10-Q 1 thirdqtr2005-edgar.txt GIANT INDUSTRIES, INC. 2005 THIRD QUARTER 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005 [ ] 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 of Incorporation) (I.R.S. Employer Identification No.) 23733 North Scottsdale Road, Scottsdale, Arizona 85255 (Address of principal executive offices) (Zip Code) (480) 585-8888 (Registrant's telephone number, including area code) _____________________________ (Former name, former address and former fiscal year, if changed since last report) 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 the 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 [X] No [ ] Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X] Number of Common Shares outstanding at October 31, 2005: 14,467,847 shares. GIANT INDUSTRIES, INC. AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION...................................... 1 Item 1 - Financial Statements....................................... 1 Condensed Consolidated Balance Sheets at September 30, 2005 and December 31, 2004 (Unaudited)....... 1 Condensed Consolidated Statements of Earnings for the Three and Nine Months Ended September 30, 2005 and 2004 (Unaudited).................................. 2 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2005 and 2004 (Unaudited)................................................ 3-4 Notes to Condensed Consolidated Financial Statements (Unaudited)................................................ 5-41 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 42-67 Item 3 - Quantitative and Qualitative Disclosures About Market Risk.......................................... 68 Item 4 - Controls and Procedures.................................... 68 PART II - OTHER INFORMATION.......................................... 69 Item 1 - Legal Proceedings.......................................... 69 Item 4 - Submission of Matters to a Vote of Security Holders........ 69 Item 6 - Exhibits and Reports on Form 8-K........................... 69-70 SIGNATURE............................................................ 71 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)
September 30, 2005 December 31, 2004 ------------------ ----------------- ASSETS Current assets: Cash and cash equivalents............................. $ 98,962 $ 23,714 Receivables, net...................................... 212,161 101,692 Inventories........................................... 130,108 93,500 Prepaid expenses and other............................ 3,666 11,265 Deferred income taxes................................. 2,292 1,834 --------- --------- Total current assets................................ 447,189 232,005 --------- --------- Property, plant and equipment........................... 745,218 671,851 Less accumulated depreciation and amortization.......... (292,683) (265,475) --------- --------- 452,535 406,376 --------- --------- Goodwill................................................ 50,592 40,303 Other assets............................................ 24,129 23,722 --------- --------- $ 974,445 $ 702,406 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable...................................... $ 149,150 $ 75,554 Accrued expenses...................................... 83,881 53,279 --------- --------- Total current liabilities........................... 233,031 128,833 --------- --------- Long-term debt.......................................... 274,742 292,759 Deferred income taxes................................... 72,785 41,039 Other liabilities and deferred income................... 23,418 23,336 Commitments and contingencies (Note 10) Stockholders' equity: Preferred stock, par value $.01 per share, 10,000,000 shares authorized, none issued Common stock, par value $.01 per share, 50,000,000 shares authorized, 18,219,827 and 16,085,631 shares issued............................ 182 161 Additional paid-in capital............................ 212,165 135,407 Retained earnings..................................... 194,576 117,325 --------- --------- 406,923 252,893 Less common stock in treasury - at cost, 3,751,980 shares.................................... (36,454) (36,454) --------- --------- Total stockholders' equity.......................... 370,469 216,439 --------- --------- $ 974,445 $ 702,406 ========= ========= 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 Nine Months Ended September 30, September 30, --------------------- ---------------------- 2005 2004 2005 2004 --------- --------- --------- ---------- Net revenues......................................... $1,085,225 $ 642,439 $2,660,309 $1,837,282 ---------- --------- ---------- ---------- Cost of products sold (excluding depreciation and amortization).................................. 920,408 564,563 2,295,082 1,582,656 Operating expenses................................... 53,901 42,158 148,889 129,895 Depreciation and amortization........................ 9,973 9,024 30,435 27,342 Selling, general and administrative expenses......... 15,431 10,110 35,072 28,362 Net loss/(gain) on the disposal/write-down of assets, including assets held for sale............. 1,055 (889) 835 (327) Gain from insurance settlement due to fire incident.. - (958) (3,688) (958) ---------- -------- ---------- ---------- Operating income..................................... 84,457 18,431 153,684 70,312 Interest expense..................................... (5,783) (7,173) (19,159) (25,222) Costs associated with early debt extinguishment...... 17 - (2,082) (10,875) Amortization of financing costs...................... (398) (1,012) (2,398) (7,827) Interest and investment income....................... 479 57 967 138 ---------- --------- ---------- ---------- Earnings from continuing operations before income taxes....................................... 78,772 10,303 131,012 26,526 Provision for income taxes........................... 32,132 4,328 53,776 10,934 ---------- --------- ---------- ---------- Earnings from continuing operations ................. 46,640 5,975 77,236 15,592 Earnings/(loss) from discontinued operations, net of income tax (provision)/benefit of ($7), ($9) and $61....................................... - 12 15 (99) ---------- --------- ---------- ---------- Net earnings......................................... $ 46,640 $ 5,987 $ 77,251 $ 15,493 ========== ========= ========== ========== Net earnings (loss) per common share: Basic Continuing operations............................ $ 3.43 $ 0.49 $ 5.88 $ 1.45 Discontinued operations.......................... - - - (0.01) --------- --------- ---------- ---------- $ 3.43 $ 0.49 $ 5.88 $ 1.44 ========= ========= ========== ========== Assuming dilution Continuing operations............................ $ 3.38 $ 0.48 $ 5.80 $ 1.42 Discontinued operations.......................... - - - (0.01) --------- --------- ---------- ---------- $ 3.38 $ 0.48 $ 5.80 $ 1.41 ========= ========= ========== ========== See accompanying notes to Condensed Consolidated Financial Statements. 2
GIANT INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
Nine Months Ended September 30, ----------------------- 2005 2004 --------- --------- Cash flows from operating activities: Net earnings.................................................... $ 77,251 $ 15,493 Adjustments to reconcile net earnings to net cash provided by operating activities: Depreciation and amortization from continuing operations........ 30,435 27,342 Depreciation and amortization from discontinued operations...... - 88 Amortization of financing costs................................. 2,398 7,827 Deferred income taxes........................................... 27,566 4,037 Deferred crude oil purchase discounts........................... 925 2,051 Net loss/(gain) on the disposal of assets from continuing operations, including assets held for sale.................... 835 (327) Net (gain) on the disposal of assets from discontinued operations, including assets held for sale.................... (22) (36) Gain from insurance settlement of fire incident................. (3,688) (958) Income tax benefit from exercise of stock options............... 838 718 Cash balance plan contribution.................................. (2,039) (1,828) Changes in operating assets and liabilities (Increase) in receivables..................................... (98,408) (16,829) (Increase) decrease in inventories............................ (31,810) 24,422 Decrease in prepaid expenses.................................. 8,341 1,367 (Increase) in other assets.................................... (170) (2,904) Increase in accounts payable.................................. 68,022 8,431 Increase in accrued expenses.................................. 