SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2004
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: 1-10398
GIANT INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 86-0642718
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
23733 North Scottsdale Road, Scottsdale, Arizona 85255
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code:
(480) 585-8888
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 Exchange Act).
Yes [ ] No [X]
Number of Common Shares outstanding at July 30, 2004: 12,182,901 shares.
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION....................................... 1
Item 1 - Financial Statements........................................ 1
Condensed Consolidated Balance Sheets June 30, 2004
and December 31, 2003 (Unaudited)........................... 1
Condensed Consolidated Statements of Earnings for the Three
And Six Months Ended June 30, 2004 and 2003 (Unaudited)..... 2
Condensed Consolidated Statements of Cash Flows for the Six
Months Ended June 30, 2004 and 2003 (Unaudited)............. 3
Notes to Condensed Consolidated Financial Statements
(Unaudited).................................................. 4-40
Item 2 - Management's Discussion and Analysis of
Financial Condition and Results of Operations............... 41-60
Item 3 - Quantitative and Qualitative Disclosures
About Market Risk........................................... 60
Item 4 - Controls and Procedures..................................... 61
PART II - OTHER INFORMATION........................................... 62
Item 1 - Legal Proceedings........................................... 62
Item 2 - Changes in Securities, Use of Proceeds and
Issuer Purchases of Equity Securities....................... 62
Item 4 - Submission Of Matters To A Vote Of Security Holders......... 62
Item 6 - Exhibits and Reports on Form 8-K............................ 63
SIGNATURE............................................................. 65
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except shares and per share data)
June 30, December 31,
2004 2003
--------- ------------
ASSETS
Current assets:
Cash and cash equivalents............................. $ 21,376 $ 27,263
Receivables, net...................................... 112,794 82,788
Inventories........................................... 117,807 133,726
Prepaid expenses and other............................ 4,529 8,030
--------- ---------
Total current assets................................ 256,506 251,807
--------- ---------
Property, plant and equipment........................... 640,055 632,483
Less accumulated depreciation and amortization.......... (248,805) (236,441)
--------- ---------
391,250 396,042
--------- ---------
Goodwill................................................ 35,863 24,578
Assets held for sale.................................... 1,357 2,223
Other assets............................................ 24,445 25,004
--------- ---------
$ 709,421 $ 699,654
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Current portion of long-term debt..................... $ 17,558 $ 11,128
Accounts payable...................................... 81,513 86,651
Accrued expenses...................................... 53,636 56,629
--------- ---------
Total current liabilities........................... 152,707 154,408
--------- ---------
Long-term debt, net of current portion.................. 292,507 355,601
Deferred income taxes................................... 31,447 28,039
Other liabilities and deferred income................... 25,242 22,170
Commitments and contingencies
Stockholders' equity:
Common stock, par value $.01 per share,
50,000,000 shares authorized, 15,934,881 and
12,537,535 shares issued............................ 159 126
Additional paid-in capital............................ 133,203 74,660
Retained earnings..................................... 110,610 101,104
--------- ---------
243,972 175,890
Less common stock in treasury - at cost,
3,751,980 shares.................................... (36,454) (36,454)
--------- ---------
Total stockholders' equity.......................... 207,518 139,436
--------- ---------
$ 709,421 $ 699,654
========= =========
See accompanying notes to condensed consolidated financial statements.
1
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF EARNINGS
(Unaudited)
(In thousands, except per share data)
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Net revenues...................................... $ 654,300 $ 408,852 $ 1,195,312 $ 889,465
Cost of products sold............................. 557,536 338,792 1,018,448 748,340
--------- --------- --------- ---------
Gross margin...................................... 96,764 70,060 176,864 141,125
Operating expenses................................ 43,596 41,258 87,845 80,380
Depreciation and amortization..................... 9,247 9,398 18,371 18,491
Selling, general and administrative expenses...... 10,052 7,271 18,252 14,295
Net loss (gain) on disposal/write-down of assets.. 79 (187) 93 218
--------- --------- --------- ---------
Operating income.................................. 33,790 12,320 52,303 27,741
Interest expense.................................. (8,688) (9,865) (18,049) (20,024)
Costs associated with early debt extinguishment... (10,875) - (10,875) -
Amortization/write-off of financing costs......... (5,857) (1,197) (6,815) (2,388)
Interest and investment income.................... 42 59 81 83
--------- --------- --------- ---------
Earnings from continuing operations
before income taxes............................. 8,412 1,317 16,645 5,412
Provision for income taxes........................ 3,112 545 6,767 2,238
--------- --------- --------- ---------
Earnings from continuing operations
before discontinued operations and
cumulative effect of change
in accounting principle....................... 5,300 772 9,878 3,174
Loss from discontinued operations, net of income
tax benefit of $191, $217, $229 and $265........ (312) (325) (372) (396)
Cumulative effect of change in accounting
principle, net of income tax benefit of $468.... - - - (704)
--------- --------- --------- ---------
Net earnings...................................... $ 4,988 $ 447 $ 9,506 $ 2,074
========= ========= ========= =========
Net earnings (loss) per common share:
Basic
Continuing operations......................... $ 0.48 $ 0.09 $ 1.00 $ 0.37
Discontinued operations....................... (0.03) (0.04) (0.04) (0.05)
Cumulative effect of change
in accounting principle..................... - - - (0.08)
--------- --------- --------- ---------
$ 0.45 $ 0.05 $ 0.96 $ 0.24
========= ========= ========= =========
Assuming dilution
Continuing operations......................... $ 0.47 $ 0.09 $ 0.97 $ 0.36
Discontinued operations....................... (0.03) (0.04) (0.04) (0.04)
Cumulative effect of change
in accounting principle..................... - - - (0.08)
--------- --------- --------- ---------
$ 0.44 $ 0.05 $ 0.93 $ 0.24
========= ========= ========= =========
See accompanying notes to condensed consolidated financial statements.
2
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
Six Months Ended
June 30,
-------------------------
2004 2003
--------- ---------
Cash flows from operating activities:
Net earnings.............................................. $ 9,506 $ 2,074
Loss from discontinued operations......................... 372 396
Cumulative effect of change in accounting principle, net.. - 704
--------- ---------
Net earnings from continuing operations................... 9,878 $ 3,174
Adjustments to reconcile net earnings from continuing
operations to net cash provided by operating activities:
Depreciation and amortization......................... 18,371 18,491
Amortization/write-off of financing costs............. 6,815 2,388
Deferred income taxes................................. 3,981 2,042
Deferred crude oil purchase discounts................. 1,936 -
Net loss on the disposal/write-down of assets......... 93 218
Changes in operating assets and liabilities
(Increase) decrease in receivables................... (27,857) 433
Decrease (increase) in inventories.................. 15,797 (12,702)
Decrease in prepaid expenses........................ 3,168 2,839
(Decrease) increase in accounts payable.............. (5,138) 7,773
(Decrease) increase in accrued expenses.............. (2,364) 2,541
(Increase) in other assets........................... (824) (229)
Increase in other liabilities....................... 2,681 951
--------- ---------
Net cash provided by operating activities................... 26,537 27,919
--------- ---------
Cash flows from investing activities:
Purchase of property, plant and equipment................. (21,849) (10,150)
Proceeds from assets held for sale and
discontinued operations................................. 937 289
Yorktown refinery acquisition contingent payment.......... (11,695) (5,475)
Proceeds from sale of property, plant and equipment
and other assets........................................ 5,929 9,347
--------- ---------
Net cash used in investing activities....................... (26,678) (5,989)
--------- ---------
Cash flows from financing activities:
Payments of long-term debt................................ (205,631) (6,276)
Payments on line of credit................................ - (65,000)
Proceeds from line of credit.............................. - 50,000
Proceeds from issuance of long-term debt.................. 147,467 -
Net proceeds from issuance of common stock................ 57,374 -
Proceeds from exercise of stock options................... 303 -
Deferred financing costs.................................. (5,259) (50)
--------- ---------
Net cash used in financing activities....................... (5,746) (21,326)
--------- ---------
Net (decrease) increase in cash and cash equivalents........ (5,887) 604
Cash and cash equivalents:
Beginning of period..................................... 27,263 10,168
--------- ---------
End of period........................................... $ 21,376 $ 10,772
========= =========
Significant Noncash Investing and Financing Activities: On February 25, 2004, we contributed 49,046 newly
issued shares of our common stock, valued at $900,000, to our 401(k) plan as a discretionary contribution for
the year 2003. On January 1, 2003, in accordance with Statement of Financial Accounting Standards No. 143,
"Accounting for Asset Retirement Obligations," we recorded an asset retirement obligation of $2,198,000, asset
retirement assets of $1,580,000 and related accumulated depreciation of $674,000. We also reversed a previously
recorded asset retirement obligation for $120,000, and recorded a cumulative effect adjustment of $1,172,000
($704,000 net of taxes). See Note 4 for further information.
See accompanying notes to condensed consolidated financial statements.
3
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1 - ORGANIZATION AND BASIS OF PRESENTATION:
ORGANIZATION
Giant Industries, Inc., through our subsidiary Giant Industries
Arizona, Inc. and its subsidiaries, refines and sells petroleum products.
Our operations are located:
- on the East Coast - primarily in Virginia, Maryland, and North
Carolina; and
- in the Southwest - primarily in New Mexico, Arizona, and Colorado,
with a concentration in the Four Corners area where these states
meet.
In addition, our Phoenix Fuel Co., Inc. subsidiary distributes
commercial wholesale petroleum products primarily in Arizona.
We have three business units:
- our refining group;
- our retail group; and
- Phoenix Fuel.
See Note 3 for a further discussion of our business segments.
Basis of Presentation:
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with accounting principles
generally accepted in the United States of America, hereafter referred to
as generally accepted accounting principles, for interim financial
information and with the instructions to Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information
and notes required by generally accepted accounting principles for
complete financial statements. In the opinion of management, all
adjustments and reclassifications considered necessary for a fair and
comparable presentation have been included. These adjustments and
reclassifications are of a normal recurring nature, with the exception of
the cumulative effect of a change in accounting for asset retirement
obligations (see Note 4), discontinued operations (see Note 6), and costs
and write-offs related to early debt extinguishment (see Note 11).
Operating results for the three and six months ended June 30, 2004 are not
necessarily indicative of the results that may be expected for the year
ending December 31, 2004. The accompanying financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto included in our Annual Report on Form 10-K for the year ended
December 31, 2003.
We have made certain reclassifications to our 2003 financial
statements and notes to conform to the financial statement classifications
used in the current year. These reclassifications relate primarily to
discontinued operations reporting. These reclassifications had no effect
on reported earnings or stockholders' equity.
4
NOTE 2 - STOCK-BASED EMPLOYEE COMPENSATION:
We have a stock-based employee compensation plan that is more fully
described in Note 18 to our financial statements included in our Annual
Report on Form 10-K for the year ended December 31, 2003. We account for
this plan under the recognition and measurement principles of Accounting
Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to
Employees", and related interpretations. We use the intrinsic value method
to account for stock-based employee compensation. The following table
illustrates the effect on net earnings and net earnings per share as if we
had applied the fair value recognition provisions of Statement of
Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-
Based Compensation", to stock-based employee compensation.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
(In thousands, except per share data)
Net earnings, as reported....... $ 4,988 $ 447 $ 9,506 $ 2,074
Add: Stock-based employee
compensation expense included
in reported net income, net
of related tax effect......... - - - -
Deduct: Total stock-based
employee compensation
expense determined under the
fair value based method for
all awards, net of related
tax effect.................... (40) (55) (99) (94)
------- ------- ------- -------
Pro forma net earnings.......... $ 4,948 $ 392 $ 9,407 $ 1,980
======= ======= ======= =======
Net earnings per share:
Basic - as reported........... $ 0.45 $ 0.05 $ 0.96 $ 0.24
======= ======= ======= =======
Basic - pro forma............. $ 0.45 $ 0.04 $ 0.95 $ 0.23
======= ======= ======= =======
Diluted - as reported......... $ 0.44 $ 0.05 $ 0.93 $ 0.24
======= ======= ======= =======
Diluted - pro forma........... $ 0.44 $ 0.04 $ 0.92 $ 0.23
======= ======= ======= =======
5
NOTE 3 - BUSINESS SEGMENTS:
We are organized into three operating segments based on manufacturing
and marketing criteria. These segments are the refining group, the retail
group and Phoenix Fuel. Our operations that are not included in any of the
three segments are included in the category "Other" and are then allocated
to the business segments. These operations consist primarily of corporate
staff operations.
Beginning in the second quarter of 2004, operating income for our
segments includes an allocation of corporate overhead. We have also
allocated interest expense to these segments. We have reclassified prior
period segment information for comparative purposes.
Operating income before corporate allocation for each segment
consists of net revenues less cost of products sold, operating expenses,
depreciation and amortization, and the segment's selling, general and
administrative expenses. Cost of products sold reflects current costs
adjusted, where appropriate, for the last-in, first-out ("LIFO") inventory
method and lower of cost or market inventory adjustments.
The total assets of each segment consist primarily of net property,
plant and equipment, inventories, accounts receivable and other assets
directly associated with the segment's operations. Included in the total
assets of the corporate staff operations are a majority of our cash and
cash equivalents, and various accounts receivable, net property, plant and
equipment, and other long-term assets.
A description of each segment and its principal products follows:
REFINING GROUP
Our refining group operates our Ciniza and Bloomfield refineries in
the Four Corners area of New Mexico and the Yorktown refinery in Virginia.
It also operates a crude oil gathering pipeline system in New Mexico, two
finished products distribution terminals, and a fleet of crude oil and
finished product trucks. Our three refineries make various grades of
gasoline, diesel fuel, and other products from crude oil, other
feedstocks, and blending components. We also acquire finished products
through exchange agreements and from various suppliers. We sell these
products through our service stations, independent wholesalers and
retailers, commercial accounts, and sales and exchanges with major oil
companies. We purchase crude oil, other feedstocks and blending components
from various suppliers.
RETAIL GROUP
Our retail group operates service stations, which include convenience
stores or kiosks. Our service stations sell various grades of gasoline,
diesel fuel, general merchandise, including tobacco and alcoholic and
nonalcoholic beverages, and food products to the general public. Our
refining group or Phoenix Fuel supplies the gasoline and diesel fuel our
retail group sells. We purchase general merchandise and food products from
various suppliers. At June 30, 2004, we operated 125 service stations with
convenience stores or kiosks.
6
PHOENIX FUEL
Phoenix Fuel distributes commercial wholesale petroleum products. It
includes several lubricant and bulk petroleum distribution plants, an
unmanned fleet fueling operation, a bulk lubricant terminal facility, and
a fleet of finished product and lubricant delivery trucks. Phoenix Fuel
purchases petroleum fuels and lubricants from suppliers and to a lesser
extent from our refining group.
Disclosures regarding our reportable segments with reconciliations to
consolidated totals for the three months ended June 30, 2004 and 2003, are
presented below.
