will be made in 2003, as none was earned based on the 2002 results of operations.
On May 29, 2003 we announced that we had entered into an amended and restated revolving credit facility with a group of banks led by Union Bank of California and BNP Paribas. Commitments under the new working capital facility are $175 million with cash advances limited to a maximum of $125 million, subject to borrowing base amounts. Any unutilized capacity after cash borrowings is available for letters of credit. The facility includes reduced interest rate spreads and letter of credit fees. In addition, a new financial covenant package is based on consolidated parent financials (as opposed to subsidiary level financials) and facilitates intra-company funds flows. We were in compliance at September 30, 2003 with the financial covenants of our new revolving credit facility. At September 30, 2003, we had borrowings of $16.8 million and outstanding letters of credit of $35.4 million under our revolving credit facility, and approximately $75.6 million borrowing base availability remaining for additional borrowings under our revolving credit facility. We had $106.6 million of cash and cash equivalents and working capital of $103.0 million at September 30, 2003.
During the first nine months of 2003 we have not purchased any additional common stock under our previously announced stock repurchase programs authorized by our Board of Directors to purchase up to six million shares; however, we did acquire 24,825 shares of stock from employees to cover their withholding taxes on shares of restricted stock which vested in March. Through December 2002, 4,367,366 shares of common stock had been purchased under the stock repurchase programs.
Dividends of $3.9 million were paid to shareholders during the first nine months of 2003. These dividends of $0.05 per share were declared in December 2002, March 2003 and June 2003 and were paid on January 13, 2003, April 14, 2003, and July 14, 2003, respectively. Our Board of Directors also declared dividends in September 2003 of $0.05 per share, which were paid on October 13, 2003 to shareholders of record on September 26, 2003. The cash required for this dividend was approximately $1.3 million and was accrued as of September 30, 2003.
On April 17, 2003, we received the net proceeds from a private placement of $220 million of 8% senior notes (“Senior Notes”) due April 15, 2013. The net proceeds of the Senior Notes were to be used, together with other available funds, to finance the cash portion of the Holly merger, to pay related fees and expenses and to refinance or pay off existing Holly indebtedness. The Senior Notes were issued at 99.156% of principal amount and were issued by Frontier Escrow Corporation, a newly formed, wholly-owned, direct subsidiary of Frontier that was created solely to issue the Senior Notes and to merge with and into Frontier Oil Corporation upon consummation of the Holly merger. Pending consummation of the Holly merger, the net proceeds of the offering, along with other amounts contributed by us, were placed in an escrow account. The amounts in this escrow account are reflected as restricted cash and the Senior Notes are reflected as a current liability on our September 30, 2003 balance sheet. We were required, pursuant to terms of the indenture, to redeem the 8% Senior Notes if the merger with Holly was not consummated by October 31, 2003. Because the merger agreement has been terminated, we redeemed the Senior Notes on October 10, 2003 at a price equal to 101% of the aggregate principal amount of the Senior Notes plus accrued interest. Financing costs, net of interest income earned on the escrow account, related to the Senior Notes were $17.6 million during the nine months ended September 30, 2003 and included interest expense, issue discount, financing issue costs and redemption premium.