20,938 292 Increase in other liabilities................................. 1,521 2,593 --------- --------- Net cash provided by operating activities......................... 102,933 71,779 --------- --------- Cash flows from investing activities: Purchase of property, plant and equipment....................... (48,390) (39,842) Acquisition activity............................................ (39,405) - Proceeds from assets held for sale.............................. 1,948 9,354 Yorktown refinery acquisition contingent payment................ - (15,300) Proceeds from insurance settlement of fire incident............. 3,688 3,032 Proceeds from sale of property, plant and equipment and other assets.................................................. 2,213 1,765 Funding of restricted cash escrow funds......................... (21,883) - Release of restricted cash escrow funds......................... 21,883 - --------- --------- Net cash used in investing activities............................. (79,946) (40,991) --------- --------- Cash flows from financing activities: Payments of long-term debt...................................... (18,828) (205,616) Proceeds from issuance of long-term debt........................ - 147,467 Long-term debt issuance costs................................... - (3,000) Proceeds from line of credit.................................... 51,245 10,000 Payments on line of credit...................................... (53,959) (27,573) Net proceeds from issuance of common stock...................... 74,406 57,374 Proceeds from exercise of stock options......................... 564 1,418 Deferred financing costs........................................ (1,167) (3,834) --------- --------- Net cash provided by (used in) financing activities............... 52,261 (23,764) --------- --------- Net increase in cash and cash equivalents......................... 75,248 7,024 Cash and cash equivalents: Beginning of period........................................... 23,714 27,263 --------- --------- End of period................................................. $ 98,962 $ 34,287 ========= ========= 3
Significant Noncash Investing and Financing Activities. In the first quarter of 2005, we transferred $118,000 of property, plant and equipment to other assets. In the second quarter of 2005, we contributed 34,196 newly issued shares of our common stock, valued at $972,000, to our 401(k) plan as a discretionary contribution for the year 2004. In connection with our acquisition activity, we assumed approximately $18,362,000 of liabilities. At September 30, 2005, approximately $5,810,000 of purchases of property, plant and equipment had not been paid and, accordingly, were accrued in accounts payable and accrued liabilities. In the first quarter of 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. See accompanying notes to Condensed Consolidated Financial Statements. 4 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1 - ORGANIZATION, BASIS OF PRESENTATION, STOCK-BASED EMPLOYEE COMPENSATION AND CURRENT PRONOUNCEMENTS: 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 wholesale distribution subsidiaries distribute commercial wholesale petroleum products primarily in Arizona and New Mexico. We have three business segments: - our refining group; - our retail group; and - our wholesale group. See Note 9 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 discontinued operations (see Note 4). Operating results for the three and nine months ended September 30, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004. 5 We have made certain reclassifications to our 2004 financial statements and notes to conform to the financial statement classifications used in the current year. These reclassifications relate primarily to discontinued operations reporting (see Note 4). They had no effect on reported earnings or stockholders' equity. Stock-Based Employee Compensation: We have a stock-based employee compensation plan that is more fully described in Note 10 to our Annual Report on Form 10-K for the year ended December 31, 2004. 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 earnings per share as if we had applied the fair value recognition provisions of Statements of Financial Accounting Standards ("SFAS") No. 123, "Accounting for Stock-Based Compensation", to stock- based employee compensation.
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 2005 2004 2005 2004 ------- ------- ------- ------- (In thousands, except per share data) Net earnings, as reported............. $46,640 $ 5,987 $77,251 $15,493 Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effect.......................... - (24) (24) (123) ------- ------- ------- ------- Pro forma net earnings................ $46,640 $ 5,963 $77,227 $15,370 ======= ======= ======= ======= Earnings per share: Basic - as reported................. $ 3.43 $ 0.49 $ 5.88 $ 1.44 ======= ======= ======= ======= Basic - pro forma................... $ 3.43 $ 0.49 $ 5.88 $ 1.44 ======= ======= ======= ======= Diluted - as reported............... $ 3.38 $ 0.48 $ 5.80 $ 1.41 ======= ======= ======= ======= Diluted - pro forma................. $ 3.38 $ 0.48 $ 5.80 $ 1.40 ======= ======= ======= =======
6 In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123R, "Share-Based Payment" that revised SFAS No. 123. This revision requires us to measure the cost of employee services received in exchange for stock options granted using the fair value method as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. We will adopt this statement beginning January 1, 2006. We do not expect this statement to have a material impact on our financial statements. Current Pronouncements The Emerging Issues Task Force (EITF) of the FASB, under Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty, reached a consensus in September 2005 that some or all of such buy/sell arrangements should be accounted for at historical cost pursuant to the guidance in paragraph 21(a) of APB Opinion No. 29, Accounting for Nonmonetary Transactions. Our buy/sell arrangements with a single counterparty are reported on a net basis and, accordingly, we believe we are in compliance with this EITF. In November 2004, FASB issued SFAS 151, "Inventory Costs - An Amendment of ARB No. 43, Chapter 4", which is effective for fiscal years beginning after June 15, 2005. This Statement requires that idle capacity expense, freight, handling costs, and wasted materials (spoilage), regardless of whether these costs are considered abnormal, be treated as current period charges. In addition, this statement requires that allocation of fixed overhead to the costs of conversion be based on the normal capacity of the production facilities. We do not expect this statement to have a material impact on our financial statements. In June 2005, the EITF Task Force reached a consensus in Issue No. 05-6, "Determining the Amortization Period for Leasehold Improvements". The consensus provides that leasehold improvements placed in service at the beginning of the lease term, should be amortized over the lesser of the useful life of the assets or the lease term, including renewals reasonably assured at the date the leasehold improvements are purchased. We do not expect this consensus to have a material impact on our financial statements. On July 14, 2005, FASB issued an exposure draft of a proposed interpretation, "Accounting for Uncertain Tax Positions-An Interpretation of FASB Statement 109". The proposed effective date is December 15, 2005 but has been deferred to 2006. Under FASB's proposal, the initial recognition of uncertain tax benefits would be based on whether the underlying tax position is "probable" of being sustained under audit by the relevant taxing authority. The "probable" confidence threshold would be based on the definition of probable in FASB Statement No. 5, "Accounting for Contingencies". We will monitor the status of this exposure draft and evaluate the effects, if any, on our financial statements in the future. 7 In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets - An Amendment of AB Opinion 29". The basic principle in Opinion 29 provides that nonmonetary exchanges should be measured based on the fair value of the assets exchanged. The guidance in that opinion, however, provides an exception to this principle if the exchange involves similar productive assets. This statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. We do not expect this pronouncement to have a material impact on our financial statements. In October 2004, the EITF reached a consensus on Issue No. 04-10, "Determining whether to aggregate operating segments that do not meet the quantitative thresholds". This EITF provides guidance on when operating segments that do not meet the quantitative thresholds can be aggregated. In summary, in order to aggregate such operating segments, aggregation must be consistent with the basic principles of SFAS 131, "Disclosures about Segments of an Enterprise and Related Information", have similar economic characteristics, and share a majority of certain business attributes. We do not expect this EITF to have a material impact on our financial statement presentation. In November 2004, the EITF reached a consensus in Issue No. 03-13, "Applying the conditions in Par. 42 of SFAS 144, in determining whether to report discontinued operations". The consensus provides that classification of a disposed component as a discontinued operation is appropriate only if the entity does not have continuing direct cash flows and does not retain an interest, contract, or other arrangement sufficient to enable it to exert significant influence over the disposed component's operating and financial policies after the disposal transaction. We do not expect this consensus to have a material impact on our financial statements. 8 NOTE 2 - INVENTORIES: Our inventories consist of the following:
September 30, 2005 December 31, 2004 ------------------ ----------------- (In thousands) First-in, first-out ("FIFO") method: Crude oil............................ $ 77,544 $ 44,435 Refined products..................... 113,584 68,863 Refinery and shop supplies........... 13,186 12,330 Merchandise.......................... 6,544 3,092 Retail method: Merchandise.......................... 8,895 9,419 -------- -------- Subtotal........................... 219,753 138,139 Adjustment for last-in, first-out ("LIFO") method............ (89,645) (44,639) -------- -------- Total.............................. $130,108 $ 93,500 ======== ========
The portion of inventories valued on a LIFO basis totaled $81,301,000 and $63,956,000 at September 30, 2005 and December 31, 2004, respectively. The information 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 September 30, 2005 and 2004, net earnings and diluted earnings per share would have been higher as follows:
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ------------------ 2005 2004 2005 2004 ------- ------- ------- ------- (In thousands, except per share data) Net earnings................... $ 14,285 $11,404 $ 26,531 $23,934 Diluted earnings per share..... $ 1.04 $ 0.91 $ 1.99 $ 2.18
9 For interim reporting purposes, inventory increments expected to be liquidated by year-end are valued at the most recent acquisition costs, and inventory liquidations that are expected to be reinstated by year-end are ignored 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 and third quarters 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:
Three Months Ended Nine Months Ended September 30, 2004 September 30, 2004 ------------------ ------------------ (In thousands, except per share data) Net earnings.................... $ 2,062 $ 2,617 Diluted earnings per share...... $ 0.16 $ 0.24
The LIFO layers that were liquidated were deemed to be a permanent liquidation. There were no LIFO layers liquidated in the first nine months of 2005. 10 NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS: At September 30, 2005 and December 31, 2004, we had goodwill of $50,592,000 and $40,303,000, respectively. The changes in the carrying amount of goodwill for the nine months ended September 30, 2005 are as follows:
Refining Retail Wholesale Group Group Group Total -------- ------- ----------------- ------- Phoenix Dial Fuel Oil ------- ------- (In thousands) Balance as of January 1, 2005.......... $21,153 $ 4,414 $14,736 $ - $40,303 Goodwill associated with Dial Oil purchase*................... - - - 10,289 10,289 ------- ------- ------- ------- ------- Balance as of September 30, 2005....... $21,153 $ 4,414 $14,736 $10,289 $50,592 ======= ======= ======= ======= =======
*See Note 11, "Acquisitions" for additional information regarding the purchase of Dial Oil Co ("Dial Oil"). A summary of intangible assets that are included in "Other Assets" in the Condensed Consolidated Balance Sheets at September 30, 2005 and December 31, 2004 is presented below:
September 30, 2005 December 31, 2004 ------------------------------------ ------------------------------------ Gross Net Gross Net Carrying Accumulated Carrying Carrying Accumulated Carrying Value Amortization Value Value Amortization Value -------- ------------ -------- -------- ------------ -------- (In thousands) Amortized intangible assets: Rights-of-way..................... $ 3,696 $ 2,829 $ 867 $ 3,630 $ 2,708 $ 922 Contracts......................... 1,376 1,198 178 1,367 1,109 258 Licenses and permits.............. 1,214 489 725 1,096 379 717 ------- ------- ------- ------- ------- ------- 6,286 4,516 1,770 6,093 4,196 1,897 ------- ------- ------- ------- ------- ------- Unamortized intangible assets: Liquor licenses................... 8,335 - 8,335 7,315 - 7,315 ------- ------- ------- ------- ------- ------- Total intangible assets............. $14,621 $ 4,516 $10,105 $13,408 $ 4,196 $ 9,212 ======= ======= ======= ======= ======= =======
11 Intangible asset amortization expense for the three and nine months ended September 30, 2005 was approximately $121,000 and $320,000, respectively. Intangible asset amortization expense for the three and nine months ended September 30, 2004 was $98,000 and $303,000, respectively. Estimated amortization expense for the rest of this fiscal year and the next five fiscal years is as follows: 2005 Remainder.................... $102,000 2006.............................. 412,000 2007.............................. 263,000 2008.............................. 221,000 2009.............................. 219,000 2010.............................. 94,000 12 NOTE 4 - DISCONTINUED OPERATIONS AND ASSET DISPOSALS: The following table contains information regarding our discontinued operations, all of which are included in our retail group.
Three Months Ended Nine Months Ended September 30, September 30, ------------------ ----------------- 2005 2004 2005 2004 ------ ------ ------ ------- (In thousands) Net revenues........................... $ - $ (10) $ - $ 1,267 ------ ------ ------ ------- Net operating income/(loss)............ $ - $ (17) $ 2 $ (196) Gain on disposal....................... $ - $ 161 $ 22 $ 533 Impairment and other write-downs....... $ - $ (125) $ - $ (497) ------ ------ ------ ------- Gain/(loss) before income taxes........ $ - $ 19 $ 24 $ (160) ------ ------ ------ ------- Net earnings/(loss).................... $ - $ 12 $ 15 $ (99)
During the first half of 2005, we sold a piece of vacant land for approximately $1,714,000 and recorded a gain on sale of approximately $118,000. In the third quarter of 2005, we sold a piece of land that was part of one of our stores to the State of New Mexico for approximately $85,000 and recorded a gain on sale of approximately $52,000. In the first half of 2005, we sold a closed store for approximately $149,000 and recorded a gain on sale of approximately $22,000. In the third quarter of 2005, we also recorded an impairment loss of $1,284,000 on certain refinery assets that we significantly changed the extent to which these assets were to be used. 13 NOTE 5 - ASSET RETIREMENT OBLIGATIONS: SFAS No. 143, "Accounting for Asset Retirement Obligations", 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. Our legally restricted assets that are set aside for purposes of settling ARO liabilities are approximately $336,000 as of September 30, 2005. These assets are set aside to fund costs associated with the closure of certain solid waste management facilities. In March 2005, the FASB issued Interpretation 47, "Accounting for Conditional Asset Retirement Obligations" (FIN 47). This interpretation clarifies the term conditional asset retirement obligation as used in SFAS No. 143. Conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Clarity is also provided regarding when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. We believe that this interpretation will not have a material impact on our financial statements. In addition, we continue to monitor our operations for potential FIN 47 issues. FIN 47 is to be applied no later than the end of fiscal years ending after December 15, 2005. We have 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 pipelines be purged. 3. Storage Tanks - we have a legal obligation under applicable law to remove or close in place certain 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. 14 The following table reconciles the beginning and ending aggregate carrying amount of our ARO's for the nine months ended September 30, 2005 and the year ended December 31, 2004.