7
As of and for the Three Months Ended June 30, 2004
----------------------------------------------------------------
Refining Retail Phoenix Reconciling
Group Group Fuel Other Items Consolidated
----------------------------------------------------------------
(In thousands)
Customer net revenues:
Finished products:
Four Corners operations.............. $103,724
Yorktown operations.................. 279,622
--------
Total................................ $383,346 $ 61,346 $154,855 $ - $ - $ 599,547
Merchandise and lubricants............. - 34,541 8,261 - - 42,802
Other.................................. 7,811 3,785 527 53 - 12,176
-------- -------- -------- -------- --------- ----------
Total................................ 391,157 99,672 163,643 53 - $ 654,525
-------- -------- -------- -------- --------- ----------
Intersegment net revenues:
Finished products...................... 47,704 - 18,766 - (66,470) -
Other.................................. 3,729 - - - (3,729) -
-------- -------- -------- -------- --------- ----------
Total................................ 51,433 - 18,766 - (70,199) -
-------- -------- -------- -------- --------- ----------
Total net revenues....................... 442,590 99,672 182,409 53 (70,199) 654,525
Less net revenues of discontinued
operations............................. - (225) - - - (225)
-------- -------- -------- -------- --------- ----------
Net revenues of continuing operations.... $442,590 $ 99,447 $182,409 $ 53 $ (70,199) $ 654,300
======== ======== ======== ======== ========= ==========
Operating income (loss):
Four Corners operations................ $ 13,704
Yorktown operations.................... 21,811
--------
Total operating income (loss) before.....
corporate allocation.................. $ 35,515 $ 2,614 $ 2,963 $ (7,256) $ (549) $ 33,287
Corporate allocation..................... (3,717) (2,152) (654) 6,523 - -
-------- -------- -------- -------- --------- ----------
Total operating income (loss) after......
corporate allocation.................. $ 31,798 $ 462 $ 2,309 $ (733) $ (549) $ 33,287
Discontinued operations loss/(gain)...... - 33 - - 470 503
-------- -------- -------- -------- --------- ----------
Operating income (loss)
from continuing operations............. 31,798 495 2,309 (733) (79) 33,790
Interest expense......................... (4,692) (2,867) (869) (260) - (8,688)
-------- -------- -------- -------- --------- ----------
Operating income from continuing
operations less interest expense....... $ 27,106 $ (2,372) $ 1,440 $ (993) $ (79) 25,102
======== ======== ======== ======== =========
Costs associated with early debt
extinguishment......................... (10,875)
Amortization and write-offs of financing.
costs.................................. (5,857)
Interest income.......................... 42
----------
Earnings from continuing operations
before income taxes.................... $ 8,412
==========
Depreciation and amortization:
Four Corners operations................ $ 4,096
Yorktown operations.................... 2,266
--------
Total................................ $ 6,362 $ 2,269 $ 409 $ 214 $ - $ 9,254
Less discontinued operations......... - (7) - - - (7)
-------- -------- -------- -------- --------- ----------
Continuing operations................ $ 6,362 $ 2,262 $ 409 $ 214 $ - $ 9,247
======== ======== ======== ======== ========= ==========
Total assets............................. $482,863 $111,247 $ 79,404 $ 35,907 $ - $ 709,421
Capital expenditures..................... $ 17,618 $ 438 $ 465 $ 115 $ - $ 18,636
Yorktown refinery acquisition
contingent payment..................... $ 7,646 $ - $ - $ - $ - $ 7,646
8
As of and for the Three Months Ended June 30, 2003
----------------------------------------------------------------
Refining Retail Phoenix Reconciling
Group Group Fuel Other Items Consolidated
----------------------------------------------------------------
(In thousands)
Customer net revenues:
Finished products:
Four Corners operations.............. $ 68,091
Yorktown operations.................. 154,880
--------
Total................................ $222,971 $ 52,638 $ 91,588 $ - $ - $ 367,197
Merchandise and lubricants............. - 34,570 6,707 - - 41,277
Other.................................. 5,126 3,893 378 145 - 9,542
-------- -------- -------- -------- --------- ----------
Total................................ 228,097 91,101 98,673 145 - 418,016
-------- -------- -------- -------- --------- ----------
Intersegment net revenues:
Finished products...................... 40,891 - 11,419 - (52,310) -
Other.................................. 4,186 - - - (4,186) -
-------- -------- -------- -------- --------- ----------
Total................................ 45,077 - 11,419 - (56,496) -
-------- -------- -------- -------- --------- ----------
Total net revenues....................... 273,174 91,101 110,092 145 (56,496) 418,016
Less net revenues of discontinued
operations............................. - (9,164) - - - (9,164)
-------- -------- -------- -------- --------- ----------
Net revenues of continuing operations.... $273,174 $ 81,937 $110,092 $ 145 $ (56,496) $ 408,852
======== ======== ======== ======== ========= ==========
Operating income (loss):
Four Corners operations................ $ 12,715
Yorktown operations.................... (2,847)
--------
Total operating income (loss) before.....
Corporate allocations................. $ 9,868 $ 4,834 $ 2,284 $ (5,033) $ (175) $ 11,778
Corporate allocation..................... (2,626) (1,521) (462) 4,609 - -
-------- -------- -------- -------- --------- ----------
Total operating income (loss) after......
Corporate allocations................. $ 7,242 $ 3,313 $ 1,822 $ (424) $ (175) $ 11,778
Discontinued operations loss............. - 180 - - 362 542
-------- -------- -------- -------- --------- ----------
Operating income (loss)
from continuing operations............. 7,242 3,493 1,822 (424) 187 12,320
Interest expense......................... (5,327) (3,255) (987) (296) - (9,865)
-------- -------- -------- -------- --------- ----------
Operating income from continuing
operations less interest expense....... $ 1,915 $ 238 $ 835 $ (720) $ 187 2,455
======== ======== ======== ======== =========
Amortization of financing costs.......... (1,197)
Interest income.......................... 59
----------
Earnings from continuing operations
before income taxes.................... $ 1,317
==========
Depreciation and amortization:
Four Corners operations................ $ 3,978
Yorktown operations.................... 2,080
--------
Total................................ $ 6,058 $ 2,781 $ 446 $ 313 $ - $ 9,598
Less discontinued operations......... - (200) - - - (200)
-------- -------- -------- -------- --------- ----------
Continuing operations................ $ 6,058 $ 2,581 $ 446 $ 313 $ - $ 9,398
======== ======== ======== ======== ========= ==========
Total assets............................. $452,207 $117,914 $ 65,076 $ 62,817 $ - $ 698,014
Capital expenditures..................... $ 4,574 $ 120 $ 129 $ 55 $ - $ 4,878
Yorktown refinery acquisition
contingent payment..................... $ 1,489 $ - $ - $ - $ - $ 1,489
9
Disclosures regarding our reportable segments with reconciliations to
consolidated totals for the six months ended June 30, 2004 and 2003, are
presented below.
As of and for the Six Months Ended June 30, 2004
----------------------------------------------------------------
Refining Retail Phoenix Reconciling
Group Group Fuel Other Items Consolidated
----------------------------------------------------------------
(In thousands)
Customer net revenues:
Finished products:
Four Corners operations.............. $189,752
Yorktown operations.................. 507,269
--------
Total................................ $697,021 $109,175 $277,718 $ - $ - $1,083,914
Merchandise and lubricants............. - 65,385 15,597 - - 80,982
Other.................................. 22,338 7,631 924 332 - 31,225
-------- -------- -------- -------- --------- ----------
Total................................ 719,359 182,191 294,239 332 - 1,196,121
-------- -------- -------- -------- --------- ----------
Intersegment net revenues:
Finished products...................... 103,661 - 31,062 - (134,723) -
Other.................................. 7,766 - - - (7,766) -
-------- -------- -------- -------- --------- ----------
Total................................ 111,427 - 31,062 - (142,489) -
-------- -------- -------- -------- --------- ----------
Total net revenues....................... 830,786 182,191 325,301 332 (142,489) 1,196,121
Less net revenues of discontinued
operations............................. - (809) - - - (809)
-------- -------- -------- -------- --------- ----------
Net revenues of continuing operations.... $830,786 $181,382 $325,301 $ 332 $(142,489) $1,195,312
======== ======== ======== ======== ========= ==========
Operating income (loss):
Four Corners operations................ $ 19,864
Yorktown operations.................... 36,246
--------
Total operating income (loss) before.....
Corporate allocations................. $ 56,110 $ 3,601 $ 5,076 $(12,522) $ (563) $ 51,702
Corporate allocation..................... (6,540) (3,786) (1,150) 11,476 - -
-------- -------- -------- -------- --------- ----------
Total operating income (loss) after......
Corporate allocations................. $ 49,570 $ (185) $ 3,926 $ (1,046) $ (563) $ 51,702
Discontinued operations (gain)/loss...... - 131 - - 470 601
-------- -------- -------- -------- --------- ----------
Operating income (loss)
from continuing operations............. 49,570 (54) 3,926 (1,046) (93) 52,303
Interest expense......................... (9,746) (5,956) (1,805) (542) - (18,049)
-------- -------- -------- -------- --------- ----------
Operating income from continuing
operations less interest expense....... $ 39,824 $ (6,010) $ 2,121 $ (1,588) $ (93) 34,254
======== ======== ======== ======== =========
Costs associated with early debt
extinguishment......................... (10,875)
Amortization and write-offs of financing.
costs................................... (6,815)
Interest income.......................... 81
----------
Earnings from continuing operations
before income taxes.................... $ 16,645
==========
Depreciation and amortization:
Four Corners operations................ $ 8,074
Yorktown operations.................... 4,392
--------
Total................................ $ 12,466 $ 4,673 $ 824 $ 436 $ - $ 18,399
Less discontinued operations......... - (28) - - - (28)
-------- -------- -------- -------- --------- ----------
Continuing operations................ $ 12,466 $ 4,645 $ 824 $ 436 $ - $ 18,371
======== ======== ======== ======== ========= ==========
Total assets................................$482,863 $111,247 $ 79,404 $ 35,907 $ - $ 709,421
Capital expenditures..................... $ 20,234 $ 696 $ 793 $ 126 $ - $ 21,849
Yorktown refinery acquisition
contingent payment..................... $ 11,695 $ - $ - $ - $ - $ 11,695
10
As of and for the Six Months Ended June 30, 2003
----------------------------------------------------------------
Refining Retail Phoenix Reconciling
Group Group Fuel Other Items Consolidated
----------------------------------------------------------------
(In thousands)
Customer net revenues:
Finished products:
Four Corners operations.............. $146,642
Yorktown operations.................. 362,947
--------
Total................................ $509,589 $104,569 $194,223 $ - $ - $ 808,381
Merchandise and lubricants............. - 65,504 12,717 - - 78,221
Other.................................. 15,088 7,928 988 210 - 24,214
-------- -------- -------- -------- --------- ----------
Total................................ 524,677 178,001 207,928 210 - 910,816
-------- -------- -------- -------- --------- ----------
Intersegment net revenues:
Finished products...................... 86,903 - 24,052 - (110,955) -
Other.................................. 8,207 - - - (8,207) -
-------- -------- -------- -------- --------- ----------
Total................................ 95,110 - 24,052 - (119,162) -
-------- -------- -------- -------- --------- ----------
Total net revenues....................... 619,787 178,001 231,980 210 (119,162) 910,816
Less net revenues of discontinued
operations............................. - (21,351) - - - (21,351)
-------- -------- -------- -------- --------- ----------
Net revenues of continuing operations.... $619,787 $156,650 $231,980 $ 210 $(119,162) $ 889,465
======== ======== ======== ======== ========= ==========
Operating income (loss):
Four Corners operations................ $ 22,218
Yorktown operations.................... 5,511
--------
Total operating income (loss) before.....
Corporate allocations................. $ 27,729 $ 5,871 $ 3,890 $ (9,957) $ (452) $ 27,081
Corporate allocation..................... (5,172) (2,995) (910) 9,077 - -
-------- -------- -------- -------- --------- ----------
Total operating income (loss) after......
Corporate allocations................. $ 22,557 $ 2,876 $ 2,980 $ (880) $ (452) $ 27,081
Discontinued operations (gain)/loss...... - 426 - - 234 660
-------- -------- -------- -------- --------- ----------
Operating income (loss)
from continuing operations............. 22,557 3,302 2,980 (880) (218) 27,741
Interest expense......................... (10,813) (6,608) (2,002) (601) - (20,024)
-------- -------- -------- -------- --------- ----------
Operating income from continuing
operations less interest expense....... $ 11,744 $ (3,306) $ 978 $ (1,481) $ (218) 7,717
======== ======== ======== ======== =========
Amortization of financing costs.......... (2,388)
Interest income.......................... 83
----------
Earnings from continuing operations
before income taxes.................... $ 5,412
==========
Depreciation and amortization:
Four Corners operations................ $ 7,958
Yorktown operations.................... 3,814
--------
Total................................ $ 11,772 $ 5,610 $ 900 $ 689 $ - $ 18,971
Less discontinued operations......... - (480) - - - (480)
-------- -------- -------- -------- --------- ----------
Continuing operations................ $ 11,772 $ 5,130 $ 900 $ 689 $ - $ 18,491
======== ======== ======== ======== ========= ==========
Total assets............................. $452,207 $117,914 $ 65,076 $ 62,817 $ - $ 698,014
Capital expenditures..................... $ 9,362 $ 374 $ 333 $ 81 $ - $ 10,150
Yorktown refinery acquisition
contingent payment..................... $ 5,475 $ - $ - $ - $ - $ 5,475
11
NOTE 4 - ASSET RETIREMENT OBLIGATIONS:
On January 1, 2003, we adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS No. 143 addresses financial accounting and
reporting obligations associated with the retirement of tangible long-
lived assets and the associated asset retirement costs.
This statement requires that the fair value of a liability for an
Asset Retirement Obligation ("ARO") be recognized in the period in which
it is incurred if a reasonable estimate of fair value can be made. The
associated Asset Retirement Cost ("ARC") is capitalized as part of the
carrying amount of the long-lived asset. To initially recognize our ARO
liability, we capitalized the fair value, calculated as of the date the
liability would have been recognized were SFAS No. 143 in effect at that
time, of all ARO's that we identified. In accordance with SFAS No. 143, we
also recognized the cumulative accretion and accumulated depreciation from
the date the liability would have been recognized had the provisions of
SFAS No. 143 been in effect, to January 1, 2003, the date we adopted SFAS
No. 143. As a result, on January 1, 2003, we recorded an ARO liability of
$2,198,000, ARC assets of $1,580,000 and related accumulated depreciation
of $674,000. We also reversed a previously recorded asset retirement
obligation of $120,000, and recorded a cumulative effect adjustment of
$1,172,000 ($704,000 net of taxes). Our legally restricted assets that are
set aside for purposes of settling ARO liabilities are less than $800,000.
These assets are set aside to fund costs associated with the closure of
certain solid waste management facilities.
We identified the following ARO's:
1. Landfills - pursuant to Virginia law, the two solid waste
management facilities at our Yorktown refinery must satisfy closure and
post-closure care and financial responsibility requirements.
2. Crude Pipelines - our right-of-way agreements generally require
that pipeline properties be returned to their original condition when the
agreements are no longer in effect. This means that the pipeline surface
facilities must be dismantled and removed and certain site reclamation
performed. We do not believe these right-of-way agreements will require us
to remove the underground pipe upon taking the pipeline permanently out of
service. Regulatory requirements, however, may mandate that such out-of-
service underground pipe be purged.
3. Storage Tanks - we have a legal obligation under applicable law
to remove or close in place all underground and aboveground storage tanks,
both on owned property and leased property, once they are taken out of
service. Under some lease arrangements, we also have committed to restore
the leased property to its original condition.
The following table reconciles the beginning and ending aggregate
carrying amount of our ARO's for the six month period ended June 30, 2004
and the year ended December 31, 2003, respectively.
12
June 30, December 31,
2004 2003
--------- ------------
(In thousands)
Liability beginning of year........... $2,223 $2,198
Liabilities incurred.................. 8 -
Liabilities settled................... (81) (146)
Accretion expense..................... 128 171
------ ------
Liability end of period............... $2,278 $2,223
====== ======
13
NOTE 5 - Goodwill and Other Intangible Assets:
At June 30, 2004 and December 31, 2003, we had goodwill of
$35,863,000 and $24,578,000, respectively.