REFINING OPERATING STATISTICAL INFORMATION
Consolidated:
Nine Months Ended Three Months Ended
September 30, September 30
--------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- -------
Charges (bpd) (1)
Light crude 30,451 37,037 31,295 48,083
Heavy and intermediate crude 116,128 109,520 127,589 102,972
Other feed and blend stocks 18,806 17,749 18,480 19,336
--------- --------- --------- ---------
Total 165,385 164,306 177,364 170,391
Manufactured product yields (bpd) (2)
Gasoline 81,936 81,303 86,014 79,779
Diesel and jet fuel 53,188 52,861 57,321 53,101
Asphalt 7,534 7,341 9,202 8,730
Chemicals (3) 811 189 835 599
Other 17,661 19,346 18,091 25,924
--------- --------- --------- ---------
Total 161,130 161,040 171,463 168,133
Total product sales (bpd)
Gasoline 88,313 88,770 92,383 88,264
Diesel and jet fuel 53,702 53,105 58,963 53,266
Asphalt 7,807 7,755 10,557 10,756
Chemicals (3) 811 283 835 379
Other 13,835 13,466 14,176 14,085
--------- --------- --------- ---------
Total 164,468 163,379 176,914 166,750
Refinery operating margin information (per sales bbl)
Refined products revenue $ 36.20 $ 28.76 $ 36.51 $ 31.84
Raw material, freight and other costs
(FIFO inventory accounting) 31.21 24.69 30.89 27.65
Refinery operating expenses, excl depreciation 3.32 2.94 2.98 2.75
Refinery depreciation .47 .45 .42 .45
Average West Texas Intermediate
crude oil price at Cushing, OK $ 32.04 $ 25.39 $ 31.03 $ 28.52
Average sales price (per sales bbl)
Gasoline $ 40.46 $ 32.38 $ 41.67 $ 35.84
Diesel and jet fuel 36.72 28.83 36.10 32.52
Asphalt 24.64 21.19 25.53 22.97
Chemicals (3) 53.97 42.25 48.05 48.94
Other 12.47 8.72 12.15 10.51
| (1) | Charges are the quantity of crude oil and other feedstocks processed through refinery units. |
| (2) | Manufactured product yields are the volumes of specification materials that are obtained through the distilling of crude oil and operations of other refinery process units. |
| (3) | During the first quarter of 2002, the process of shutting down the petro-chemical complex at El Dorado began and we discontinued the production of phenol and acetone and began producing and selling benzene. |
REFINING OPERATING STATISTICAL INFORMATION
Cheyenne Refinery:
Nine Months Ended Three Months Ended
September 30, September 30,
--------------------- ---------------------
2003 2002 2003 2002
-------- -------- -------- -------
Charges (bpd) (1)
Light crude 5,226 3,889 6,235 4,082
Heavy crude 40,299 36,845 41,902 40,292
Other feed and blend stocks 5,688 4,601 5,703 5,570
--------- --------- --------- ---------
Total 51,213 45,335 53,840 49,944
Manufactured product yields (bpd) (2)
Gasoline 20,226 17,416 20,588 19,962
Diesel 15,159 12,952 15,797 13,326
Asphalt 7,534 7,341 9,202 8,730
Other 6,658 6,252 6,263 6,780
--------- --------- --------- ---------
Total 49,577 43,961 51,850 48,798
Total product sales (bpd)
Gasoline 26,381 23,731 27,143 26,220
Diesel 15,228 12,979 15,847 13,414
Asphalt 7,807 7,755 10,557 10,756
Other 4,613 4,206 4,901 4,524
--------- --------- --------- ---------
Total 54,029 48,671 58,448 54,914
Refinery operating margin information (per sales bbl)
Refined products revenue $ 35.88 $ 28.97 $ 35.80 $ 31.74
Raw material, freight and other costs
(FIFO inventory accounting) 29.68 24.44 28.93 26.95
Refinery operating expenses, excl depreciation 2.99 3.11 2.76 2.53
Refinery depreciation .79 .83 .72 .77
Average light/heavy crude spread based on
delivered crude costs (per bbl) (3) $ 5.92 $ 3.74 $ 6.00 $ 3.95
Average sales price (per sales bbl)
Gasoline $ 42.31 $ 34.57 $ 43.38 $ 38.06
Diesel 38.81 30.63 38.19 34.41
Asphalt 24.64 21.19 25.53 22.97
Other 8.51 6.65 8.15 8.30
| (1) | Charges are the quantity of crude oil and other feedstocks processed through refinery units. |
| (2) | Manufactured product yields are the volumes of specification materials that are obtained through the distilling of crude oil and operations of other refinery process units. |
| (3) | Average light/heavy spread is the discount at which heavy crude oil (gravity is low) sells compared to the sales price of light crude oil (gravity is high). |
REFINING OPERATING STATISTICAL INFORMATION
El Dorado Refinery:
Nine Months Ended Three Months Ended
September 30, September 30,
---------------------- ----------------------
2003 2002 2003 2002
-------- -------- -------- -------
Charges (bpd) (1)
Light crude 25,225 33,148 25,061 44,001
Heavy and intermediate crude 75,829 72,675 85,687 62,680
Other feed and blend stocks 13,118 13,148 12,777 13,767
--------- --------- --------- ---------
Total 114,172 118,971 123,525 120,448
Manufactured product yields (bpd) (2)
Gasoline 61,710 63,886 65,426 59,817
Diesel and jet fuel 38,029 39,909 41,524 39,774