September 30, December 31, 2005 2004 ------------- ------------ (In thousands) Liability beginning of year........... $2,272 $2,223 Liabilities incurred.................. 109 57 Liabilities settled................... (82) (259) Accretion expense..................... 211 251 ------ ------ Liability end of period............... $2,510 $2,272 ====== ======
Our ARO's are recorded in "Other Liabilities and Deferred Income" on our Condensed Consolidated Balance Sheets. 15 NOTE 6 - LONG-TERM DEBT: Our long-term debt consisted of the following:
September 30, December 31, 2005 2004 ------------- ------------ (In thousands) 11% senior subordinated notes, due 2012, net of unamortized discount of $2,958 and $3,635, interest payable semi-annually..................... $127,043 $145,194 8% senior subordinated notes, due 2014, net of unamortized discount of $2,301 and $2,435, interest payable semi-annually..................... 147,699 147,565 -------- -------- Total $274,742 $292,759 ======== ========
In March 2005, we issued 1,000,000 shares of our common stock and received approximately $22,349,000, net of expenses. On May 5, 2005, we used $21,905,000 of these proceeds to redeem approximately $18,828,000 of our outstanding 11% senior subordinated notes. The amount paid to redeem the notes included interest of $978,000 to the date of redemption (May 5, 2005) and redemption costs of $2,099,000. Repayment of both the 11% and 8% senior subordinated notes (collectively, the "notes") is jointly and severally guaranteed on an unconditional basis by our 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. 16 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 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 September 30, 2005, retained earnings available for dividends under the most restrictive terms of the indentures were approximately $65,138,000. 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. On June 27, 2005, we amended and restated our revolving credit facility (the "Credit Facility"). The Credit Facility is a $175,000,000 revolving credit facility and is for, among other things, working capital, acquisitions, and other general corporate purposes. The interest rate applicable to the Credit Facility is based on various short-term indices. At September 30, 2005, this rate was approximately 5.7% per annum. We are required to pay a quarterly commitment fee of between .25% and .50% of the unused amount of the facility depending on our ratio of total debt to EBITDA (as defined in the Credit Facility). Under the new Credit Facility, our existing borrowing costs are reduced, certain of the covenants have been eased, and the term was extended to 2010. The availability of funds under this facility is the lesser of (i) $175,000,000, or (ii) the amount determined under a borrowing base calculation tied to eligible accounts receivable and inventories. We also have options to increase the size of the facility to up to $250,000,000. At September 30, 2005, there were no direct borrowings outstanding under the Credit Facility. At September 30, 2005, there were, however, $8,379,000 of irrevocable letters of credit outstanding, primarily to crude oil suppliers, insurance companies, and regulatory agencies. At December 31, 2004, there were no direct borrowings and $12,068,000 of irrevocable letters of credit outstanding primarily to crude oil suppliers, insurance companies, and regulatory agencies. 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: 17 - accounts receivable; - inventory; - contracts; - chattel paper; - trademarks; - copyrights; - patents; - license rights; - deposits; and - investment accounts and general intangibles. 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 - 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 consolidated interest 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. 18 NOTE 7 - PENSION AND POST-RETIREMENT BENEFITS: The components of the Net Periodic Benefit Cost are as follows:
Yorktown Cash Balance Plan ----------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- 2005 2004 2005 2004 --------- --------- --------- --------- Service cost........................... $ 339,000 $ 345,000 $1,017,000 $1,035,000 Interest cost.......................... 168,000 135,000 504,000 403,000 Expected return on plan assets......... (69,000) (29,000) (208,000) (86,000) Amortization of prior service cost..... (27,000) - (80,000) - Amortization of net loss............... 15,000 - 45,000 - --------- --------- ---------- ---------- Net Periodic Benefit Cost.............. $ 426,000 $ 451,000 $1,278,000 $1,352,000 ========= ========= ========== ==========
Yorktown Retiree Medical Plan ----------------------------------------------- Three Months Ended Nine Months Ended September 30, September 30, ---------------------- ---------------------- 2005 2004 2005 2004 --------- --------- --------- --------- Service cost........................... $ 55,000 $ 52,000 $ 165,000 $ 156,000 Interest cost.......................... 55,000 49,000 165,000 146,000 Expected return on plan assets......... - - - - Amortization of prior service costs.... - - - - Amortization of net loss............... 4,000 4,000 12,000 13,000 --------- --------- --------- --------- Net Periodic Benefit Cost.............. $ 114,000 $ 105,000 $ 342,000 $ 315,000 ========= ========= ========= =========
In September 2005, we made a cash contribution of $2,039,000 to the Cash Balance Plan for the 2004 plan year. 19 NOTE 8 - EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted earnings (loss) per share:
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2005 2004 2005 2004 ---------- --------- ---------- --------- Numerator (In thousands) Earnings from continuing operations.............. $ 46,640 $ 5,975 $ 77,236 $ 15,592 Earnings/(loss) from discontinued operations..... - 12 15 (99) ---------- --------- ---------- --------- Net earnings..................................... $ 46,640 $ 5,987 $ 77,251 $ 15,493 ========== ========= ========== =========
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2005 2004 2005 2004 ---------- --------- ---------- --------- Denominator Basic - weighted average shares outstanding...... 13,611,847 12,242,994 13,137,526 10,693,386 Effect of dilutive stock options................. 174,937 253,210 187,160 267,298 ---------- ---------- ---------- ---------- Diluted - weighted average shares outstanding.... 13,786,784 12,496,204 13,324,686 10,960,684 ========== ========== ========== ==========
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2005 2004 2005 2004 ---------- --------- ---------- --------- Basic Earnings (Loss) Per Share Earnings from continuing operations.............. $ 3.43 $ 0.49 $ 5.88 $ 1.45 Loss from discontinued operations................ - - - (0.01) ---------- --------- ---------- --------- Net earnings..................................... $ 3.43 $ 0.49 $ 5.88 $ 1.44 ========== ========= ========== =========
20
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2005 2004 2005 2004 ---------- --------- ---------- --------- Diluted Earnings (Loss) Per Share Earnings from continuing operations.............. $ 3.38 $ 0.48 $ 5.80 $ 1.42 Loss from discontinued operations................ - - - (0.01) ---------- --------- ---------- --------- Net earnings..................................... $ 3.38 $ 0.48 $ 5.80 $ 1.41 ========== ========= ========== =========
In March 2005, we issued 1,000,000 shares of common stock. In April 2005, we contributed 34,196 newly issued shares of our common stock, valued at $972,000, to our 401(k) plan as a discretionary contribution for the year 2004. In September 2005, we issued 1,000,000 shares of our common stock and received approximately $52,057,000, net of expenses. We intend to use the proceeds for general corporate purposes, including to test and take other actions required to place our recently acquired crude oil pipeline in service, and for possible future acquisitions. In February 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. 21 NOTE 9 - 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 the wholesale group (formerly known as Phoenix Fuel). 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 our wholesale group supplies the gasoline and diesel fuel that our retail group sells. We purchase general merchandise and food products from various suppliers. At September 30, 2005, our retail group operated 124 service stations with convenience stores or kiosks. WHOLESALE GROUP Our wholesale group consists of Phoenix Fuel and Dial Oil (See Note 11, "Acquisitions", for further information). Our wholesale group primarily distributes commercial wholesale petroleum products. Our wholesale group includes several lubricant and bulk petroleum distribution plants, an unmanned fleet fueling operation, a bulk lubricant terminal facility, a fleet of finished product and lubricant delivery trucks, and 12 service stations acquired in the Dial Oil acquisition. We purchase petroleum fuels and lubricants from suppliers and to a lesser extent from our refining group. OTHER Our operations that are not included in any of the three segments are included in the category "Other." These operations consist primarily of corporate staff operations. 22 Operating income 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 LIFO 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. Disclosures regarding our reportable segments with a reconciliation to consolidated totals for the three and nine months ended September 30, 2005 and 2004, are presented below. The tables pertaining to the three and nine months ended September 30, 2004 do not include the results of Dial Oil. 23