The changes in the carrying amount of goodwill for the six months
ended June 30, 2004 are as follows:
Refining Retail Phoenix
Group Group Fuel Total
-------- ------- ------- -------
(In thousands)
Balance as of January 1, 2004.......... $ 5,379 $ 4,464 $14,735 $24,578
Yorktown refinery acquisition
contingent consideration(a).......... 11,323 - - 11,323
Goodwill written off related to
The sale of certain retail units..... - (38) - (38)
------- ------- ------- -------
Balance as of June 30, 2004............ $16,702 $ 4,426 $14,735 $35,863
======= ======= ======= =======
(a) We paid $11,695,000 in earn-out payments under the earn-out provision of the
Yorktown acquisition agreement in the first half of 2004. These earn-out
payments are an additional element of cost that represents an excess of
purchase price over the amounts assigned to the assets and liabilities
assumed. We allocated $11,323,000 of this amount to goodwill and $372,000 to
deferred taxes. At June 30, 2004, we have paid approximately $20,549,000 in
earn-out payments since the acquisition. We have a maximum payment obligation
of $25,000,000.
A summary of intangible assets that are included in "Other Assets" in
the Condensed Consolidated Balance Sheets at June 30, 2004 is presented
below:
Gross Net
Carrying Accumulated Carrying
Value Amortization Value
-------- ------------ --------
(In thousands)
Amortized intangible assets:
Rights-of-way.......................... $ 3,564 $ 2,627 $ 937
Contracts.............................. 1,369 1,049 320
Licenses and permits................... 1,074 261 813
------- ------- -------
6,007 3,937 2,070
------- ------- -------
Unamortized intangible assets:
Liquor licenses........................ 7,416 - 7,416
------- ------- -------
Total intangible assets.................. $13,423 $ 3,937 $ 9,486
======= ======= =======
14
Intangible asset amortization expense for the three and six months
ended June 30, 2004 was $95,800 and $205,000, respectively. Intangible
asset amortization expense for the three and six months ended June 30,
2003 was $140,900 and $235,000, respectively. Estimated amortization
expense for the five succeeding fiscal years is as follows:
(In thousands)
--------------
2004 remainder.................. $ 192
2005............................ 384
2006............................ 381
2007............................ 238
2008............................ 196
2009............................ 196
15
NOTE 6 - DISCONTINUED OPERATIONS, ASSET DISPOSALS, AND ASSETS HELD FOR SALE:
The following table contains information regarding our discontinued
operations, all of which are included in our retail group and include some
service station/convenience stores in both periods and our travel center
in 2003.
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ----------------
2004 2003 2004 2003
------ ------ ------ -------
(In thousands)
Net revenues......................... $ 225 $9,164 $ 809 $21,351
Net operating loss................... $ (33) $ (180) $ (131) $ (426)
Gain/(loss) on disposal.............. $ 389 $ (286) $ 389 $ (159)
Impairment and other write-downs..... $ (859) $ (76) $ (859) $ (76)
------ ------ ------ -------
Loss before income taxes............. $ (503) $ (542) $ (601) $ (661)
------ ------ ------ -------
Net income/(loss).................... $ (312) $ (325) $ (372) $ (396)
Allocated goodwill included in
gain/(loss) on disposal............ $ 38 $ 12 $ 38 $ 62
Included in "Assets Held for Sale" in the accompanying Condensed
Consolidated Balance Sheets are the following categories of assets.
June 30, December 31,
2004 2003
--------- ------------
(In thousands)
Closed retail units..................... $ 946 $1,318
Vacant land............................. 411 905
------ ------
$1,357 $2,223
====== ======
All of these assets are or were being marketed for sale at the
direction of management. We expect to dispose of the remaining properties
within the next twelve months.
In the first quarter of 2004, we sold one closed retail unit, and in
the first quarter of 2003 we sold two retail units, one of which was
closed.
16
In the second quarter of 2004, we sold 40 acres of vacant land known
as the Jomax property for approximately $5,341,000, net of expenses. In
addition, we also sold two operating service station/convenience stores
for approximately $812,000, net of expenses. Furthermore, we recorded a
loss on impairment of approximately $859,000 on two pieces of vacant land
and a retail unit that was classified as held for sale. These properties
were sold in July 2004.
17
NOTE 7 - EARNINGS PER SHARE:
The following table sets forth the computation of basic and diluted
earnings per share:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
---------- --------- ---------- ---------
Numerator (In thousands)
Earnings from continuing operations.............. $ 5,300 $ 772 $ 9,878 $ 3,174
Loss from discontinued operations................ (312) (325) (372) (396)
Cumulative effect of change in
accounting principle........................... - - - (704)
---------- --------- ---------- ---------
Net earnings..................................... $ 4,988 $ 447 $ 9,506 $ 2,074
========== ========= ========== =========
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
---------- --------- ---------- ---------
Denominator
Basic - weighted average shares outstanding...... 10,997,348 8,780,857 9,910,068 8,676,895
Effect of dilutive stock options................. 274,077 80,966 272,378 61,851
---------- --------- ---------- ---------
Diluted - weighted average shares outstanding.... 11,271,425 8,861,823 10,182,446 8,738,746
========== ========= ========== =========
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
---------- --------- ---------- ---------
Basic Earnings (Loss) Per Share
Earnings from continuing operations.............. $ 0.48 $ 0.09 $ 1.00 $ 0.37
Loss from discontinued operations................ (0.03) (0.04) (0.04) (0.05)
Cumulative effect of change in
accounting principle........................... - - - (0.08)
---------- --------- ---------- ---------
Net earnings..................................... $ 0.45 $ 0.05 $ 0.96 $ 0.24
========== ========= ========== =========
18
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
---------- --------- ---------- ---------
Diluted Earnings (Loss) Per Share
Earnings from continuing operations.............. $ 0.47 $ 0.09 $ 0.97 $ 0.36
Loss from discontinued operations................ (0.03) (0.04) (0.04) (0.04)
Cumulative effect of change in
accounting principle........................... - - - (0.08)
---------- --------- ---------- ---------
Net earnings..................................... $ 0.44 $ 0.05 $ 0.93 $ 0.24
========== ========= ========== =========
On February 25, 2004, we contributed 49,046 newly issued shares of
our common stock to our 401(k) plan as a discretionary contribution for
the year 2003.
On May 3, 2004, we issued 3,000,000 shares of our common stock at a
public offering price of $18.50 per share. On May 7, 2004, the
underwriters purchased an additional 283,300 shares pursuant to their
over-allotment option.
At June 30, 2004, there were 12,182,901 shares of our common stock
outstanding. There were no transactions subsequent to June 30, 2004, that
if the transactions had occurred before June 30,2004, would materially
change the number of common shares or potential common shares outstanding
as of June 30, 2004.
19
NOTE 8 - INVENTORIES:
Our inventories consist of the following:
June 30, December 31,
2004 2003
-------- ------------
(In thousands)
First-in, first-out ("FIFO") method:
Crude oil............................ $ 49,592 $ 54,771
Refined products..................... 78,407 68,622
Refinery and shop supplies........... 12,056 11,306
Merchandise.......................... 3,213 2,946
Retail method:
Merchandise.......................... 11,076 11,579
-------- --------
Subtotal........................... 154,344 149,224
Adjustment for LIFO.................... (36,537) (15,498)
-------- --------
Total.............................. $117,807 $133,726
======== ========
The portion of inventories valued on a LIFO basis totaled $81,731,000
and $89,239,000 at June 30, 2004 and December 31, 2003, respectively. The
data in the following paragraph will facilitate comparison with the
operating results of companies using the FIFO method of inventory
valuation.
If inventories had been determined using the FIFO method at June 30,
2004 and 2003, net earnings and diluted earnings per share would have been
higher (lower) as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2004 2003 2004 2003
------- ------- ------- -------
(In thousands, except per share data)
Net earnings.................... $ 5,631 $(8,644) $12,476 $ 1,788
Diluted earnings per share...... $ 0.50 $ (0.98) $ 1.23 $ 0.20
20
For interim reporting purposes, inventory increments expected to be
liquidated by year-end are valued at the most recent acquisition costs,
and inventory liquidations expected to be reinstated by year end are
excluded for LIFO inventory valuation calculations. The LIFO effects of
inventory increments not expected to be liquidated by year-end, and the
LIFO effects of inventory liquidations not expected to be reinstated by
year-end, are recorded in the period such increments and liquidations
occur.
In the first quarter of 2004, we liquidated certain lower cost
refining crude oil LIFO inventory layers, which resulted in an increase in
our net earnings and related diluted earnings per share as follows:
Six Months Ended
June 30, 2004
----------------
(In thousands, except per share data)
Net earnings.................... $ 538
Diluted earnings per share...... $ 0.05
The LIFO layers that were liquidated were deemed to be a permanent
liquidation due to the terms of our agreement with Statoil regarding the
ownership of crude oil under the agreement. There were no similar
liquidations in 2003.
21
NOTE 9 - DERIVATIVE INSTRUMENTS:
We are exposed to various market risks, including changes in certain
commodity prices and interest rates. To manage these normal business
exposures, from time to time, we use commodity futures and options
contracts to reduce price volatility, to fix margins in our refining and
marketing operations, and to protect against price declines associated
with our crude oil and finished products inventories.
In the first half of 2003, we entered into various crude oil futures
contracts in order to economically hedge crude oil inventories and
purchases for the Yorktown refinery operations. For the three and six
months ended June 30, 2003, we recognized losses on these contracts of
approximately $161,000 and $1,594,000, respectively, in cost of products
sold. These transactions did not qualify for hedge accounting in
accordance with SFAS No. 133 "Accounting for Derivative Instruments and
Hedging Activities," as amended, and accordingly were marked to market
each month. There were no similar transactions in the first half of 2004,
and there were no open crude oil futures contracts or other commodity
derivative contracts at June 30, 2004.
22
NOTE 10 - PENSION AND POST-RETIREMENT BENEFITS:
In December 2003, FASB revised SFAS No. 132, "Employers' Disclosures
about Pensions and Other Postretirement Benefits," to enhance disclosures
of relevant accounting information by providing additional information on
plan assets, obligations, cash flows, and net cost. The components of the
Net Periodic Benefit Cost are as follows:
Yorktown
Cash Balance Plan
-----------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost........................... $ 345,005 $ 287,996 $ 690,010 $ 575,992
Interest cost.......................... 134,294 132,739 268,588 265,478
Expected return on plan assets......... (28,624) (5,891) (57,248) (11,782)
Amortization of prior service costs.... - - - -
Amortization of net (gain)/loss........ - - - -
--------- --------- --------- ---------
Net Periodic Benefit Cost.............. $ 450,675 $ 414,844 $ 901,350 $ 829,688
========= ========= ========= =========
Yorktown
Retiree Medical Plan
-----------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
---------------------- ----------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Service cost........................... $ 51,893 $ 48,095 $ 103,786 $ 96,190
Interest cost.......................... 48,673 44,403 97,346 88,806
Expected return on plan assets......... - - - -
Amortization of prior service costs.... - - - -
Amortization of net (gain)/loss........ 4,374 2,537 8,748 5,074
--------- --------- --------- ---------
Net Periodic Benefit Cost.............. $ 104,940 $ 95,035 $ 209,880 $ 190,070
========= ========= ========= =========
We previously disclosed in our financial statements for the year
ended December 31, 2003, that we expected to contribute $2,200,000 to our
Yorktown Cash Balance Plan in 2004. Due to recent legislation, which
affected the calculation of our required contribution, we expect to
contribute $1,836,000 to the plan. As of June 30, 2004, we had not made
any contributions to the plan. We presently anticipate making the
contribution on or before September 15, 2004.
23
On December 8, 2003, the President signed the Medicare Prescription
Drug, Improvement and Modernization Act of 2003 (the "Act"). One feature
of the Act is a government subsidy of prescription drug costs. We have not
yet quantified the effect of the subsidy, if any, on the accumulated post-
retirement benefit obligation or the net periodic post-retirement benefit
cost under our Yorktown Retiree Medical Benefit Plan in our financial
statements and accompanying notes. Specific accounting guidance for this
subsidy is effective July 1, 2004 and will, therefore, be reflected in the
quarterly period beginning July 1, 2004.
24
NOTE 11 - LONG-TERM DEBT:
Our long-term debt consisted of the following:
June 30, December 31,
2004 2003
-------- ------------
(In thousands)
11% senior subordinated notes, due 2012, net
of unamortized discount of $3,788 and $5,288,
interest payable semi-annually...................... $145,040 $194,712
9% senior subordinated notes, due 2007,
interest payable semi-annually...................... - 150,000
8% senior subordinated notes, due 2014,
net of unamortized discount of $2,533,
interest payable semi-annually...................... 147,467 -
Senior secured revolving credit facility, due 2005,
floating interest rate, interest payable monthly.... - -
Senior secured mortgage loan facility, due 2005,
floating interest rate, principal and interest
payable monthly..................................... 17,556 22,000
Other................................................. 2 17
-------- --------
Subtotal............................................ 310,065 366,729
Less current portion.................................. (17,558) (11,128)
-------- --------
Total............................................... $292,507 $355,601
======== ========
On April 13, 2004, we made an offer to purchase for cash all
$150,000,000 aggregate principal amount outstanding of our 9% senior
subordinated notes due 2007 (the "9% notes") at a price of 103.375% of
their principal amount, plus accrued interest. The offer included a
consent solicitation, which expired on April 26, 2004. The offer was
subject to our successful completion of a new offering of senior
subordinated notes.
At the expiration of the consent period on April 26, 2004, the
holders of $116,115,000 of our 9% notes had tendered into the tender
offer. The tender offer expired on May 10, 2004. On May 3, 2004, and May
11, 2004, we purchased all of the 9% notes tendered in the consent
solicitation and tender offer. On May 11, 2004, we provided irrevocable
notice to the trustee to redeem the rest of the 9% notes that were not
tendered when the tender offer expired. The redemption of the remaining 9%
notes occurred on June 11, 2004.
25
On April 28, 2004, we priced our offering of $150,000,000 aggregate
principal amount of 8% senior subordinated notes due 2014 at a discount,
to yield 8-1/4%. The offering closed on May 3, 2004. At closing, we
received net proceeds (before expenses) of approximately $147,466,500. We
used all of the net proceeds of the new senior subordinated notes
offering, together with cash on hand, to settle the tender offer and
consent solicitation and to redeem all 9% notes that remained outstanding
after the expiration of the tender offer.
On May 3, 2004, we issued 3,000,000 shares of our common stock at a
public offering price of $18.50 per share. In connection with the
offering, we granted the underwriters an option for a period of 30 days
from the initial offering to purchase up to an additional 450,000 shares
of common stock to cover over-allotments, if any. On May 7, 2004, the
underwriters purchased an additional 283,300 shares pursuant to their
over-allotment option. We received net proceeds from the two sales of
approximately $57,374,000. On June 17, 2004, we used all of the net
proceeds of the common stock offering to redeem a portion of our
outstanding 11% senior subordinated notes due 2012 (including interest to
the date of redemption and the redemption premium) through the exercise of
the provision of the indenture governing the notes that allows us to
repurchase such debt as a result of an equity offering. The redemption
date was June 17, 2004.
Repayment of both the 11% and 8% senior subordinated notes
(collectively, the "Notes") is jointly and severally guaranteed on an
unconditional basis by our direct and indirect wholly owned subsidiaries,
subject to a limitation designed to ensure that such guarantees do not
constitute a fraudulent conveyance. Except as otherwise specified in the
indentures pursuant to which the Notes were issued, there are no
restrictions on the ability of our subsidiaries to transfer funds to us in
the form of cash dividends, loans or advances. General provisions of
applicable state law, however, may limit the ability of any subsidiary to
pay dividends or make distributions to us in certain circumstances.