Chemicals (3) 811 189 835 599
Other 11,003 13,095 11,828 19,144
--------- --------- --------- ---------
Total 111,553 117,079 119,613 119,334
Total product sales (bpd)
Gasoline 61,932 65,039 65,240 62,044
Diesel and jet fuel 38,473 40,126 43,115 39,852
Chemicals (3) 811 283 835 379
Other 9,222 9,260 9,276 9,561
--------- --------- --------- ---------
Total 110,438 114,708 118,466 111,836
Refinery operating margin information (per sales bbl)
Refined products revenues $ 36.36 $ 28.67 $ 36.87 $ 31.89
Raw material, freight and other costs
(FIFO inventory accounting) 31.96 24.80 31.85 27.99
Refinery operating expenses, excl depreciation 3.48 2.86 3.09 2.86
Refinery depreciation .31 .29 .28 .29
WTI/WTS crude spread (per bbl) (4) $ 2.67 $ 1.24 $ 2.44 $ .97
Average sales price (per sales bbl)
Gasoline $ 39.68 $ 31.59 $ 40.96 $ 34.90
Diesel and jet fuel 35.90 28.24 35.33 31.92
Chemicals (3) 53.97 42.25 48.05 48.94
Other 14.45 9.65 14.26 11.55
| (1) | Charges are the quantity of crude oil and other feedstocks processed through refinery units. |
| (2) | Manufactured product yields are the volumes of specification materials that are obtained through the distilling of crude oil and operations of other refinery process units. |
| (3) | During the first quarter of 2002, the process of shutting down the petro-chemical complex at El Dorado began and we discontinued the production of phenol and acetone and began producing and selling benzene. |
| (4) | Average differential between benchmark West Texas intermediate (sweet) crude oil priced at Cushing, Oklahoma and West Texas sour crude oil priced at Midland, Texas. |
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Impact of Changing Prices. Our revenues and cash flows, as well as estimates of future cash flows, are very sensitive to changes in energy prices. Major shifts in the cost of crude oil and the price of refined products and natural gas can result in large changes in the operating margin from refining operations. These prices also determine the carrying value of the refineries’ inventories.
Price Risk Management Activities. At times, we enter into commodity derivative contracts to manage our price exposure to our inventory positions, our purchases of foreign crude oil and consumption of natural gas in the refining process as well as fix margins on certain future production. The commodity derivative contracts we use may take the form of futures contracts or price swaps and are entered into with reputable counterparties. We use futures transactions to price foreign crude oil cargos at the time when the crude oil is processed by the El Dorado Refinery instead of the price when purchased. Foreign crude oil delivery times can exceed one month from when the purchase is made. In addition, we may engage in futures transactions for the purchase of natural gas at fixed prices. The El Dorado and Cheyenne refineries consume natural gas for energy and feedstock purposes. We account for our commodity derivative contracts under 1) the hedge (or deferral) method of accounting when the derivative contracts qualify and are designated as hedges for accounting purposes, or 2) mark-to-market accounting if we elect not to designate derivative contracts as accounting hedges or if such derivative contracts do not qualify for hedge accounting. As such, gains or losses on commodity derivative contracts accounted for as hedges are recognized in refining operating expenses when the associated transactions are consummated while gains and losses on transactions accounted for using mark-to-market accounting are reflected in other revenues at each period end.
Other revenues for the nine months ended September 30, 2003 include $1.2 million realized and unrealized net gains on derivative contracts accounted for using mark-to-market accounting and $20,000 net realized gains for the ineffective portion of crude oil hedges. Other revenues for the nine months ended September 30, 2002 included $1.2 million realized net gains on the ineffective portion of fair value hedges on crude oil cargos and $2.6 million realized and unrealized net losses on derivative contracts accounted for using mark-to-market accounting. Other revenues for the three months ended September 30, 2003 includes $186,000 realized and unrealized net gains on derivative contracts accounted for using mark-to-market accounting while other revenues for the three months ended September 30, 2002 included $2.1 million realized and unrealized net losses on derivative contracts accounted for using mark-to-market accounting The ineffective portion of foreign crude oil hedges arises primarily from changes in the shape of the forward futures price curve.