As of and for the Three Months Ended September 30, 2005 ------------------------------------------------------------------------- Wholesale Group --------------- Refining Retail Phoenix Dial Reconciling Group Group Fuel Oil Other Items Consolidated ------------------------------------------------------------------------- (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $158,251 Yorktown operations.................. 483,941 -------- Total.............................. 642,192 95,335 231,136 52,254 - - 1,020,917 Merchandise and lubricants............. - 38,286 8,816 8,560 - - 55,662 Other.................................. 3,520 3,893 499 667 67 - 8,646 -------- -------- -------- -------- -------- -------- --------- Total.............................. 645,712 137,514 240,451 61,481 67 - 1,085,225 -------- -------- -------- -------- -------- -------- --------- Intersegment net revenues: Finished products...................... 95,704 - 21,978 - - (117,682) - Merchandise and lubricants............. - - - 14 - (14) - Other.................................. 5,026 - 33 94 - (5,153) - -------- -------- -------- -------- -------- -------- --------- Total.............................. 100,730 - 22,011 108 - (122,849) - -------- -------- -------- -------- -------- -------- --------- Total net revenues....................... 746,442 137,514 262,462 61,589 67 (122,849) 1,085,225 Less net revenues of discontinued operations............................. - - - - - - - -------- -------- -------- -------- -------- -------- --------- Net revenues of continuing operations.... 746,442 137,514 262,462 61,589 67 (122,849) 1,085,225 ======== ======== ======== ======== ======== ======== ========= 24 As of and for the Three Months Ended September 30, 2005 ------------------------------------------------------------------------- Wholesale Group --------------- Refining Retail Phoenix Dial Reconciling Group Group Fuel Oil Other Items Consolidated ------------------------------------------------------------------------- (In thousands) Operating income (loss): Four Corners operations................ $ 32,968 Yorktown operations.................... 52,288 -------- Total operating income (loss) before corporate allocation...... $ 85,256 3,804 6,641 1,509 (11,698) (1,055) 84,457 Corporate allocation..................... (6,073) (3,820) (1,120) (184) 11,197 - - -------- -------- -------- -------- -------- -------- --------- Total operating income (loss) after corporate allocation................... 79,183 (16) 5,521 1,325 (501) (1,055) 84,457 Discontinued operations (gain) loss...... - - - - - - - -------- -------- -------- -------- -------- -------- --------- Operating income (loss) from continuing operations................ $ 79,183 (16) 5,521 1,325 (501) (1,055) 84,457 ======== ======== ======== ======== ======== ======== ========= Interest expense......................... (5,783) Costs associated with early debt extinguishment.................... 17 Amortization and write-offs of financing costs........................ (398) Interest and investment income........... 479 --------- Earnings from continuing operations before income taxes.................... $ 78,772 ========= Depreciation and amortization: Four Corners operations................ $ 4,267 Yorktown operations.................... 2,653 -------- Total.............................. $ 6,920 2,042 389 420 202 - 9,973 Less discontinued operations........... - - - - - - - -------- -------- -------- -------- -------- -------- --------- Continuing operations.................. $ 6,920 2,042 389 420 202 - 9,973 ======== ======== ======== ======== ======== ======== ========= Total assets............................. $585,563 104,302 117,950 56,033 110,597 - 974,445 Capital expenditures..................... $ 27,692 1,221 470 58 252 - 29,693 25
As of and for the Three Months Ended September 30, 2004** ---------------------------------------------------------------- Refining Retail Phoenix Reconciling Group Group Fuel Other Items Consolidated ---------------------------------------------------------------- (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $116,983 Yorktown operations.................. 261,041 -------- Total................................ $378,024 $ 63,121 $149,543 $ - $ - $ 590,688 Merchandise and lubricants............. - 36,276 8,393 - - 44,669 Other.................................. 2,873 3,539 506 154 - 7,072 -------- -------- -------- -------- --------- ---------- Total................................ 380,897 102,936 158,442 154 - 642,429 -------- -------- -------- -------- --------- ---------- Intersegment net revenues: Finished products...................... 50,653 - 14,883 - (65,536) - Other.................................. 3,887 - - - (3,887) - -------- -------- -------- -------- --------- ---------- Total................................ 54,540 - 14,883 - (69,423) - -------- -------- -------- -------- --------- ---------- Total net revenues....................... 435,437 102,936 173,325 154 (69,423) 642,429 Less net revenues of discontinued operations............................. - 10 - - - 10 -------- -------- -------- -------- --------- ---------- Net revenues of continuing operations.... $435,437 $102,946 $173,325 $ 154 $ (69,423) $ 642,439 ======== ======== ======== ======== ========= ========== Operating income (loss): Four Corners operations................ $ 8,150 Yorktown operations.................... 11,652 -------- Total operating income (loss) before corporate allocation................... $ 19,802 $ 1,428 $ 2,216 $ (6,879) $ 1,883 $ 18,450 Corporate allocation..................... (3,273) (1,895) (574) 5,742 - - -------- -------- -------- -------- --------- ---------- Total operating income (loss) after corporate allocation................... 16,529 (467) 1,642 (1,137) 1,883 18,450 Discontinued operations loss/(gain)...... - 17 - - (36) (19) -------- -------- -------- -------- --------- ---------- Operating income (loss) from continuing operations............. $ 16,529 $ (450) $ 1,642 $ (1,137) $ 1,847 18,431 ======== ======== ======== ======== ========= Interest expense......................... (7,173) Amortization and write-offs of financing costs........................ (1,012) Interest income.......................... 57 ---------- Earnings from continuing operations before income taxes.................... $ 10,303 ========== 26 As of and for the Three Months Ended September 30, 2004** ---------------------------------------------------------------- Refining Retail Phoenix Reconciling Group Group Fuel Other Items Consolidated ---------------------------------------------------------------- (In thousands) Depreciation and amortization: Four Corners operations................ $ 4,045 Yorktown operations.................... 2,275 -------- Total................................ $ 6,320 $ 2,119 $ 380 $ 211 $ - $ 9,030 Less discontinued operations......... - (6) - - - (6) -------- -------- -------- -------- --------- ---------- Continuing operations................ $ 6,320 $ 2,113 $ 380 $ 211 $ - $ 9,024 ======== ======== ======== ======== ========= ========== Total assets............................. $471,659 $107,278 $ 85,719 $ 50,328 $ - $ 714,984 Capital expenditures..................... $ 16,438 $ 919 $ 500 $ 135 $ - $ 17,992 Yorktown refinery acquisition contingent payment..................... $ 3,605 $ - $ - $ - $ - $ 3,605 **Information does not include Dial Oil. 27