The indentures governing the notes contain restrictive covenants
that, among other things, restrict our ability to:
- create liens;
- incur or guarantee debt;
- pay dividends;
- repurchase shares of our common stock;
- sell certain assets or subsidiary stock;
- engage in certain mergers;
- engage in certain transactions with affiliates; or
- alter our current line of business.
In addition, subject to certain conditions, we are obligated to offer
to repurchase a portion of the notes at a price equal to 100% of the
principal amount thereof, plus accrued and unpaid interest, if any, to the
26
date of repurchase, with the net cash proceeds of certain sales or other
dispositions of assets. Upon a change of control, we would be required to
offer to repurchase all of the notes at 101% of the principal amount
thereof, plus accrued interest, if any, to the date of purchase. At June
30, 2004, retained earnings available for dividends under the most
restrictive terms of the indentures were approximately $20,663,000.
At June 30, 2004, we had a $100,000,000 three-year senior secured
revolving credit facility (the "Credit Facility") with a group of banks.
There were no direct borrowings outstanding under this facility at June
30, 2004 and December 31, 2003, and there were approximately $34,212,000
at June 30, 2004 and $36,961,000 at December 31, 2003 of irrevocable
letters of credit outstanding, primarily to crude oil suppliers, insurance
companies and regulatory agencies. The interest rate applicable to the
Credit Facility was based on various short-term indices. At June 30, 2004,
this rate was approximately 5.2% per annum. We were required to pay a
quarterly commitment fee of 0.50% per annum of the unused amount of the
facility.
On July 15, 2004, we amended and restated the Credit Facility. Under
the new Credit Facility, our existing borrowing costs are reduced and
certain of the covenants have been relaxed. The amended and restated
Credit Facility is primarily a working capital and letter of credit
facility. The availability of funds under this facility is the lesser of
(i) $100,000,000, or (ii) the amount determined under a borrowing base
calculation tied to the eligible accounts receivable and inventories. We
have a option exercisable one time to increase the size of the facility to
up to $125,000,000. At July 31, 2004, the availability of funds under the
Credit Facility was $100,000,000. There were no direct borrowings
outstanding under this facility at July 31, 2004, and there were
approximately $42,912,000 of irrevocable letters of credit outstanding,
primarily to crude oil suppliers, insurance companies and regulatory
agencies.
The interest rate applicable to the Credit Facility is tied to
various short-term indices. At July 31, 2004, the weighted average rate
was approximately 3.82% per annum. We are required to pay a quarterly
commitment fee of 0.50% per annum of the unused amount of the facility.
The obligations under the Credit Facility are guaranteed by each of
our principal subsidiaries and secured by a security interest in our
personal property, including:
- accounts receivable;
- inventory;
- contracts;
- chattel paper;
- trademarks;
- copyrights;
- patents;
- license rights;
- deposits; and
- investment accounts and general intangibles.
27
The Credit Facility contains negative covenants limiting, among other
things:
- our ability to incur additional indebtedness;
- create liens;
- dispose of assets;
- consolidate or merge;
- make loans and investments;
- enter into transactions with affiliates;
- use loan proceeds for certain purposes;
- guarantee obligations and incur contingent obligations;
- enter into agreements restricting the ability of subsidiaries to
pay dividends to us;
- make distributions or stock repurchases;
- make significant changes in accounting practices or change our
fiscal year; and
- except on terms acceptable to the senior secured lenders, to
prepay or modify subordinated indebtedness.
The Credit Facility also requires us to meet certain financial
covenants, including maintaining a minimum consolidated net worth, a
minimum fixed charge coverage ratio, and a maximum consolidated funded
indebtedness to total capitalization percentage.
Our failure to satisfy any of the covenants in the Credit facility is
an event of default under the Credit Facility. The Credit Facility also
includes other customary events of default, including, among other things,
a cross-default to our other material indebtedness and certain changes of
control.
We also had a $40,000,000 three-year senior secured mortgage loan
facility (the "Loan Facility") with a group of financial institutions that
at June 30, 2004 had a balance of $17,556,000. We prepaid the remaining
balance on July 14, 2004 from cash on hand. The interest rate applicable
to the Loan Facility was based on various short-term indices. At June 30,
2004, this rate was approximately 6.7% per annum.
Separate financial statements of our subsidiaries are not included
herein because the aggregate assets, liabilities, earnings, and equity of
the subsidiaries are substantially equivalent to our assets, liabilities,
earnings, and equity on a consolidated basis; the subsidiaries are jointly
and severally liable for the repayment of the Notes; and the separate
financial statements and other disclosures concerning the subsidiaries are
not deemed by us to be material to investors.
28
NOTE 12 - COMMITMENTS AND CONTINGENCIES
We have various legal actions, claims, assessments and other
contingencies arising in the normal course of our business, including
those matters described below, pending against us. Some of these matters
involve or may involve significant claims for compensatory, punitive or
other damages. These matters are subject to many uncertainties, and it is
possible that some of these matters could be ultimately decided, resolved
or settled adversely. We have recorded accruals for losses related to
those matters that we consider to be probable and that can be reasonably
estimated. We currently believe that any amounts exceeding our recorded
accruals should not materially affect our financial condition or
liquidity. It is possible, however, that the ultimate resolution of these
matters could result in a material adverse effect on our results of
operations for a particular reporting period.
Federal, state and local laws relating to the environment, health and
safety affect nearly all of our operations. As is the case with all
companies engaged in the refining and related businesses, we face
significant exposure from actual or potential claims and lawsuits
involving environmental matters. These matters include soil and water
contamination, air pollution and personal injuries or property damage
allegedly caused by substances made, handled, used, released or disposed
of by us or by our predecessors.
Future expenditures related to environmental, health and safety
matters cannot be reasonably quantified in many circumstances for various
reasons. These reasons include the speculative nature of remediation and
clean-up cost estimates and methods, imprecise and conflicting data
regarding the hazardous nature of various types of substances, the number
of other potentially responsible parties involved, various defenses that
may be available to us, and changing environmental, health and safety
laws, including changing interpretations of those laws.
ENVIRONMENTAL AND LITIGATION ACCRUALS
As of June 30, 2004 and December 31, 2003, we had environmental
liability accruals of approximately $7,138,000 and $7,592,000,
respectively, which are summarized below, and litigation accruals in the
aggregate of $1,123,000 at June 30, 2004 and $573,000 at December 31,
2003. The environmental accruals are recorded in the current and long-term
sections of our consolidated balance sheets and the litigation accruals
are all recorded as current liabilities.
29
SUMMARY OF ACCRUED ENVIRONMENTAL CONTINGENCIES
(In thousands)
December 31, Increase June 30,
2003 (Decrease) Payments 2004
------------ ---------- -------- --------
Yorktown 1991 Order....................... $ 5,916 $ - $ (452) $ 5,464
Farmington Refinery....................... 570 - - 570
Bloomfield Refinery....................... 267 - - 267
Ciniza - Solid Waste Management Units..... 275 - - 275
Ciniza - Land Treatment Facility.......... 186 - - 186
Ciniza Well Closures...................... 140 - - 140
Retail Service Stations - Various......... 146 10 (1) 155
East Outfall - Bloomfield................. 25 - (1) 24
Bloomfield Tank Farm (Old Terminal)....... 67 - (10) 57
------- ----- ------ -------
Totals................................. $ 7,592 $ 10 $ (464) $ 7,138
======= ===== ====== =======
Approximately $6,762,000 of our environmental accruals are for the
following projects:
- certain environmental obligations assumed in connection with our
acquisitions of the Yorktown refinery and the Bloomfield refinery;
- the remediation of the hydrocarbon plume that appears to extend no
more than 1,800 feet south of our inactive Farmington refinery;
- the closure of certain solid waste management units at the Ciniza
refinery in accordance with the refinery's Resource Conservation
and Recovery Act permit; and
- closure of the Ciniza refinery land treatment facility, including
post-closure expenses.
The remaining amount of the accruals relate to smaller remediation
and monitoring projects.
YORKTOWN ENVIRONMENTAL LIABILITIES
We assumed certain liabilities and obligations in connection with our
purchase of the Yorktown refinery from BP. BP agreed to reimburse us in
specified amounts for some matters. Among other things, and subject to
certain exceptions, we assumed responsibility for all costs, expenses,
liabilities, and obligations under environmental, health and safety laws
caused by, arising from, incurred in connection with or relating to the
ownership of the refinery or its operation. We agreed to reimburse BP for
losses incurred in connection with or related to liabilities and
obligations assumed by us. Certain environmental matters relating to the
Yorktown refinery are discussed below.
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YORKTOWN CONSENT DECREE
We assumed environmental obligations that include BP's
responsibilities relating to the Yorktown refinery under a consent decree
among various parties covering many locations (the "Consent Decree").
Parties to the Consent Decree include the United States, BP Exploration
and Oil Co., Amoco Oil Company, and Atlantic Richfield Company. We assumed
BP's responsibilities as of January 18, 2001, the date the Consent Decree
was lodged with the court. As applicable to the Yorktown refinery, the
Consent Decree requires, among other things, reduction of NOx, SO2 and
particulate matter emissions and upgrades to the refinery's leak detection
and repair program. We estimate that we will incur capital expenditures of
between $20,000,000 and $27,000,000 to comply with the Consent Decree
through 2006, although we believe we will incur most of those expenditures
in 2005 and 2006. In addition, we estimate that we will incur operating
expenses associated with the requirements of the Consent Decree of between
$1,600,000 and $2,600,000 per year.
YORKTOWN 1991 ORDER
In connection with the Yorktown acquisition, we also assumed BP's
obligations under an administrative order issued by EPA in 1991 under the
Resource Conservation and Recovery Act. The order requires an
investigation of certain areas of the refinery and the development of
measures to correct any releases of contaminants or hazardous substances
found in these areas. A Resource Conservation and Recovery Act Facility
Investigation was conducted and approved conditionally by EPA in 2002.
Following the investigation, in November 2003, a Risk
Assessment/Corrective Measures Study ("RA/CMS") was finalized, which
summarized the remediation measures agreed upon by us, EPA, and the
Virginia Department of Environmental Quality ("VDEQ"). The RA/CMS includes
certain investigation, sampling, monitoring, and cleanup measures,
including the construction of an on-site corrective action management unit
that would be used to consolidate hazardous solid materials associated
with these measures. These proposed actions relate to soil, sludge, and
remediation wastes relating to solid waste management units. Groundwater
in the aquifers underlying the refinery, and surface water and sediment in
a small pond and tidal salt marsh on the refinery property also are
addressed in the RA/CMS.
Based upon the RA/CMS, EPA issued a proposed cleanup plan for public
comment in December 2003 setting forth preferred corrective measures for
remediating soil, groundwater, sediment, and surface water contamination
at the refinery. Following the public comment period, EPA issued its final
remedy decision and response to comments in April 2004. EPA currently is
developing the administrative consent order pursuant to which we will
implement the corrective measures.
31
We estimate that expenses associated with the actions described in
the clean up plan will cost between $19,000,000 and $21,000,000, and will
be incurred over a period of approximately 30 years. We believe that about
$5,000,000 of this amount will be incurred over an initial 3-year period,
and additional expenditures of about $5,000,000 will be incurred over the
following 3-year period. As more fully described below, we may not,
however, be responsible for all of these expenditures due to the
environmental reimbursement provisions included in our purchase agreement
with BP. Additionally, the facility's underground sewer system will be
cleaned, inspected and repaired as needed as part of the RA/CMS process.
We anticipate that this work will cost from $3,000,000 to $5,000,000 over
a period of three to five years, beginning around the time the
construction of the corrective action management unit and related
remediation work is completed in approximately 2007 or 2008.
CLAIMS FOR REIMBURSEMENT FROM BP
BP has agreed to reimburse us for all losses that are caused by or
relate to property damage caused by, or any environmental remediation
required due to, a violation of environmental health, and safety laws
during BP's operation of the refinery. In order to have a claim against
BP, however, the total of all our losses must exceed $5,000,000, in which
event our claim only relates to the amount exceeding $5,000,000. After
$5,000,000 is reached, our claim is limited to 50% of the amount by which
our losses exceed $5,000,000 until the total of all our losses exceeds
$10,000,000. After $10,000,000 is reached, our claim would be for 100% of
the amount by which our losses exceed $10,000,000. In applying these
provisions, losses amounting to a total of less than $250,000 arising out
of the same event are not added to any other losses for purposes of
determining whether and when the $5,000,000 or $10,000,000 thresholds have
been reached. After the $5,000,000 or $10,000,000 thresholds have been
reached, BP has no obligation to reimburse us for any losses amounting to
a total of less than $250,000 arising out of the same event. Except as
specified in the refinery purchase agreement, in order to seek
reimbursement from BP, we were required to notify BP of a claim within two
years following the closing date. Further, BP's total liability for
reimbursement under the refinery purchase agreement, including liability
for environmental claims, is limited to $35,000,000.
FARMINGTON REFINERY
In 1973, we constructed the Farmington refinery that was operated
until 1982. In 1985, we became aware of soil and shallow groundwater
contamination at this facility. We hired environmental consulting firms to
investigate the contamination and undertake remedial action. The
consultants identified several areas of contamination in the soils and
shallow groundwater underlying the Farmington property. One of our
consultants indicated that contamination attributable to past operations
at the Farmington property had migrated off the refinery property,
including a hydrocarbon plume that appears to extend no more than 1,800
feet south of the refinery property. Our remediation activities are
ongoing under the supervision of the New Mexico Oil Conservation Division
("OCD"), although OCD has not issued a cleanup order.
32
LEE ACRES LANDFILL
The Farmington refinery property is located next to the Lee Acres
Landfill, a closed landfill formerly operated by San Juan County. The
landfill is situated on lands owned by the United States Bureau of Land
Management (the "BLM"). Industrial and municipal wastes were disposed of
in the landfill by numerous sources. While the landfill was operational,
we used it to dispose of office trash, maintenance shop trash, used tires,
and water from the Farmington refinery's evaporation pond.
The landfill was added to the National Priorities List as a
Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA") Superfund site in 1990. In connection with this listing, EPA
defined the site as the landfill and the landfill's associated groundwater
plume. EPA excluded any releases from the Farmington refinery itself from
the definition of the site. In May 1991, EPA notified us that we may be a
potentially responsible party under CERCLA for the release or threatened
release of hazardous substances, pollutants or contaminants at the
landfill.
BLM made a proposed cleanup plan for the landfill available to the
public in 1996. Remediation alternatives examined by BLM in connection
with the development of its proposed plan ranged in projected cost from no
cost to approximately $14,500,000. BLM proposed the adoption of a remedial
action alternative that it believes would cost approximately $3,900,000 to
implement. BLM's $3,900,000 cost estimate is based on certain assumptions
that may or may not prove to be correct and is contingent on confirmation
that the remedial actions, once implemented, are adequately addressing
landfill contamination. For example, if assumptions regarding groundwater
mobility and contamination levels are incorrect, BLM is proposing to take
additional remedial actions with an estimated cost of approximately
$1,800,000.
BLM has received public comment on its proposed plan. The final
remedy for the site, however, has not yet been selected. Although we were
given reason to believe that a final remedy would be selected in 2003,
that selection did not occur. We have been advised that the site remedy
may be announced in 2004. In 1989, one of our consultants estimated, based
on various assumptions, that our share of potential liability could be
approximately $1,200,000. This figure was based upon estimated landfill
remediation costs significantly higher than those being proposed by BLM.
The figure also was based on the consultant's evaluation of such factors
as available clean-up technology, BLM's involvement at the site and the
number of other entities that may have had involvement at the site, but
did not include an analysis of all of our potential legal defenses and
arguments, including possible setoff rights.