At September 30, 2003 we had the following open commodity derivative contracts which, while economic hedges, did not qualify for hedge accounting treatment and whose gains or losses are being reflected in other revenues:
| • |
Derivative contracts on 398,000 barrels of crude oil to hedge normal butane
inventory expected to be utilized at the El Dorado refinery between October 2003
and December 2003. These open contracts have total net unrealized gains at
September 30, 2003 of approximately $58,000. During the nine months ended
September 30, 2003 the Company realized net losses of approximately $524,000 on
closed out contracts to hedge butane inventory.
|
| • |
Derivative contracts on 15,000 barrels of crude oil to hedge gas oil inventory
at the Cheyenne refinery. These open contracts have unrealized gains at
September 30, 2003 of approximately $17,000. During the nine months ended
September 30, 2003 the Company realized net losses of approximately $26,000 on
closed out contracts to hedge gas oil inventory at Cheyenne.
|
We had no open derivative contracts at September 30, 2003 being accounted for as hedges. During the nine months ended September 30, 2003, we had the following derivatives that were appropriately designated and accounted for as hedges:
| • |
Natural Gas Collars. Price swaps on natural gas for the purpose of
hedging against natural gas price increases for February and March 2003 for
approximately 100% of the El Dorado refinery’s anticipated usage and which
are accounted for as cash flow hedges. The February group of contracts to hedge
natural gas costs were for 700,000 MMBTU and expired with no gain or loss. The
March group of contracts to hedge natural gas totaled 720,000 MMBTU and the
Company realized a $1.7 million gain which reduced our refining operating
expenses in March.
|
| • |
Crude Contracts. In January 2003, we had derivative contracts on 200,000
barrels of crude oil to hedge Canadian crude costs for the Cheyenne refinery
which were accounted as fair value hedges. A $13,000 loss was realized on these
positions, of which $31,000 increased crude costs and $18,000 income was
reflected in other revenues for the ineffective portion of this hedge. In May
2003, we closed out derivative contracts we had purchased in April 2003 on
675,000 barrels of crude oil to hedge two foreign crude cargos purchased for the
El Dorado refinery. A $13,000 gain was realized on these positions, of which
$11,000 reduced crude costs and $2,000 was reflected in other revenues for the
ineffective portion of these hedges.
|
Interest Rate Risk. Borrowings under our revolving credit facility bear a current market rate of interest. Our approximately $39.5 million principal of outstanding 9-1/8% Senior Notes, due 2006, and our approximately $170.5 million principal of 11¾% Senior Notes outstanding, due 2009, have fixed interest rates. Accordingly, our long-term debt is not exposed to cash flow risk from interest rate changes; however, our long-term debt is exposed to fair value risk. The estimated fair value of the 9-1/8% Senior Notes at September 30, 2003 was $40.3 million and the estimated fair value of the 11¾% Senior Notes was $185.8 million.
ITEM 4. CONTROLS AND PROCEDURES
We maintain a set of disclosure controls and procedures that are designed to ensure that information required to be disclosed by us in the reports filed by us under the Securities Exchange Act of 1934, as amended (“Exchange Act”) is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. As of the end of the period covered by this report, we evaluated, under the supervision and with the participation of our management, including our Chairman of the Board, President and Chief Executive Officer and our Executive Vice President - Finance & Administration, Chief Financial Officer, of the effectiveness of our disclosure controls and procedures pursuant to Rule 13a-15 of the Exchange Act. Based on that evaluation, our Chairman of the Board, President and Chief Executive Officer and our Executive Vice President - Finance & Administration, Chief Financial Officer, concluded that our disclosure controls and procedures are effective.