As of and for the Nine Months Ended September 30, 2005 ------------------------------------------------------------------------- Wholesale Group --------------- Refining Retail Phoenix Dial Reconciling Group Group Fuel Oil Other Items Consolidated ------------------------------------------------------------------------- (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $ 428,402 Yorktown operations.................. 1,193,325 --------- Total.............................. 1,621,727 235,463 584,940 52,254 - - 2,494,384 Merchandise and lubricants............. - 105,898 27,466 8,560 - - 141,924 Other.................................. 9,415 11,952 1,589 667 378 - 24,001 -------- -------- -------- -------- -------- -------- --------- Total.............................. 1,631,142 353,313 613,995 61,481 378 - 2,660,309 -------- -------- -------- -------- -------- -------- --------- Intersegment net revenues: Finished products...................... 206,956 - 55,823 - - (262,779) - Merchandise and lubricants............. - - - 14 - (14) - Other.................................. 14,491 - 33 94 - (14,618) - -------- -------- -------- -------- -------- -------- --------- Total.............................. 221,447 - 55,856 108 - (277,411) - -------- -------- -------- -------- -------- -------- --------- Total net revenues....................... 1,852,589 353,313 669,851 61,589 378 (277,411) 2,660,309 Less net revenues of discontinued operations............................. - - - - - - - -------- -------- -------- -------- -------- -------- --------- Net revenues of continuing operations.... 1,852,589 353,313 669,851 61,859 378 (277,411) 2,660,309 ======== ======== ======== ======== ======== ======== ========= 28 As of and for the Nine Months Ended September 30, 2005 ------------------------------------------------------------------------- Wholesale Group --------------- Refining Retail Phoenix Dial Reconciling Group Group Fuel Oil Other Items Consolidated ------------------------------------------------------------------------- (In thousands) Operating income (loss): Four Corners operations................ $ 58,978 Yorktown operations.................... 97,250 -------- Total operating income (loss) before corporate allocation...... $156,228 5,239 13,155 1,509 (25,298) 2,875 153,708 Corporate allocation..................... (13,184) (7,918) (2,442) (184) 23,728 - - -------- -------- -------- -------- -------- -------- --------- Total operating income (loss) after corporate allocation................... 143,044 (2,679) 10,713 1,325 (1,570) 2,875 153,708 Discontinued operations (gain) loss...... - (2) - - - (22) (24) -------- -------- -------- -------- -------- -------- --------- Operating income (loss) from continuing operations................ $143,044 (2,681) 10,713 1,325 (1,570) 2,853 153,684 ======== ======== ======== ======== ======== ======== Interest expense......................... (19,159) Costs associated with early debt extinguishment.................... (2,082) Amortization and write-offs of financing costs........................ (2,398) Interest and investment income........... 967 --------- Earnings from continuing operations before income taxes.................... $ 131,012 ========= Depreciation and amortization: Four Corners operations................ $ 12,438 Yorktown operations.................... 7,949 -------- Total.............................. $ 20,387 7,779 1,275 420 574 - 30,435 Less discontinued operations........... - - - - - - - -------- -------- -------- -------- -------- -------- --------- Continuing operations.................. $ 20,387 7,779 1,275 420 574 - 30,435 ======== ======== ======== ======== ======== ======== ========= Total assets............................. $585,563 104,302 117,950 56,033 110,597 - 974,445 Capital expenditures..................... $ 51,416 3,231 1,504 58 1,181 - 57,390 29
As of and for the Nine Months Ended September 30, 2004** ---------------------------------------------------------------- Refining Retail Phoenix Reconciling Group Group Fuel Other Items Consolidated ------------------------------------------------------------------ (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $ 306,735 Yorktown operations.................. 784,587 ---------- Total................................ $1,091,322 $172,295 $427,261 $ - $ - $1,690,878 Merchandise and lubricants............. - 101,661 23,989 - - 125,650 Other.................................. 8,934 11,171 1,430 486 - 22,021 ---------- -------- -------- -------- --------- ---------- Total................................ 1,100,256 285,127 452,680 486 - 1,838,549 ---------- -------- -------- -------- --------- ---------- Intersegment net revenues: Finished products...................... 154,314 - 45,944 - (200,258) - Other.................................. 11,653 - - - (11,653) - ---------- -------- -------- -------- --------- ---------- Total................................ 165,967 - 45,944 - (211,911) - ---------- -------- -------- -------- --------- ---------- Total net revenues....................... 1,266,223 285,127 498,624 486 (211,911) 1,838,549 Less net revenues of discontinued operations............................. - (1,267) - - - (1,267) ---------- -------- -------- -------- --------- ---------- Net revenues of continuing operations.... $1,266,223 $283,860 $498,624 $ 486 $(211,911) $1,837,282 ========== ======== ======== ======== ========= ========== Operating income (loss): Four Corners operations................ $ 28,014 Yorktown operations.................... 47,899 ---------- Total operating income (loss) before corporate allocation................... $ 75,913 $ 5,030 $ 7,290 $(19,402) $ 1,321 $ 70,152 Corporate allocation..................... (9,359) (5,418) (1,642) 16,419 - - ---------- -------- -------- -------- --------- ---------- Total operating income (loss) after corporate allocation................... 66,554 (388) 5,648 (2,983) 1,321 70,152 Discontinued operations loss/(gain)...... - 196 - - (36) 160 ---------- -------- -------- -------- --------- ---------- Operating income (loss) from continuing operations............. $ 66,554 $ (192) $ 5,648 $ (2,983) $ 1,285 70,312 ========== ======== ======== ======== ========= Interest expense......................... (25,222) Costs associated with early debt extinguishment......................... (10,875) Amortization and write-offs of financing costs........................ (7,827) Interest income.......................... 138 ---------- Earnings from continuing operations before income taxes.................... $ 26,526 ========== 30 Depreciation and amortization: Four Corners operations................ $ 12,120 Yorktown operations.................... 6,667 ---------- Total................................ $ 18,787 $ 6,792 $ 1,204 $ 647 $ - $ 27,430 Less discontinued operations......... - (88) - - - (88) ---------- -------- -------- -------- --------- ---------- Continuing operations................ $ 18,787 $ 6,704 $ 1,204 $ 647 $ - $ 27,342 ========== ======== ======== ======== ========= ========== Total assets............................. $ 471,659 $107,278 $ 85,719 $ 50,328 $ - $ 714,984 Capital expenditures..................... $ 36,673 $ 1,616 $ 1,293 $ 260 $ - $ 39,842 Yorktown refinery acquisition contingent payment..................... $ 15,300 $ - $ - $ - $ - $ 15,300 ** Information does not include Dial Oil. 31
NOTE 10 - 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. 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 similar industries, 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 September 30, 2005 and December 31, 2004, we had environmental liability accruals of approximately $5,376,000 and $6,156,000, respectively, which are summarized below, and litigation accruals in the aggregate of $1,218,000 at September 30, 2005 and $525,000 at December 31, 2004. Environmental accruals are recorded in the current and long-term sections of our Condensed Consolidated Balance Sheets. Litigation accruals are recorded in the current section of our Condensed Consolidated Balance Sheets. 32
SUMMARY OF ACCRUED ENVIRONMENTAL CONTINGENCIES (In thousands) December 31, Increase September 30, 2004 (Decrease) Payments 2005 ------------ ---------- -------- ------------- Yorktown Refinery......................... $ 4,531 $ 57 $ (787) $ 3,801 Farmington Refinery....................... 570 - - 570 Bloomfield Refinery....................... 251 - (22) 229 Bloomfield - West Outfall................. 44 - (44) - Bloomfield - River Terrace................ - 209 (67) 142 Bloomfield Tank Farm (Old Terminal)....... 53 - (8) 45 Ciniza - Solid Waste Management Units..... 274 - (10) 264 Ciniza - Land Treatment Facility.......... 186 - (8) 178 Ciniza Well Closures...................... 109 - (109) - Retail Service Stations - Various......... 138 106 (163) 81 Other..................................... - 211 (145) 66 ------- ------ ------ ------- Totals................................. $ 6,156 $ 583 $(1,363) $ 5,376 ======= ====== ====== =======