Potentially responsible party liability is joint and several, which
means that a responsible party may be liable for all of the clean-up costs
33
at a site even though the party was responsible for only a small part of
the contamination. Although it is possible that we may ultimately incur
liability for clean-up costs associated with the landfill, a reasonable
estimate of the amount of this liability, if any, cannot be made at this
time for various reasons. These reasons include:
- the final site remedy has not been selected;
- a number of entities had involvement at the site;
- allocation of responsibility among potentially responsible parties
has not yet been made; and
- potentially applicable factual and legal issues have not been
resolved.
We have not recorded a liability in relation to BLM's proposed plan
because the amount of any potential liability is currently not
determinable.
BLM may assert claims against others and us for reimbursement of
investigative, cleanup and other costs incurred by BLM in connection with
the landfill and surrounding areas. We may assert claims against BLM in
connection with contamination that may be originating from the landfill.
Private parties and other governmental entities also may assert claims
against us, BLM, and others for property damage, personal injury and other
damages allegedly arising out of any contamination originating from the
landfill and the Farmington property. Parties also may request judicial
determination of their rights and responsibilities, and the rights and
responsibilities of others, in connection with the landfill and the
Farmington property. Currently, however, there is no outstanding
litigation against us by BLM or any other party.
BLOOMFIELD REFINERY
In connection with the acquisition of the Bloomfield refinery, we
assumed certain environmental obligations including Bloomfield Refining
Company's ("BRC") obligations under an administrative order issued by EPA
in 1992 pursuant to the Resource Conservation and Recovery Act. The order
required BRC to investigate and propose measures for correcting any
releases of hazardous waste or hazardous constituents at or from the
Bloomfield refinery. EPA has delegated its oversight authority over the
order to NMED's Hazardous Waste Bureau ("HWB"). In December 2002, HWB and
OCD approved a cleanup plan for the refinery, subject to various actions
to be taken by us to implement the plan. We estimate that remediation
expenses associated with the cleanup plan will be approximately $267,000,
and that these expenses will be incurred through approximately 2018.
NOTICES OF VIOLATION AT FOUR CORNERS REFINERIES
In June 2002, we received a draft compliance order from the NMED in
connection with alleged violations of air quality regulations at the
Ciniza refinery. These alleged violations relate to an inspection
completed in April 2001.
34
In August 2002, we received a compliance order from NMED in
connection with alleged violations of air quality regulations at the
Bloomfield refinery. These alleged violations relate to an inspection
completed in September 2001.
In the second quarter of 2003, EPA informally told us that it also
intended to allege air quality violations in connection with the 2001
inspections at both refineries. We have since participated in joint
meetings with NMED and EPA. These discussions have included alleged
violations through December 31, 2003, in addition to matters relating to
the 2001 inspections. We currently estimate that, if no settlement is
reached, potential penalties could amount to between $4,000,000 and
$6,000,000. We have accrued significantly less than these amounts because
settlement discussions with NMED and EPA are ongoing. These discussions
may result in reductions in the amount of potential penalties. In lieu of
fines and as part of an administrative settlement, we expect that EPA and
NMED may require us to undertake certain environmentally beneficial
projects, known as supplemental environmental projects. We have not yet
determined the nature or scope of any work that may be required in lieu of
fines.
In the first quarter of 2004, EPA told us that any administrative
settlement also must be consistent with the consent decrees EPA has
entered with other refiners as part of its national refinery enforcement
program. In these other settlements, EPA generally has required that the
refiner:
- implement controls to reduce emissions of nitrogen oxide, sulfur
dioxide, and particulate matter from the largest emitting process
units;
- upgrade leak-detection and repair practices;
- minimize the number and severity of flaring events; and
- adopt strategies to ensure compliance with benzene waste
requirements.
We currently anticipate that it would cost us between approximately
$14,000,000 and $20,000,000 to make the necessary modifications at our
refineries to comply with these national refinery enforcement program
requirements, and that it might be possible to spread these costs over a
period of five to eight years following the date of any settlement.
Further, on-going annual operating costs associated with these
modifications are currently estimated to be as much as $1,500,000 per
year. We currently anticipate that the majority of the capital and
operating costs would be incurred in the later portion of the projected
five to eight year phase-in period. These costs could be subject to
reduction in the event of the temporary, partial or permanent
discontinuance of operations at one or both facilities, as more fully
discussed in the section titled "Other" in Part I, Item 2, Management's
Discussion and Analysis of Financial Condition and Results of Operations.
As of June 30, 2004, we were continuing joint settlement discussions
with NMED and EPA.
35
JET FUEL CLAIM
In February 2003, we filed a complaint against the United States in
the United States Court of Federal Claims related to military jet fuel
that we sold to the Defense Energy Support Center ("DESC") from 1983
through 1994. We asserted that the U.S., acting through DESC, underpaid
for the jet fuel by about $17,000,000. Our claims include a request that
we be made whole in connection with payments that were less than the fair
market value of the fuel, as well as a request that we be reimbursed for
the value of transporting the fuel in some contracts, as well as for
certain additional costs of complying with the government's special
requirements. The U.S. has said that it may counterclaim and assert, based
on its interpretation of the contracts, that we owe additional amounts of
between $2,100,000 and $4,900,000. In the first quarter of 2004, the
United States Court of Appeals for the Federal Circuit agreed to hear
appeals in other jet fuel cases. The issues before the Court of Appeals in
these cases are almost identical to the issues in our case. The judge in
our case has halted any further action, pending a guiding decision by the
Court of Appeals. As of June 30, 2004, we are continuing to await further
action by the appellate court. Due to the preliminary nature of this
matter, there can be no assurance that we will ultimately prevail on our
claims or the U.S.'s potential counterclaim, nor is it possible to predict
when any payment will be received if we are successful. Accordingly, we
have not recorded a receivable for these claims or a liability for any
potential counterclaim.
MTBE LITIGATION
Lawsuits have been filed in numerous states alleging that MTBE, a
blendstock used by many refiners in producing specially formulated
gasoline, has contaminated water wells. MTBE contamination primarily
results from leaking underground or aboveground storage tanks. We are a
defendant in three MTBE lawsuits filed in the fourth quarter of 2003. The
plaintiffs are two Virginia county boards of education and a Virginia
county water authority. The suits allege MTBE contamination of water wells
owned and operated by the plaintiffs. The plaintiffs assert that numerous
refiners, distributors, or sellers of MTBE and/or gasoline containing MTBE
are responsible for the contamination. The plaintiffs also claim that the
defendants are jointly and severally liable for compensatory and punitive
damages, costs, and interest. Joint and several liability means that each
defendant may be liable for all of the damages even though that party was
responsible for only a small part of the damages. As of June 30, 2004, we
are continuing to vigorously defend these lawsuits. It is possible that we
could be named as a defendant in additional lawsuits, which we also would
plan to vigorously defend.
YORKTOWN POWER OUTAGE CLAIM
On April 28, 2003, a breaker failure disrupted operations at the
electric generation plant that supplies our Yorktown refinery with power.
As a result of the failure, the refinery suffered a complete loss of power
36
and shut down all processing units. By the middle of May 2003, the
refinery was operating at full capacity. We incurred costs of
approximately $1,254,000 as a result of the loss of power, all of which we
expensed in the second quarter of 2003. Reduced production also resulted
in a loss of earnings. We are pursuing reimbursement from the power
station owner as well as other forms of relief. We are currently unable to
determine the probability of recovery of any amounts related to this
claim, and we have not recorded any receivables related to this claim.
CINIZA REFINERY INCIDENT
On April 8, 2004, a fire occurred at our Ciniza refinery in the
alkylation unit that produces high octane blending stock for gasoline. The
refinery is located near Gallup, New Mexico, and has a crude oil
throughput capacity of 20,800 barrels per day and a total capacity
including natural gas liquids of 26,000 barrels per day. The alkylation
unit has throughput capacity of 1,800 barrels per day. Emergency personnel
responded immediately and contained the fire to the alkylation unit,
although there also was some damage to ancillary equipment and to two
adjacent units. Four of our employees were injured and transported to an
Albuquerque hospital. Presently, three have been released and one remains
hospitalized.
As a result of the fire, we temporarily shut down all of the
operating units at the Ciniza refinery. The fire is currently under
investigation by the Occupational Health and Safety Board of the New
Mexico Environment Department ("OHSB") and the U.S. Chemical Safety and
Hazard Investigation Board. The OHSB investigation could result in fines
or penalties, which we would plan to vigorously contest. In June 2004, we
completed our own investigation with the assistance of an independent
refinery expert to determine the cause of the fire.
We had previously scheduled a major repair and upgrade shutdown
(known as a "turnaround"), which was to commence at the refinery on April
17, 2004, and some of the turnaround team already was on site at the
refinery when the fire occurred. In order to minimize the disruption to
the refinery's operations, we started the turnaround early. This allowed
us to work on the necessary repairs to the alkylation unit during the
turnaround period when the refinery was not operating anyway. Except for
repairs to the alkylation unit, the turnaround has been completed.
We expensed $1,740,000 associated with the fire damage including
$1,500,000 for insurance deductibles in the second quarter. We also
recorded a loss of $2,100,000 for the net book value of the assets
destroyed. In addition, we recorded $2,100,000 for the probable recovery
of insurance proceeds.
Based upon a very preliminary investigation, we had estimated that
the cost to repair the damage caused by the fire would be in the range of
$2,500,000 to $10,000,000 and that repairs would be completed before the
37
end of June. As the investigation proceeded, and we began to make repairs,
additional damage was discovered. We are in the process of completing the
repairs and we anticipate restarting the unit in the near future. The
repairs took longer than initially anticipated as we experienced delays in
receiving a vessel and instrumentation necessary to complete the repairs.
We currently estimate that the cost to repair the fire damage is
approximately $14,000,000. Further delays in receipt of materials may
extend our estimated completion date. We have property insurance coverage
that should cover a significant portion of the repair costs and also could
receive proceeds from business interruption insurance if the waiting
period and deductible level under the policy are exceeded. We also have
worker's compensation insurance to cover the physical injuries sustained
by personnel.
NEW MEXICO RETAIL STORE SAFETY REGULATIONS
In May 2004, OHSB issued regulations that require additional security
measures in the convenience store industry in New Mexico. These
requirements relate to exterior lighting, late night security, employee
training, door and window signage, and security surveillance systems and
alarms. In June 2004, the New Mexico Environmental Improvement Board
agreed to stay some of these regulations, including those related to late
night security, for further study. We currently anticipate that the cost
to comply with regulations that have not been stayed will not be material.
These regulations also are subject to legal challenge.
If, however, all the regulations go into effect in their original
form, we will incur additional costs to comply. For example, one way to
comply with the late night security requirements of the regulations is to
have two employees on duty between the hours of 5:00 p.m. and 5:00 a.m.
We estimate that having two employees at all of our stores during late
night hours could increase our payroll costs between $1,400,000 and
$1,900,000 annually. Alternately, we could add security enclosures to our
stores at an estimated one-time cost of approximately $2,200,000. We also
could incur additional one-time costs of approximately $300,000 for
enhanced security surveillance systems and alarms, safes, and security
signs for a total one-time cost of approximately $2,500,000, if the
security enclosure option was used. These are preliminary cost estimates
with many variables that could affect the actual costs. We are evaluating
our options for complying with these regulations.
FORMER CEO MATTERS
The board of directors terminated James E. Acridge as our President
and Chief Executive Officer on March 29, 2002, and replaced him as our
Chairman of the Board. Mr. Acridge's term of office as a director
subsequently expired on April 29, 2004.
On July 22, 2002, Mr. Acridge filed a lawsuit in the Superior Court
of Arizona for Maricopa County against a number of our officers and
directors. The lawsuit was also filed against unidentified accountants,
38
auditors, appraisers, attorneys, bankers and professional advisors. Mr.
Acridge alleged that the defendants wrongfully interfered with his
employment agreement and caused the board to fire him. The complaint
sought unspecified damages to compensate Mr. Acridge for the defendants'
alleged wrongdoing, as well as punitive damages, and costs and attorneys'
fees. The complaint also stated that Mr. Acridge intended to initiate a
separate arbitration proceeding against us, alleging that we breached his
employment agreement and violated an implied covenant of good faith and
fair dealing. The court subsequently ruled that the claims raised in Mr.
Acridge's lawsuit were subject to arbitration and the lawsuit was
dismissed. Arbitration proceedings have not been initiated. Subsequent to
the filing of the claims, Mr. Acridge filed for bankruptcy. The trustee
appointed in the Chapter 11 bankruptcy proceeding has questioned whether
the Superior Court should have stayed the lawsuit until after the
arbitration was completed instead of dismissing it. Regardless, we believe
that the officers and directors sued by Mr. Acridge are entitled to
indemnification from us in connection with the defense of, and any
liabilities arising out of, the claims alleged by Mr. Acridge.
In addition to Mr. Acridge's personal bankruptcy filing, Pinnacle
Rodeo LLC, Pinnacle Rawhide LLC, and Prime Pinnacle Peak Properties, Inc.,
three entities originally controlled by Mr. Acridge, have commenced
Chapter 11 bankruptcy proceedings. A Chapter 11 trustee has been appointed
in these cases. The four bankruptcy cases are administered together.
We have an outstanding loan to Mr. Acridge in the principal amount of
$5,000,000. In the fourth quarter of 2001, we established a reserve for
the entire amount of the loan plus interest accrued through December 31,
2001. The loan was subsequently written off, at which time the reserve was
removed. We have filed proofs of claim in the bankruptcy proceedings
seeking to recover amounts we believe are owed to us by Mr. Acridge, and
the other entities, including amounts relating to the outstanding
$5,000,000 loan. We also filed a complaint in the Acridge bankruptcy
proceeding on July 31, 2003, in which we sought a determination that
certain of the amounts we believe are owed to us by Mr. Acridge are not
dischargeable in bankruptcy. The court has entered a default against Mr.
Acridge in connection with our complaint. The court, however, has not yet
ruled on whether we are entitled to receive any of the damages that we
have requested. Even if the court decides that we can receive damages, we
do not know whether we would be able to recover any of these damages from
Mr. Acridge.
The official committee of unsecured creditors for the bankruptcy
cases filed a plan of reorganization on November 7, 2003. The plan
describes a process for the liquidation of the estates and the payment of
liquidation proceeds to creditors. It will only become effective if
approved by the bankruptcy court. Under the committee's plan, we would
make a payment for the benefit of unsecured creditors in the Acridge
estate. Additionally, we would give up all of our claims against the
estates, with the exception of a claim for our share of any assets of the
Acridge estate that have not yet been identified. In return, the four
39
estates would release us from all of their claims against us, if any. The
plan would not preclude us from pursuing our non-dischargeability
complaint against Mr. Acridge.
The court-appointed trustee in Mr. Acridge's personal bankruptcy has
retained counsel to investigate the claims that Mr. Acridge asserted in
his state court lawsuit, along with other pre-bankruptcy claims that Mr.
Acridge might have had against us, our officers or directors, or our
third-party advisors. The trustee's counsel ultimately informed us that he
believed that such potential claims might exist. We believe that, as a
result of Mr. Acridge's bankruptcy filing, any such claims would now
belong to Mr. Acridge's bankruptcy estate rather than to Mr. Acridge
personally, and the trustee has indicated that he also believes that the
claims that he has identified would belong to the estate.
We have evaluated the trustee's contentions and do not believe that
the potential claims have any merit. Nonetheless, in an effort to avoid
the considerable expense associated with litigation, we have discussed
resolution of these matters, both with the trustee and with the official
committee of unsecured creditors. These discussions include the
possibility of resolving the trustee's potential claims against us without
the need to await plan approval. The court has not taken any action on the
committee's plan during these negotiations, which are ongoing. Any
agreement reached with the trustee or the committee would require court
approval.