During the most recent fiscal quarter, there have been no changes in our internal control over financial reporting that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
| ITEM 1. |
Legal Proceedings - Beverly Hills Lawsuits. A Frontier subsidiary, Wainoco Oil & Gas Company, owned and operated an interest in an oil field in the Los Angeles, California metropolitan area from 1985 to 1995. The production facilities for that interest in the oil field are located at the campus of the Beverly Hills High School. In April 2003, a law firm began filing claims with the Beverly Hills Unified School District and the City of Beverly Hills on behalf of former students, school employees, area residents and others alleging that emissions from the oil field or the production facilities caused cancers or various other health problems in those individuals. Wainoco Oil & Gas Company and Frontier are defendants in three pending lawsuits relating to some of those claims; other defendants include the Beverly Hills Unified School District, the City of Beverly Hills, ten other oil and gas companies, two additional companies involved in owning or operating a power plant adjacent to the Beverly Hills High School and three of their related parent companies. The lawsuits include claims for personal injury, wrongful death, loss of consortium and/or fear of contracting diseases, and also ask for punitive damages. No dollar amounts of damages have been specified in any of the lawsuits. The three pending lawsuits have been formally related to one another and have been transferred to a judge on the complex civil litigation panel in the Superior Court of the State of California for the County of Los Angeles. The oil production site operated by Frontier’s subsidiary was a modern facility and was operated with a high level of safety and responsibility. We believe that our subsidiary’s activities did not cause any health problems for anyone, including former Beverly Hills high school students, school employees or area residents. Nevertheless, as a matter of prudent risk management, we have recently purchased insurance from an insurance company with an A.M. Best rating of A++ (Superior) covering the existing claims described above and any similar claims for bodily injury or property damage asserted during the five-year period following the policy’s September 30, 2003 commencement date. The claims are covered, whether asserted directly against the insured parties or as a result of contractual indemnity. The policy covers defense costs, and any payments made to claimants, up to an aggregate limit of $120 million, including coinsurance by Frontier of up to $3.9 million in the coverage between $40 million and $120 million. In October 2003, we paid $6.25 million to the insurance company (which includes indemnity premium of $5.75 million and a $500,000 administration fee) and have funded with the insurance company a Commutation Account of approximately $19.5 million, from which the insurance company will fund the first costs under the policy including, but not limited to, the costs of defense of the claims. We have the right to terminate the policy at any time after the first year and prior to September 30, 2008, receive back up to $4.3 million of return premium, the dollar amount which declines over time, plus, any unspent balance in the Commutation Account plus accumulated interest. While the policy is in effect, the insurance company will manage the defense of the claims. We are also seeking coverage with respect to the Beverly Hills, California claims from the insurance companies that provided policies to Frontier during the 1985 to 1995 period. We believe that neither the claims that have been made, the three pending lawsuits, nor other potential future litigation by which similar or related claims may be asserted against Frontier or its subsidiary will result in any material liability or have any material adverse effect upon Frontier. Holly Lawsuit. On August 20, 2003, we announced that Holly Corporation had advised us that Holly was not willing to proceed with our previously announced March 30, 2003 merger agreement on the agreed terms. As a result, we filed suit for damages in the Delaware Court of Chancery. On September 2, 2003, Holly Corporation filed an answer and counterclaims, denying our claims, asserting that Frontier repudiated the merger agreement by filing the Delaware lawsuit, and claiming among other things that the Beverly Hills, California litigation caused the Company to be in breach of its representations and warranties in the merger agreement. Frontier has denied all of Holly’s counterclaims. The Delaware Court of Chancery has scheduled the suit and Holly’s counterclaims for trial in early December 2003. |
| ITEM 2. |
Changes in Securities - There have been no changes in the constituent instruments defining the rights of the holders of any class of registered securities during the current quarter. |
| ITEM 3. |
Defaults Upon Senior Securities - None. |
| ITEM 4. |
Submission of Matters to a Vote of Security Holders - None. |
| ITEM 5. |
Other Information - None. |
| ITEM 6. |
Exhibits and Reports on Form 8-K - (a) Exhibits 31.1 – Certification by Chief Executive Officer required by Rule 13a-14(a) and 15d-14(a) under the Exchange Act. 31.2 – Certification by Chief Financial Officer required by Rule 13a-14(a) and 15d-14(a) under the Exchange Act. 32.1 – Certification by Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 – Certification by Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (b) Reports on Form 8-K A report on Form 8-K dated July 30, 2003 and filed July 31, 2003, File Number 001-07627 regarding a press release announcing the Company’s second quarter results. A report on Form 8-K dated and filed August 20, 2003, File Number 001-07627 included Item 5 for the reporting of Other Events and Item 7 for an exhibit of a press release regarding Frontier filing suit against Holly Corporation for anticipatory repudiation of the merger agreement. A report on Form 8-K dated October 30, 2003 and filed October 31, 2003, File Number 001-07627 regarding a press release announcing the Company’s third quarter results. |
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
| FRONTIER OIL CORPORATION |
| By: |
/s/ Nancy J. Zupan –––––––––––––––––––– Nancy J. Zupan Vice President - Controller (principal accounting officer) |
Date: October 31, 2003