Approximately $4,787,000 of our environmental accrual is for the following projects discussed below: - the remediation of the hydrocarbon plume that appears to extend no more than 1,800 feet south of our inactive Farmington refinery; - environmental obligations assumed in connection with our acquisitions of the Yorktown refinery and the Bloomfield refinery; - the remediation of hydrocarbon contamination discovered at the Bloomfield refinery after its purchase (the "West Outfall" and "River Terrace" contamination); and - hydrocarbon contamination on and adjacent to the 5.5 acres that we own in Bloomfield, New Mexico. The remaining amount of the accrual relates to the following: - closure of certain solid waste management units at the Ciniza refinery, which is being conducted in accordance with the refinery's Resource Conservation and Recovery Act permit; - closure of the Ciniza refinery land treatment facility including post-closure expenses; and - amounts for smaller remediation projects. 33 YORKTOWN ENVIRONMENTAL LIABILITIES We assumed certain liabilities and obligations in connection with our purchase of the Yorktown refinery from BP Corporation North America Inc. and BP Products North America Inc. (collectively "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. YORKTOWN CONSENT DECREE Environmental obligations assumed by us 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 nitrous oxides, sulfur dioxide, 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, and have expended approximately $6,115,000 of this amount through the third quarter of 2005. 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 in 1991 by the Environmental Protection Agency ("EPA") under the Resource Conservation and Recovery Act ("RCRA"). 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 RCRA Facility Investigation was conducted and approved conditionally by EPA in 2002. Following the investigation, a Risk Assessment/Corrective Measures Study ("RA/CMS") was finalized in 2003, which summarized the remediation measures agreed upon by us, EPA, and the Virginia Department of Environmental Quality ("VDEQ"). The RA/CMS proposes investigation, sampling, monitoring, and clean-up 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. 34 Based on the RA/CMS, EPA issued a proposed clean-up 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 our clean-up plan. Our most current estimate of expenses associated with the order is between $24,000,000 and $26,000,000, and we anticipate that these expenses will be incurred over a period of approximately 35 years after EPA approves our clean-up plan. We believe that approximately $9,600,000 of this amount will be incurred over an initial four-year period, and additional expenditures of approximately $7,700,000 will be incurred over the following four-year period, with the remainder thereafter. EPA may require financial assurance of our ability to perform the clean-up plan, such as depositing funds into a trust or posting a letter of credit or performance bond. We may, however, be able to receive reimbursement for some of the expenditures associated with the plan due to the environmental reimbursement provisions included in our purchase agreement with BP, as more fully discussed below. As part of the clean-up plan, the facility's underground sewer system will be cleaned, inspected and repaired as needed. A portion of this sewer work is scheduled to begin during the construction of the corrective action management unit and related remediation work and is included in our associated cost estimate. We anticipate that the balance of the sewer work will cost from $1,500,000 to $3,500,000 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 nearing completion. We anticipate that construction of the corrective action management unit and related remediation work will be completed approximately five to seven years after EPA approves our clean-up plan. 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 has 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 35 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 MATTERS In 1973, we constructed the Farmington refinery that we operated until 1982. In 1985, we became aware of soil and shallow groundwater contamination at this facility. Our environmental consulting firms 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 has 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 clean-up order. BLOOMFIELD REFINERY ENVIRONMENTAL OBLIGATIONS 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 RCRA. 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 New Mexico Environment Department's ("NMED") Hazardous Waste Bureau ("HWB"). In December 2002, HWB and OCD approved a clean-up plan for the refinery, subject to various actions to be taken by us to implement the plan. We estimate that remaining remediation expenses associated with the clean-up plan will be approximately $229,000, and that these expenses will be incurred through approximately 2018. BLOOMFIELD REFINERY - WEST OUTFALL AND RIVER TERRACE In August 2004, hydrocarbon discharges were discovered seeping into two small gullies, or draws, in an area of the Bloomfield refinery site known as the west outfall. We took immediate containment and other corrective actions, including removal of contaminated soils, construction of lined collection sumps, and further investigation and monitoring. To further remediate these discharges and prevent additional migration of contamination, with OCD approval, we completed construction of an underground barrier with a pollutant extraction and collection system in the second quarter of 2005 at a cost of approximately $790,000. 36 In connection with the underground barrier at the west outfall, OCD required more investigation of elevated hydrocarbon levels in an area of the Bloomfield refinery site known as the river terrace. With the approval of OCD, we installed sheet piling in this area in 1999 to block migration of groundwater contaminants. Monitoring wells were also installed, with annual sampling results submitted to OCD. In August 2005, OCD approved a bioventing plan to reduce hydrocarbon levels in this area. Bioventing involves pumping air into the soil to stimulate bacterial activity, which in turn consumes hydrocarbons. We estimate that remaining expenses associated with the bioventing plan will be approximately $142,000, and that these expenses will be incurred through the first half of 2006. BLOOMFIELD REFINERY - OCD COMPLIANCE ORDER On September 19, 2005, we received an Administrative Compliance Order from OCD alleging that: (1) we had failed to notify OCD of the west outfall discharges at our Bloomfield refinery; (2) we had allowed contaminants to enter the San Juan River from the refinery's river terrace area; and (3) we had failed to comply with certain conditions of the refinery's groundwater discharge permit. The Order seeks a civil penalty of $120,000, and also specifies that we apply for a discharge permit modification. We have already applied for and received the permit modification, which requires us to prepare a comprehensive action plan for the investigation and remediation of contaminated soil and groundwater at the refinery. Until this plan is completed and approved by the two agencies with regulatory oversight, OCD and HWB, we cannot reasonably estimate the cost of any associated remediation activities. We are continuing settlement discussions with OCD in connection with the Order. As part of any settlement, we may be required to make further modifications to our discharge permit. BLOOMFIELD REFINERY - EPA COMPLIANCE ORDER On October 12, 2005, we received an Administrative Compliance Order from EPA in connection with a 2000 Bloomfield refinery compliance evaluation inspection and a follow-up inspection in early 2001. We send waste water from the refinery's process units through an oil-water separator, a series of aeration ponds that continue the treatment and processing of oily water, and a series of evaporation ponds, before the water is injected into a permitted deep well. EPA alleges that benzene levels in the aeration ponds exceed permissible RCRA levels. EPA also alleges that we failed to make a RCRA hazardous waste determination in connection with waste water going into the aeration ponds. The Order seeks a civil penalty of $890,000 in connection with this matter, but EPA has indicated it would consider settling for a lesser amount if we commit to operational changes that would reduce benzene levels in the aeration ponds. As part of any settlement, we may be required to undertake one or more environmentally beneficial projects known as supplemental environmental projects. We are continuing settlement discussions with EPA. 37 BLOOMFIELD TANK FARM (OLD TERMINAL) We have discovered hydrocarbon contamination adjacent to a 55,000 barrel crude oil storage tank that was located in Bloomfield, New Mexico. We believe that all or a portion of the tank and the 5.5 acres we own on which the tank was located may have been a part of a refinery, owned by various other parties, that, to our knowledge, ceased operations in the early 1960s. We received approval to conduct a pilot bioventing project to address remaining contamination at the site, which was completed in 2001. Bioventing involves pumping air into the soil to stimulate bacterial activity, which in turn consumes hydrocarbons. Based on the results of the pilot project, we submitted a remediation plan to OCD proposing the use of bioventing to address the remaining contamination. This remediation plan was approved by OCD in 2002. We anticipate that we will incur approximately $45,000 in expenses from 2005 through 2007 to continue remediation, including groundwater monitoring and testing, until natural attenuation has completed the process of groundwater remediation. CONSENT AGREEMENTS 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. 