The trustee in the Prime Pinnacle proceeding filed a separate plan of
reorganization. The Prime Pinnacle trustee initially indicated that he was
going to object to the proof of claim that we filed in the Prime Pinnacle
proceeding. In addition, the Prime Pinnacle trustee indicated that he was
going to evaluate any possible preferential or fraudulent transfer of
assets from Prime Pinnacle to us in satisfaction of debts owed by Mr.
Acridge or his other entities. An agreement was subsequently reached
between the Prime Pinnacle trustee, the unsecured creditors committee, and
us. The committee agreed to carve out the Prime Pinnacle estate from the
Committee's plan. We agreed not to receive any distribution on our
unsecured claim against the Prime Pinnacle estate. The Prime Pinnacle
trustee agreed to incorporate the terms of the Committee's settlement with
us in the Prime Pinnacle plan and to release us from any claims the Prime
Pinnacle estate may have against us. The Prime Pinnacle trustee's
agreement to release us and our agreement not to receive a distribution
from the Prime Pinnacle estate are both conditioned upon the entry of a
final court order, which is not subject to appeal, confirming the
unsecured creditors committee's plan. The Prime Pinnacle plan, which
reflects these agreements, has been approved by the bankruptcy court.
40
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
COMPANY OVERVIEW
We refine and sell petroleum products and operate service stations
and convenience stores. Our operations are divided into three strategic
business units, the refining group, the retail group and Phoenix Fuel. The
refining group operates two refineries in the Four Corners area of New
Mexico and one refinery in Yorktown, Virginia. The refining group sells
its products to wholesale distributors and retail chains. Our retail group
operated 125 service stations at June 30, 2004. The retail group sells its
petroleum products and merchandise to consumers located in New Mexico,
Arizona and southern Colorado. Phoenix Fuel distributes commercial
wholesale petroleum products primarily in Arizona.
Our strategy is to maintain and improve our financial performance. To
this end, we are focused on several critical and challenging objectives.
We will be addressing these objectives in the short-term as well as over
the next three to five years. In our view, the most important of these
objectives are:
- increasing gross margins through management of inventories and
taking advantage of sales and purchasing opportunities, while
minimizing or reducing operating expenses and capital
expenditures;
- increasing the available crude oil supply for our Four Corners
refineries;
- cost effectively complying with current environmental regulations
as they apply to our refineries, including future clean air
standards, between now and the end of 2008;
- improving our overall financial health and flexibility by reducing
our debt and overall cost of capital, including our interest and
financing costs, and maximizing our return on capital employed; and
- evaluating opportunities for growth by acquisition.
CRITICAL ACCOUNTING POLICIES
A critical step in the preparation of our financial statements is the
selection and application of accounting principles, policies, and
procedures that affect the amounts that we report. In order to apply these
principles, policies, and procedures, we must make judgments, assumptions,
and estimates based on the best available information at the time. Actual
results may differ based on the accuracy of the information utilized and
subsequent events, some of which we may have little or no control over. In
addition, the methods used in applying the above may result in amounts
that differ considerably from those that would result from the application
41
of other acceptable methods. The development and selection of these
critical accounting policies, and the related disclosure below, have been
reviewed with the audit committee of our board of directors.
Our significant accounting policies, including revenue recognition,
inventory valuation, and maintenance costs, are described in Note 1 to our
Consolidated Financial Statements included in our Annual Report on Form
10-K for the year ended December 31, 2003. The following accounting
policies are considered critical due to the uncertainties, judgments,
assumptions and estimates involved:
- accounting for contingencies, including environmental remediation
and litigation liabilities;
- assessing the possible impairment of long-lived assets;
- accounting for asset retirement obligations; and
- accounting for our pension and post-retirement benefit plans.
There have been no changes to these policies in 2004.
RESULTS OF OPERATIONS
The following discussion of our Results of Operations should be read
in conjunction with the Consolidated Financial Statements and related
notes thereto included in Part I, Item 1, and Part I, Item 8 in our Annual
Report on Form 10-K for the year ended December 31, 2003.
Below is operating data for our operations:
42
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- ---------------------
2004 2003 2004 2003
--------- --------- --------- ---------
Refining Group Operating Data:
Four Corners Operations:
Crude Oil/NGL Throughput (BPD)................ 26,463 31,854 27,372 31,502
Refinery Sourced Sales Barrels (BPD).......... 25,175 30,472 26,395 31,000
Average Crude Oil Costs ($/Bbl)............... $ 35.97 $ 27.90 $ 34.30 $ 29.55
Refining Margins ($/Bbl)...................... $ 12.44 $ 9.41 $ 10.30 $ 8.86
Yorktown Operations:
Crude Oil/NGL Throughput (BPD)................ 67,639 52,316 64,420 54,275
Refinery Sourced Sales Barrels (BPD).......... 69,862 54,046 66,843 56,703
Average Crude Oil Costs ($/Bbl)............... $ 35.53 $ 28.06 $ 34.11 $ 30.74
Refining Margins ($/Bbl)...................... $ 6.20 $ 2.82 $ 5.89 $ 3.57
Retail Group Operating Data:
(Continuing operations only)
Fuel Gallons Sold (000's)....................... 38,326 37,587 75,678 72,399
Fuel Margins ($/gal)............................ $ 0.202 $ 0.223 $ 0.180 $ 0.194
Merchandise Sales ($ in 000's).................. $ 34,483 $ 32,472 $ 65,166 $ 60,829
Merchandise Margins............................. 24% 30% 25% 30%
Operating Retail Outlets at Period End:
Continuing Operations......................... 125 125 125 125
Discontinued Operations....................... - 4 - 4
Phoenix Fuel Operating Data:
Fuel Gallons Sold (000's)....................... 124,342 105,148 237,186 208,185
Fuel Margins ($/gal)............................ $ 0.055 $ 0.055 $ 0.054 $ 0.051
Lubricant Sales ($ in 000's).................... $ 7,827 $ 6,212 $ 14,703 $ 11,827
Lubricant Margins............................... 13% 15% 13% 16%
We believe the comparability of our continuing results of operations
for the three and six months ended June 30, 2004 with the same periods in
2003 was affected by, among others, the following factors:
- stronger net refining margins for our refineries in 2004,
due to, among other things:
- increased finished product demand;
- increased sales in our Tier 1 markets;
- reduced imports of foreign gasoline, due to a reduction in
gasoline sulfur limits;
- elimination of MTBE in Connecticut, New York, and California; and
- tight finished product supply in certain of our market areas.
43
- the processing of lower priced acidic crude oils at our
Yorktown refinery, including crude oil purchased under our supply
agreement with Statoil that began deliveries in late February
2004;
- a processing unit turnaround at our Yorktown refinery in 2003,
which resulted in the refinery being out of operation from March
21, 2003 to April 16, 2003;
- On April 28, 2003, a breaker failure disrupted operations at the
electric generation plant that supplies our Yorktown refinery with
power. As a result of the failure, the refinery suffered a
complete loss of power and shut down all processing units. The
refinery was operating at full capacity by the middle of May. We
incurred costs of approximately $1,254,000 as a result of the loss
of power, all of which were expensed in the second quarter of
2003. Reduced production also resulted in the loss of earnings;
- continued reduced production at our Four Corners refineries
because of lower crude oil receipts due to supplier production
problems and reduced supply availability;
- stronger finished product sales volumes and margins for our
Phoenix Fuel operations, due to, among other things:
- increased finished product demand;
- an expanded customer base; and
- tight finished product supplies in our Phoenix market;
- lower merchandise margins for our retail group; and
- On April 8, 2004, a fire occurred at our Ciniza refinery in the
alkylation unit that produces high octane blending stock for
gasoline. As a result of the fire, we temporarily shut down all of
the operating units at the Ciniza refinery. We also started early
a previously scheduled repairs and upgrade shutdown (known as a
"turnaround"). At June 30, 2004, the alkylation unit is still not
back in operation.
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
Our earnings from continuing operations before income taxes increased
$7,095,000 for the three months ended June 30, 2004, compared to the same
period in 2003. This increase was primarily due to the following:
- an increase in operating earnings before corporate allocation from
our refinery operations of $25,647,000 due to higher margins and
volumes sold;
- an 18% increase in fuel volumes sold by Phoenix Fuel while
maintaining the same margins; and
- a 12% decrease in interest expense.
44
This increase was partially offset by the following:
- a 6% increase in operating expenses;
- a 17% decline in our Four Corners refineries' fuel volumes sold;
- $10,875,000 of costs incurred and write-offs of $4,885,000 of
previously deferred financing costs and original issue discount
that were related to early extinguishment of part of our long-term
debt; and
- a 20% decline in our retail group's merchandise margin due to,
among other things, lower rebates.
Our earnings from continuing operations before income taxes increased
$11,233,000 for the six months ended June 30, 2004, compared to the same
period in 2003. This increase was primarily due to the following:
- an increase in operating earnings before corporate allocation from
our refinery operations of $28,381,000 due to higher margins and
volumes sold;
- a 14% increase in fuel volumes sold by Phoenix Fuel; and
- a 10% decrease in interest expense.
This increase was partially offset by the following:
- a 10% increase in operating expenses;
- a 15% decline in our Four Corners refineries' fuel volumes sold;
- $10,875,000 of costs incurred and write-offs of $4,885,000 of
previously deferred financing costs and original issue discount
that were related to early extinguishment of part of our long-term
debt; and
- a 17% decline in our retail group's merchandise margin due to,
among other things, lower rebates.
YORKTOWN REFINERY
Our Yorktown refinery operated at an average throughput rate of
approximately 67,600 barrels per day in the second quarter of 2004,
compared to 52,300 barrels per day in the second quarter of 2003. For the
six months ended June 30, 2004 and 2003, the average throughput rate was
64,400 and 54,300 barrels per day, respectively.
In the month of September, we will be reducing the production at our
Yorktown refinery to approximately 25,000 barrels per day as we perform
various upgrades throughout the refinery. These upgrades will allow us to
substantially increase the amount of acidic crude oil that can be
processed under the crude supply agreement that we entered into with
Statoil earlier this year.
Refining margins for the second quarter of 2004 were $6.20 per barrel
as compared to $2.82 per barrel for the same period in 2003. Refining
margins for the six months ended June 30, 2004 and 2003 were $5.89 and
$3.57 per barrel, respectively. This increase was primarily due to
45
increased demand, lower imports into the East coast of finished products,
lower nationwide production due to turnarounds being done, and limited
refining capacity in the United States.
Revenues for our Yorktown refinery increased for the three and six
months ended June 30, 2004, respectively, as compared to the same periods
in 2003. This increase was primarily due to increases in volume sold and
increases in price per barrel sold.
Cost of products sold for our Yorktown refinery increased for the
three and six months ended June 30, 2004, respectively, as compared to the
same periods in 2003. This was primarily due to the increase in finished
product volumes sold and an increase in the average cost per barrel of
crude oil. In late February 2004, we began receiving supplies of acidic
crude oil under a long-term supply agreement with Statoil. This contract
enabled us to reduce our cost of crude oil as compared to other supply
alternatives.
Operating expenses increased in the first half of 2004 primarily due
to the following:
- higher maintenance costs primarily related to tank inspections and
repairs and coker unit repairs;
- higher operating costs due to higher volumes, higher electrical
costs and higher purchased costs of natural fuel gas;
- higher chemical and catalyst costs, primarily related to higher
cost catalyst required to meet more stringent sulfur reduction
requirements; and
- higher payroll and related costs, due in part to the
capitalization of certain wages in the first half of 2003
(primarily due to turnaround activity) and
increased group medical insurance premiums and workers
compensation costs.
Operating expenses were unchanged for the three months ended June 30,
2004 as compared to the same period in 2003.
Depreciation and amortization expense increased for the three and six
months ended June 30, 2004 as compared with the same periods in 2003,
primarily due to the amortization of certain refinery turnaround costs
incurred in 2003.
FOUR CORNERS REFINERIES
Our Four Corners refineries operated at an average throughput rate of
approximately 26,500 barrels per day in the second quarter of 2004,
compared to 31,900 barrels per day in the second quarter of 2003. For the
six months ended June 30, 2004 and 2003, the average throughput rate was
27,400 and 31,500 barrels per day, respectively.
46
Refining margins for the second quarter of 2004 were $12.44 per
barrel as compared to $9.41 per barrel for the same period in 2003.
Refining margins for the six months ended June 30, 2004 and 2003 were
$10.30 and $8.86 per barrel, respectively. This increase was primarily due
to increased demand, lower imports into the West coast of finished
products, lower nationwide production due to turnarounds being done, and
limited refining capacity in the United States.
Revenues increased for the three months ended June 30, 2004 as
compared with the same period in 2003, primarily due to significantly
higher prices, partially offset by lower sales volume. Sales volumes were
reduced because of the Ciniza fire and turnaround and lower crude oil
supplies. Revenues increased for the six months ended June 30, 2004, as
compared to the same period in 2003. This increase was primarily due to
increases in price per barrel sold, partially offset by decreases in sales
volume.
Cost of products sold increased for the three and months ended June
30, 2004, as compared with the same periods in 2003, primarily due to the
increase in average crude oil prices, partially offset by the decrease in
finished product volumes sold.
Operating expenses increased for the three and six months ended June
30, 2004 compared with the same periods in 2003. This was primarily due to
increased outside maintenance for the Bloomfield refinery and the
expensing of insurance deductibles incurred in connection with the fire at
the Ciniza refinery.
Depreciation and amortization expense for our Four Corners refineries
increased slightly for the three and six months ended June 30, 2004, as
compared to the same periods in 2003, respectively.
RETAIL GROUP
Average fuel margins were $0.202 per gallon for the three months
ended June 30, 2004 as compared to $0.223 per gallon for the same period
in 2003. Fuel volumes sold for the three months ended June 30, 2004
increased slightly as compared to the same period a year ago. Average
merchandise margins were 24% for the three months ended June 30, 2004 as
compared to 30% for the same period in 2003. The decrease in merchandise
margins was due to, among other factors, lower rebates.
Average fuel margins were $0.180 per gallon for the six months ended
June 30, 2004 as compared to $0.194 per gallon for the same period in
2003. Fuel volumes sold for the six months ended June 30, 2004 increased
by 5% as compared to the same period a year ago. Average merchandise
margins were 25% for the six months ended June 30, 2004 as compared to 30%
for the same period in 2003. The decrease in merchandise margins was
primarily due to, among other factors, lower rebates.
47
Revenues for our retail group increased for the three months ended
June 30, 2004, compared to the same period in 2003, primarily due to an
increase in fuel selling prices and a slight increase in fuel volumes
sold. Revenues for our retail group remained relatively unchanged for the
six months ended June 30, 2004, compared to the same period in 2003.
Cost of products sold for our retail group increased for the three
and six months ended June 30, 2004, as compared to the same periods in
2003, primarily due to an increase in finished product purchase prices and
an increase in finished product volumes sold.
Our fuel margins decreased by 9% and 7% respectively, for the three
and six months ended June 30, 2004 due to the current competitive
environment and higher costs of finished products.
Our retail merchandise margins declined by 20% and 17% during the
three and six months ended June 30, 2004, as compared to the same periods
in 2003, due to, among other things, a reduction in rebates from suppliers
for 2004 as compared to 2003.
Operating expenses decreased for the three and six months ended June
30, 2004 as compared with the same periods in 2003, primarily due to a
reduction in payroll costs for the periods in 2004 as compared to 2003.
Depreciation expense declined for the three and six months ended June
30, 2004, as compared to the same periods in 2003, primarily due to some
retail assets becoming fully depreciated.
PHOENIX FUEL
Fuel volumes sold by Phoenix Fuel increased by 18% and 14% for the
three and six months ended June 30, 2004, as compared with the same
periods in 2003. Average fuel margins for Phoenix Fuel were $0.055 per
gallon and $0.054 per gallon for the three and six months ended June 30,
2004, as compared with $0.055 per gallon and $0.051 per gallon for three
and six months ended June 30, 2003.
Revenues for Phoenix Fuel increased for the three and six months
ended June 30, 2004 as compared to the same periods in 2003, primarily due
to an 18% and 14% increase in finished product volumes sold, respectively,
and a 32% and 19% increase in finished product selling prices,
respectively.
Cost of products sold for Phoenix Fuel increased during the three and
six months ended June 30, 2004 as compared to the same periods in 2003,
primarily due to the increase in finished product volumes sold and an
increase in finished product purchase prices.
Phoenix Fuel's finished product margins remained unchanged during the
three months ended June 30, 2004 as compared to the same period a year
ago. For the six months ended June 30, 2004, however, finished product
margin increased by $0.03 per gallon as compared to the same period a year
ago, as a result of the favorable market conditions previously discussed.
48
Operating expenses for Phoenix Fuel increased during the three and
six months ended June 30, 2004 as compared to the same periods a year ago,
primarily due to higher payroll and related costs due to higher sales
volumes, and higher fuel and repair and maintenance costs due to expanded
fleet operations resulting from the higher sales volumes.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES FROM CONTINUING OPERATIONS
For the three and six months ended June 30, 2004, selling, general
and administrative expenses increased by approximately $2,781,000 and
$3,957,000, respectively, primarily due to:
- higher accruals for management incentive bonuses associated with
increased company financial performance;
- higher accruals related to litigation reserves; and
- increased costs associated with complying with the Sarbanes-Oxley
Act.
These increases were partially offset by a reduction in costs related
to our self-insured health plan due to improved claims experience.
INTEREST EXPENSE FROM CONTINUING OPERATIONS
For the three and six months ended June 30, 2004, interest expense
decreased by approximately $1,177,000 and $1,975,000, respectively. The
decrease was primarily due to interest incurred on borrowings under our
revolving credit facility in the first half of 2003. We had no borrowings
under this facility in the first half of 2004. In addition, interest
expense was reduced due to the payoff in 2003 of certain capital lease
obligations and the reduction of our mortgage loan facility principal
balance.
INCOME TAXES FROM CONTINUING OPERATIONS
The effective tax rates for the three months ended June 30, 2004 and
2003 were approximately 37.3% and 41.3%, respectively. The effective tax
rates for the six months ended June 30, 2004 and 2003 were approximately
40.7% and 41.4%, respectively. The differences in the effective rates are
primarily due to the recognition of certain state tax benefits.
DISCONTINUED OPERATIONS
Discontinued operations include the operations of some of our retail
service station/convenience stores and our travel center, which was sold
on June 19, 2003. See Note 6 to our Condensed Consolidated Financial
Statements included in Part I, Item 1 for additional information relating
to these operations.
49
OUTLOOK
Overall, we believe that our current refining fundamentals are more
positive now than the same time last year. Same store fuel volumes and
merchandise sales for our retail group are above the prior year's levels.
Merchandise margins, are however, lower than they were this time last
year. Phoenix Fuel currently continues to see growth in both wholesale and
unmanned fleet fueling volumes with stronger margins than the same time
last year. Our businesses are, however, very volatile and there can be no
assurance that currently existing conditions will continue for any of our
business segments.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL STRUCTURE
At June 30, 2004, we had long-term debt of $292,507,000, net of the
current portion of $17,558,000. At December 31, 2003 we had long-term debt
of $355,601,000, net of the current portion of $11,128,000.
The amount at June 30, 2004 includes:
- $150,000,000 of 8% Senior Subordinated Notes due 2014; and
- $148,828,000 of 11% Senior Subordinated Notes due 2012.
The amount at December 31, 2003 includes:
- $150,000,000 of 9% Senior Subordinated Notes due 2007; and
- $200,000,000 of 11% Senior Subordinated Notes due 2012.
As discussed below, we recently completed offerings of $150,000,000
of 8% Senior Subordinated Notes due 2014 and 3,283,300 shares of common
stock. We used the proceeds from the note offering and cash on hand to
repurchase or redeem our 9% Notes, and the proceeds from the common stock
offering to redeem a portion of the 11% Notes.
At June 30, 2004, we also had a $100,000,000 revolving credit
facility. We amended and extended the credit facility on July 15, 2004.
The credit facility was primarily a working capital and letter of credit
facility. At June 30, 2004, we had no direct borrowings outstanding under
the facility and $34,212,000 of letters of credit outstanding. At December
31, 2003, we had no direct borrowings outstanding under the facility and
$36,961,000 of letters of credit outstanding.
On July 15, 2004, we completed an amendment to our Credit Facility
that, among other things, extends the maturity of the facility for an
additional three years. This amendment substantially reduces our existing
borrowing and letter of credit costs and relaxes some of the covenants in
the Credit Facility. We also expanded the size of our bank group to
accommodate a much larger credit facility should it become useful. For a
further discussion of this matter, see Note 11 to our Condensed
Consolidated Financial Statements, captioned "Long-Term Debt".
50
We also had a mortgage loan facility that had a balance of
$17,556,000 at June 30, 2004 and $22,000,000 at December 31, 2003. We
prepaid this facility in full from cash on hand on July 14, 2004.
At June 30, 2004, our long-term debt, net of current portion, was
58.5% of total capital (long-term debt, net of current portion, plus total
stockholders' equity). At December 31, 2003, it was 71.8%. Our net debt
(long-term debt, net of current portion, less cash and cash equivalents)
to total capitalization percentage at June 30, 2004, was 56.6%. At
December 31, 2003, this percentage was 70.2%.
Our credit facility and the indentures governing our notes contain
restrictive covenants and other terms and conditions that if not
maintained, if violated, or if certain conditions are met, could result in
default, affect our ability to borrow funds, make certain payments, or
engage in certain activities. A default under any of the notes or the
credit facility could cause such debt, and by reason of cross-default
provisions, our other debt to become immediately due and payable. If we
are unable to repay such amounts, the lenders under our credit facility,
could proceed against the collateral granted to them to secure that debt.
If those lenders accelerate the payment of the credit facility, we cannot
provide assurance that our assets would be sufficient to pay that debt and
other debt or that we would be able to refinance such debt or borrow more
money on terms acceptable to us, if at all. Our ability to comply with the
covenants, and other terms and conditions, of the indentures and the
credit facility may be affected by many events beyond our control, and we
cannot provide assurance that our operating results will be sufficient to
allow us to comply with the covenants.
We expect to be in compliance with the covenants going forward, and
we do not believe that any presently contemplated activities will be
constrained. A prolonged period of low refining margins, however, would
have a negative impact on our ability to borrow funds and to make
expenditures and would have an adverse impact on compliance with our debt
covenants.
We presently have senior subordinated ratings of "B3" from Moody's
Investor Services and "B-" from Standard & Poor's. Moody's Investor
Services recently confirmed its "B3" rating. Standard and Poor's also
reaffirmed its ratings but revised the outlook to positive from negative.
As is discussed in more detail in Note 11 to our Condensed
Consolidated Financial Statements included in Part I, Item 1, we completed
a refinancing of a portion of our long-term debt in the second quarter of
2004. As part of the refinancing, we completed the following:
- a tender offer and consent solicitation of our 9% senior
subordinated notes due 2007;
- a redemption of the 9% notes not tendered in the tender offer;
- the sale of $150,000,000 of 8% senior subordinated notes due 2014;
- the sale of 3,283,300 shares of our common stock;
51
- the prepayment of the outstanding balance on our mortgage loan
facility; and
- the renegotiation of our revolving credit facility.
This refinancing should reduce our annual after tax interest expense
by approximately $6,300,000 in comparison to the 2003 level, assuming no
future borrowings on our revolving credit facility.
In connection with these transactions, we incurred and expensed
$10,875,000 of costs associated with early debt extinguishment, and we
wrote-off $4,885,000 of previously deferred financing costs and original
issue discount. We also incurred additional costs that have been deferred
and are being amortized over the term of the 8% notes.
We also incurred financing costs in connection with our credit
facility that have been deferred and are being amortized over the term of
the facility.
CASH FLOW FROM OPERATIONS
Our operating cash flows decreased by $1,382,000 for the six months ended
June 30, 2004 compared to the six months ended June 30, 2003. This
resulted primarily from increases in the first half of 2004 in cash used
by working capital items, partially offset by an increase in net earnings
before depreciation and amortization, amortization of financing costs,
deferred income taxes, and deferred crude oil purchase discounts.
WORKING CAPITAL
We anticipate that working capital, including that necessary for
capital expenditures and debt service, will be funded through existing
cash balances, cash generated from operating activities, existing credit
facilities, and, if necessary, future financing arrangements. Future
liquidity, both short and long-term, will continue to be primarily
dependent on producing or purchasing, and selling, sufficient quantities
of refined products at margins sufficient to cover fixed and variable
expenses. Based on the current operating environment for all of our
operations, we believe that we will have sufficient working capital to
meet our needs over the next 12-month period.
Working capital at June 30, 2004 consisted of current assets of
$256,506,000 and current liabilities of $152,707,000, or a current ratio
of 1.68:1. At December 31, 2003, the current ratio was 1.63:1, with
current assets of $251,807,000 and current liabilities of $154,408,000.
Current assets increased in the first half of 2004 by $4,699,000,
primarily due to increases in accounts receivable. These increases were
offset, in part, by decreases in inventories and cash and cash
equivalents. Cash and cash equivalents at July 31, 2004 were approximately
$25,000,000.
52
Accounts receivable increased in the first half of 2004 primarily due
to higher trade receivables, due in part to higher finished product
selling prices and volumes sold.
Inventories decreased in the first half of 2004 primarily due to:
- decreases in onsite crude oil volumes at our Yorktown refinery;
and
- decreases in Four Corners, Phoenix Fuel and terminal refined
product volumes.
These decreases were offset, in part, by:
- increases in crude oil and refined product prices; and
- increases in crude oil volumes at the Four Corners refineries.
Current liabilities decreased in the first half of 2004 by
$1,701,000, primarily due to decreases in accounts payable and accrued
expenses, offset by an increase in our current portion of long-term debt.
Accrued expenses decreased in the first half of 2004 primarily due to
lower accrued interest payable, lower fuel and petroleum products taxes
payable, lower accruals related to the 401(k) and ESOP plans, partially
offset by higher income tax accruals and accrued payroll and vacation pay.
CAPITAL EXPENDITURES AND RESOURCES
Net cash used in investing activities for capital expenditures
totaled approximately $26,678,000 and $5,989,000 for the six months ended
June 30, 2004 and 2003, respectively. Expenditures for 2004 include
$9,321,000 of costs that were capitalized as construction-in-progress due
to the Ciniza fire incident, and $6,609,000 of "turnaround" costs that
were capitalized. The remainder of these expenditures primarily were for
operational and environmental projects for the refineries, Phoenix Fuel
and retail operations. Expenditures for 2003 primarily were for turnaround
expenditures at the Yorktown refinery and operational and environmental
projects for the refineries and retail operations.
We received proceeds of approximately $5,929,000 from the sale of
property, plant and equipment and other assets in the first half of 2004
and $9,347,000 in the first half of 2003. We received approximately
$6,531,000 of proceeds from the sale of 40 acres of vacant land known as
the Jomax property and three other service stations/convenience stores.
Proceeds received in the first half of 2003 were primarily from the sale
of our Giant Travel Center, including its related inventories, to Pilot
Travel Centers LLC for approximately $6,311,000. The remaining proceeds
for 2003 were from the sale of property, plant and equipment and other
assets.
Subsequent to June 30, 2004, we sold two pieces of vacant land and
two service stations/convenience stores for approximately $1,316,600, net
of expenses.
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We continue to monitor and evaluate our assets and may sell
additional non-strategic or underperforming assets that we identify as
circumstances allow. We also continue to evaluate potential acquisitions
in our strategic markets, including lease arrangements.
As part of the Yorktown acquisition, we agreed to pay earn-out
payments, up to a maximum of $25,000,000, to the sellers, beginning in
2003 and concluding at the end of 2005 based upon certain market value
factors. For the six months ended June 30, 2004 and 2003, we paid
$11,695,000 and $5,475,000, respectively, in earn-outs under the purchase
agreement. Total earn-out payments through June 30, 2004 were $20,549,000.
On April 8, 2004, we had a fire in the alkylation unit at our Ciniza
refinery, requiring us to temporarily shutdown all of the operating units
at the refinery. As a result of this incident, a major repair and upgrade
shutdown (known as a "turnaround") that was scheduled for April 17, 2004
was accelerated and completed. See Note 12 to our Condensed Consolidated
Financial Statements included in Part I, Item 1 for a further discussion
of this matter.
We continue to investigate other capital improvements to our existing
facilities. The amount of capital projects that are actually undertaken in
2004 will depend on, among other things, general business conditions and
results of operations.
DIVIDENDS
We currently do not pay dividends on our common stock. The board of
directors will periodically review our policy regarding the payment of
dividends. Any future dividends are subject to the results of our
operations, declaration by the board of directors, and existing debt
covenants.
RISK MANAGEMENT
We are exposed to various market risks, including changes in certain
commodity prices and interest rates. To manage these normal business
exposures, we may, from time to time, use commodity futures and options
contracts to reduce price volatility, to fix margins in our refining and
marketing operations, and to protect against price declines associated
with our crude oil and finished products inventories.
In the first half of 2003, we entered into various crude oil futures
contracts in order to economically hedge crude oil inventories and
purchases for the Yorktown refinery operations. For the six months ended
June 30, 2003, we recognized losses on these contracts of approximately
$1,594,000 in cost of products sold. These transactions did not qualify
for hedge accounting in accordance with SFAS No. 133 "Accounting for
Derivative Instruments and Hedging Activities," as amended, and
accordingly were marked to market each month. There were no similar
transactions in the first half of 2004, and there were no open crude oil
futures contracts or other commodity derivative contracts at June 30,
2004.
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Our credit facility is floating-rate debt tied to various short-term
indices. As a result, our annual interest costs associated with this debt
may fluctuate. At June 30, 2004, there were no direct borrowings
outstanding under this facility.
Our operations are subject to the normal hazards, including fire,
explosion and weather-related perils. We maintain various insurance
coverages, including business interruption insurance, subject to certain
deductibles. We are not fully insured against some risks because some
risks are not fully insurable, coverage is unavailable or premium costs,
in our judgment, do not justify such expenditures.
Credit risk with respect to customer receivables is concentrated in
the geographic areas in which we operate and relates primarily to
customers in the oil and gas industry. To minimize this risk, we perform
ongoing credit evaluations of our customers' financial position and
require collateral, such as letters of credit, in certain circumstances.
ENVIRONMENTAL, HEALTH AND SAFETY
Federal, state and local laws and regulations relating to health,
safety and the environment affect nearly all of our operations. As is the
case with other companies engaged in our industries, we face significant
exposure from actual or potential claims and lawsuits, brought by either
governmental authorities or private parties, alleging non-compliance with
environmental, health, and safety laws and regulations, or property damage
or personal injury caused by the environmental, health, or safety impacts
of current or historic operations. These matters include soil and water
contamination, air pollution, and personal injuries or property damage
allegedly caused by substances manufactured, handled, used, released, or
disposed of by us or by our predecessors.
Applicable laws and regulations govern the investigation and
remediation of contamination at our current and former properties, as well
as at third-party sites to which we sent wastes for disposal. We may be
held liable for contamination existing at current or former properties,
notwithstanding that a prior operator of the site, or other third party,
caused the contamination. We may also be held responsible for costs
associated with contamination clean up at third-party disposal sites,
notwithstanding that the original disposal activities were in accordance
with all applicable regulatory requirements at such time. We are currently
engaged in a number of such remediation projects.
Future expenditures related to compliance with environmental, health
and safety laws and regulations, the investigation and remediation of
contamination, and the defense or settlement of governmental or private
party claims and lawsuits cannot be reasonably quantified in many
circumstances for various reasons. These reasons include the speculative
nature of remediation and clean up cost estimates and methods, imprecise
and conflicting data regarding the hazardous nature of various types of
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substances, the number of other potentially responsible parties involved,
various defenses that may be available to us, and changing environmental,
health and safety laws, regulations, and their respective interpretations.
We cannot provide assurance that compliance with such laws or regulations,
such investigations or cleanups, or such enforcement proceedings or
private-party claims will not have a material adverse effect on our
business, financial condition or results of operations.
Rules and regulations implementing federal, state and local laws
relating to the environment, health, and safety will continue to affect
our operations. We cannot predict what new environmental, health, or
safety legislation or regulations will be enacted or become effective in
the future or how existing or future laws or regulations will be
administered or enforced with respect to products or activities to which
they have not been previously applied. Compliance with more stringent laws
or regulations, as well as more vigorous enforcement policies of
regulatory agencies, could have an adverse effect on our financial
position and the results of our operations and could require substantial
expenditures by us for, among other things:
- the installation and operation of refinery equipment, pollution
control systems and other equipment not currently possessed by us;
- the acquisition or modification of permits applicable to our
activities; and
- the initiation or modification of clean-up activities.
OTHER
We continue to negotiate jointly with the New Mexico Environment
Department and the U.S. Environmental Protection Agency in conjunction
with alleged air quality violations at our Ciniza and Bloomfield
refineries. For a further discussion of this matter, see Note 12 to our
Condensed Consolidated Financial Statements, captioned "Commitments and
Contingencies".
A fire occurred at our Ciniza refinery on April 8, 2004 in the
alkylation unit that produces high octane blending stock for gasoline.
Repairs to the alkylation unit are in process, but it is not yet back in
service. The fire is currently under investigation by the Occupational
Health and Safety Bureau of the New Mexico Environment Department and by
the U.S. Chemical Safety and Hazard Investigation Board. For a further
discussion of this matter, see Note 12 to our Condensed Consolidated
Financial Statements, captioned "Commitments and Contingencies".
The Occupational Health and Safety Bureau of the New Mexico
Environment Department has issued safety regulations that could require us
to incur additional expenses for security at our retail stores. These
regulations may be subject to legal challenge. For a further discussion of
this matter, see Note 12 to our Condensed Consolidated Financial
Statements, captioned "Commitments and Contingencies".
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The trustee in the James E. Acridge bankruptcy proceeding has advised
us the bankruptcy estate may have potential claims against us. We have
evaluated the trustee's contentions and do not believe that the potential
claims have any merit. For a further discussion of matters relating to
James E. Acridge, our former President, Chief Executive Officer, and
Chairman of the Board, see Note 12 to our Condensed Consolidated Financial
Statements, captioned "Commitments and Contingencies".
Our Ciniza and Bloomfield refineries continue to be affected by
reduced crude oil production in the Four Corners area. The Four Corners
basin is a mature production area and, as a result, is subject to a
natural decline in production over time. This natural decline is being
offset to some extent by new drilling, field workovers, and secondary
recovery projects, which have resulted in additional production from
existing reserves.
As a result of the declining production of crude oil in the Four
Corners area in recent years, we have not been able to cost-effectively
obtain sufficient amounts of crude oil to operate our Four Corners
refineries at full capacity. Crude oil utilization rates for our Four
Corners refineries have declined from approximately 67% for 2003 to
approximately 60% for the first six months of 2004. Our current
projections of Four Corners crude oil production indicate that our crude
oil demand will exceed the crude oil supply that is available from local
sources for the foreseeable future and that our crude oil capacity
utilization rates at our Four Corners refineries will continue to decline.
If additional crude oil or other refinery feedstocks become available in
the future, we may increase production runs at our Four Corners refineries
depending on the demand for finished products and the refining margins
attainable. To that end, we continue to assess short-term and long-term
options to address the continuing decline in Four Corners crude oil
production. The options being considered include:
- evaluating potentially economic sources of crude oil produced
outside the Four Corners area, including ways to reduce raw
material transportation costs to our refineries;
- evaluating ways to encourage further production in the Four
Corners area;
- changing equipment operation/configuration at one or both
refineries to further the integration of the two refineries and
reduce fixed costs; and
- with sufficient further decline in raw material supply,
temporarily, partially or permanently discontinue of operations at
one of these refineries.
None of these options, however, may prove to be economically viable.
We cannot assure you that the Four Corners crude oil supply for our Ciniza
and Bloomfield refineries will continue to be available at all or on
acceptable terms for the long term. Because large portions of the
refineries' costs are fixed, any significant interruption or decline in
the supply of crude oil or other feedstocks would have an adverse effect
on our Four Corners refinery operations and on our overall operations.
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We are aware of a number of actions, proposals or industry
discussions regarding product pipeline projects that could impact portions
of our marketing areas. The completion of some or all of these projects
would result in increased competition by increasing the amount of refined
products potentially available in our markets, as well as improving
competitor access to these areas. It also could result in new
opportunities for us, as we are a net purchaser of refined products in
some of these areas. We were informed that the Longhorn Pipeline project
that runs from Houston, Texas to El Paso, Texas and connects the Chevron
pipeline to the Albuquerque area and to the Kinder-Morgan pipeline to the
Phoenix and Tucson, Arizona markets had a planned start-up date of June
2004. We believe, however, that operational problems have delayed the
start-up. In view of this and past postponements of previously announced
start-up dates, we do not know if the Longhorn Pipeline will begin
operation in 2004 or at all.
Our refining activities are conducted at our two refinery locations
in New Mexico and the Yorktown refinery in Virginia. These refineries
constitute a significant portion of our operating assets, and the two New
Mexico refineries supply a significant portion of our retail operations.
As a result, our operations would be significantly interrupted if any of
the refineries were to experience a major accident, be damaged by severe
weather or other natural disaster, or otherwise be forced to shut down. If
any of the refineries were to experience an interruption in supply or
operations, our business, financial condition and operating results could
be materially and adversely affected.
FORWARD-LOOKING STATEMENTS
This report includes forward-looking statements within the meaning of
Section 27A of the Securities Act and Section 21E of the Securities and
Exchange Act of 1934. These statements are included throughout this
report, including in the section entitled "Management's Discussion and
Analysis of Financial Condition and Results of Operations." These
statements relate to projections of capital expenditures and other
financial items. These statements also relate to, among other things, our
business strategy, goals and expectations concerning our market position,
future operations, acquisitions, dispositions, margins, profitability,
liquidity and capital resources. We have used the words "believe,"
"expect," "anticipate," "estimate," "could," "plan," "intend," "may,"
"project," "predict," "will" and similar terms and phrases to identify
forward-looking statements in this report.
Although we believe the assumptions upon which these forward-looking
statements are based are reasonable, any of these assumptions could prove
to be inaccurate, and the forward-looking statements based on these
assumptions could be incorrect. While we have made these forward-looking
statements in good faith and they reflect our current judgment regarding
such matters, actual results could vary materially from the forward-
looking statements.
58
Actual results and trends in the future may differ materially
depending on a variety of important factors. These important factors
include the following:
- the availability of crude oil and the adequacy and costs of raw
material supplies generally;
- our ability to negotiate new crude oil supply contracts;
- the risk that our long-term crude oil supply agreement with
Statoil will not supply a significant portion of the crude oil
needs of our Yorktown refinery over the term of the agreement, and
will not reduce our crude oil costs, improve our high-value
product output, contribute significantly to higher earnings,
improve our competitiveness, or reduce the impact of crude oil
markets' pricing volatility;
- our ability to successfully manage the liabilities, including
environmental liabilities, that we assumed in the
Yorktown acquisition;
- our ability to obtain anticipated levels of indemnification;
- competitive pressures from existing competitors and new entrants,
including the potential effects of various pipeline projects and
various actions that have been undertaken to increase the supply
of refined products to El Paso, Texas;
- volatility in the difference, or spread, between market prices for
refined products and crude oil and other feedstocks;
- the risk that our operations will not remain competitive and
realize acceptable sales volumes and margins in those markets
where they currently do so;
- our ability to adequately control capital and operating expenses,
including the cost to comply with the Sarbanes-Oxley Act;
- the risk of increased costs resulting from employee matters,
including unionization efforts and increased employee benefit
costs;
- state, federal or tribal legislation or regulation, or findings by
a regulator with respect to our operations, including the
impact of government-mandated specifications for gasoline and
diesel fuel on our operations;
- unplanned or extended shutdowns in refinery operations;
- the risk that we will not be able to repair and start-up the
alkylation unit at the Ciniza refinery in the near future;
59
- the risk that we will not remain in compliance with covenants, and
other terms and conditions, contained in our notes and our credit
facility;
- the risk that we will not be able to post satisfactory letters of
credit;
- general economic factors affecting our operations, markets,
products, services and prices;
- unexpected environmental remediation costs;
- weather conditions affecting our operations or the areas in which
our products are refined or marketed;
- the risk we will be found to have substantial liability in
connection with existing or pending litigation;
- the occurrence of events that cause losses for which we are not
fully insured;
- the risk that costs associated with environmental projects,
including costs associated with EPA's national refinery
enforcement program, will be higher than currently estimated; and
- other risks described elsewhere in this report or described from
time to time in our other filings with the Securities and Exchange
Commission.
All subsequent written and oral forward-looking statements
attributable to us or persons acting on our behalf are expressly qualified
in their entity by the previous statements. Forward-looking statements we
make represent our judgment on the dates such statements are made. We
assume no obligation to update any information contained in this report or
to publicly release the results of any revisions to any forward-looking
statements to reflect events or circumstances that occur, or that we
become aware of, after the date of this report.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
The information required by this item is incorporated herein by
reference to the section entitled "Risk Management" in the Company's
Management's Discussion and Analysis of Financial Condition and Results of
Operations in Part I, Item 2.
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ITEM 4. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and Procedures
In order to ensure that the information we must disclose in our
filings with the SEC is recorded, processed, summarized and reported on a
timely basis, we have developed and implemented disclosure controls and
procedures. The Company's management, with the participation of the
Company's Chief Executive Officer and Chief Financial Officer, evaluated
the effectiveness of the Company's disclosure controls and procedures as
of the end of the period covered by this report. Based on that evaluation,
the Chief Executive Officer and Chief Financial Officer concluded that the
Company's disclosure controls and procedures as of the end of the period
covered by this report were effective as of the date of that evaluation.
(b) Change in Internal Control Over Financial Reporting
During the first half of 2004, Deloitte & Touche LLP informed us
that they had identified two reportable conditions in the design of our
internal controls. The conditions, which were not material weaknesses,
were related to our corporate accounting review process and our
information systems.
In respect to our corporate accounting review processes, certain
analyses are prepared outside of our corporate accounting department, and
are provided to our corporate accounting department as the basis for
significant accounting adjustments or account balances. Certain audit
adjustments were necessary to correctly state accounts related to vacation
pay and loan fee amortization at December 31, 2003. Other analyses
required extensive review of amounts recorded. We have implemented and
continue to implement corrective actions and organizational changes to
correct this condition.
With regard to our information systems, we were advised to
improve our general computer controls related to program changes and
access security. In addition, we were advised to prepare and implement a
plan to replace our VAX processing platform, which processes invoicing,
crude leasing accounting, drivers' payroll and tank inventory, because it
is no longer supported by the vendor and poses processing continuity
risks. The VAX processing platform was replaced by a new technology
platform in June 2004. We believe we have strengthened mitigating controls
and procedures in place and have implemented policies and procedures to
enhance access security.
We do not yet know whether the mitigating controls and
procedures and the corrective actions and organizational changes will be
adequate.
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PART II
OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
We are a party to ordinary routine litigation incidental to our
business, as well as other litigation more fully described in Note 12 to
the Condensed Consolidated Financial Statements set forth in Part I, Item
1, and the discussion of certain contingencies contained in Part I, Item
2, under the heading "Liquidity and Capital Resources - Other."
ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF
EQUITY SECURITIES
On April 13, 2004, we made an offer to purchase for cash all
$150,000,000 aggregate principal amount outstanding of our 9% senior
subordinated notes due 2007 (the "9% notes"). The offer included a consent
solicitation for amendments to the indenture governing the notes. In the
consent solicitation, we asked the holders of the notes to consent to
proposed amendments to the indenture governing the notes to eliminate
substantially all of the restrictive covenants in the indenture. The
consent solicitation expired on April 26, 2004, and on that date we had
received sufficient consents to make the proposed amendments. As a result,
on April 26, 2004, we executed a supplemental indenture implementing the
proposed amendments. The amendments became operative on May 3, 2004, when
we repurchased the notes tendered through that date and paid the
consideration for the consents. On June 11, 2004, we completed the
repurchase and redemption of all of our outstanding 9% notes.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Our annual meeting of stockholders was held on April 29, 2004.
Proxies for the meeting were solicited under Regulation 14A. There were no
matters submitted to a vote of security holders other than the election of
two directors and approval of auditors as specified in our Proxy
Statement. There was no solicitation in opposition to management's
nominees to the Board of Directors.
Larry L. DeRoin was elected as a director of the Company. The vote
was as follows:
Shares Voted "For" Shares Voted "Withholding"
- ------------------ --------------------------
7,333,786 215,884
Richard T. Kalen, Jr. was elected as a director of the Company. The
vote was as follows:
Shares Voted "For" Shares Voted "Withholding"
- ------------------ --------------------------
7,171,949 377,721
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Deloitte & Touche LLP was ratified as independent auditors for the
Company for the year ending December 31, 2004. The vote was as follows:
Shares Voted "For" Shares Voted "Against" Shares Voted "Abstaining"
- ------------------ ---------------------- -------------------------
7,079,378 17,838 452,454
In addition to the two directors elected above, other members of our
Board of Directors include Fred L. Holliger, Chairman, Anthony J.
Bernitsky, Brooks J. Klimley, George M. Rapport and Donald M. Wilkinson.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
10.1* Third Amended and Restated Credit Agreement, dated July 15,
2004, among Giant Industries, Inc. as the Borrower, Bank of
America, N.A., as Administrative Agent and as Issuing Bank,
and the lenders parties thereto.
31.1* Certification of Principal Executive Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2* Certification of Principal Financial Officer Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1* Certification of Principal 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 of Principal Financial Officer Pursuant to 18
U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
*Filed herewith.
(b) Reports on Form 8-K: We filed the following reports on Form
8-K during the quarter for which this report is being filed and
subsequently:
(i) On April 8, 2004, we filed a Form 8-K dated April 8, 2004,
containing a press release announcing that a fire had occurred
at our Ciniza refinery.
(ii) On April 29, 2004, we filed a Form 8-K dated April 29, 2004,
containing (1) a supplemental indenture to our $150,000,000
senior subordinated notes due 2007, (2) a press release about
our tender offer and consent solicitation, (3) a press release
about the pricing of our common stock offering, and (4) a press
release about the pricing of our offering of 8% senior
subordinated notes due 2014.
63
(iii) On May 13, 2004, we filed a Form 8-K dated May 13, 2004,
containing a press release detailing our earnings for the three
months ended March 31, 2004.
(iv) On August 10, 2004, we filed a Form 8-K dated August 9,
2004, containing a press release detailing our earnings for the
three months ended June 30, 2004.
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SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report on Form 10-Q for the quarter
ended June 30, 2004 to be signed on its behalf by the undersigned
thereunto duly authorized.
GIANT INDUSTRIES, INC.
/s/ MARK B. COX
---------------------------------------------
Mark B. Cox, Executive Vice President, Treasurer,
Chief Financial Officer and Assistant Secretary,
on behalf of the Registrant and as the
Registrant's Principal Financial Officer
Date: August 11, 2004
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