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. In July 2005, we reached an administrative settlement with NMED and EPA in the form of consent agreements. The administrative settlement resolves all alleged violations related to the 2001 inspections. In August 2005, we paid fines of $100,000 to EPA and $150,000 to NMED. We must also undertake certain environmentally beneficial projects known as supplemental environmental projects at a cost of up to $600,000. In addition, the administrative settlement is consistent with the judicial consent decrees EPA has entered into with other refiners as part of its national refinery enforcement program and requires that we do the following: - 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 continued compliance with benzene waste requirements. 38 We currently believe that we can satisfy the requirements of the settlement and the requirements of the national refinery enforcement program by making equipment modifications to our Four Corners refineries, which we estimate could cost approximately $20,000,000, spread over a period of four to seven years following the date of the settlement. We currently anticipate that the majority of these costs will be incurred in the latter portion of the four to seven year phase-in period. In addition, we estimate that on-going annual operating costs associated with these modifications could cost approximately $4,000,000 per year. These amounts are the currently estimated upper limits for both capital expenditures and annual operating costs. Undertaking the upper limit for one type of expenditure could result in our having to spend less than the upper limit for the other. The costs associated with our settlement also could be subject to reduction in the event of the temporary, partial or permanent discontinuance of operations at one or both facilities. JET FUEL CLAIM In February 2003, we filed a complaint against the United States ("U.S.") 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 federal government underpaid for the jet fuel by about $17,000,000. We requested that we be made whole in connection with payments that were less than the fair market value of the fuel, that we be reimbursed for the value of transporting the fuel in some contracts, and that we be reimbursed 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. In April 2005, a three judge panel of the Court of Appeals ruled in favor of the U.S. The full Court of Appeals declined to reconsider this decision. Our case has been stayed pending a possible appeal of that decision to the U.S. Supreme Court. We are continuing to evaluate our claims and monitor further developments in the appellate case. Based on the current status of our claim, 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 supplies. MTBE contamination primarily results from leaking underground or aboveground storage tanks. The suits allege MTBE contamination of water supplies owned and operated by the plaintiffs, who are generally water providers or governmental entities. The plaintiffs assert that numerous refiners, distributors, or sellers of MTBE and/or gasoline containing MTBE are responsible for the 39 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. We are a defendant in approximately 30 of these MTBE lawsuits pending in Virginia, Connecticut, Massachusetts, New Hampshire, New York, New Jersey, and Pennsylvania. We intend to vigorously defend these lawsuits. Although it is possible that these lawsuits may ultimately be decided against us, or otherwise adversely affect us, a reasonable estimate of the amount of our potential liability, if any, cannot be made at this time for various reasons. These reasons include: - we anticipate that numerous parties are potentially responsible for the MTBE contamination alleged in these lawsuits; and - potentially applicable factual and legal issues have not been resolved. CINIZA REFINERY INCIDENT A fire occurred in the alkylation unit at our Ciniza refinery on April 8, 2004. This unit produces high octane blending stock for gasoline. 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 hospitalized, and all employees have since been released from the hospital. On October 26, 2005, the U.S. Chemical Safety and Hazard Investigation Board ("CSB") issued a case study of matters relating to the fire. We do not agree with all of its findings. CSB does not have authority to issue citations or any monetary fines. 40 NOTE 11 - ACQUISITIONS: On August 1, 2005, we acquired an idle crude oil pipeline running from Jal, New Mexico to Bisti, New Mexico and related assets from Texas- New Mexico Pipe Line Company. This pipeline is connected to our existing pipeline network that directly supplies crude oil to the Bloomfield and Ciniza refineries. Following the acquisition, we will test the pipeline and take other actions related to placing it in service. Unless currently unanticipated obstacles are encountered, we anticipate the pipeline will become operational before the end of 2006. On July 12, 2005, we acquired 100% of the common shares of Dial Oil. We funded this acquisition with cash on hand. Dial Oil is a wholesale distributor of gasoline, diesel and lubricants in the Four Corners area of the Southwest. Dial Oil also owns and operates 12 service stations/convenience stores. Dial Oil's assets include bulk petroleum distribution plants, cardlock fueling locations, and a fleet of truck transports. The acquisition has been accounted for using the purchase method of accounting whereby the total purchase price has been preliminarily allocated to tangible and intangible assets acquired and liabilities assumed based on the fair market values on the date of acquisition. The pro forma effect of the acquisition on Giant's results of operations is immaterial. 41 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 the wholesale group (formerly known as 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 124 service stations at September 30, 2005. The retail group sells its petroleum products and merchandise to consumers in New Mexico, Arizona and Southern Colorado. The wholesale group distributes commercial wholesale petroleum products primarily in Arizona and New Mexico and 12 service stations acquired in the Dial Oil acquisition. 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 margins through management of inventories and taking advantage of sales and purchasing opportunities; - 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; - improving our overall financial health and flexibility by, among other things, 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 internal growth and 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 42 that differ considerably from those that would result from the application 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, 2004. 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; - accounting for our pension and post-retirement benefit plans; and - accounting for inventories. There have been no changes to these policies in 2005. 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 in this Form 10-Q, and in our Annual Report on Form 10-K for the year ended December 31, 2004 in Item 8. 43 Below is operating data for our operations:
Three Months Ended Nine Months Ended September 30, September 30, --------------------- --------------------- 2005 2004 2005 2004 --------- --------- --------- --------- Refining Group Operating Data: Four Corners Operations: Crude Oil/NGL Throughput (BPD)........... 29,867 29,271 29,500 28,010 Refinery Sourced Sales Barrels (BPD)..... 29,096 28,412 29,002 27,072 Average Crude Oil Costs ($/Bbl).......... $ 60.59 $ 40.99 $ 53.30 $ 36.60 Refining Margins ($/Bbl)................. $ 18.08 $ 8.14 $ 13.21 $ 9.54 Yorktown Operations: Crude Oil/NGL Throughput (BPD)........... 68,201 53,991 67,472 60,918 Refinery Sourced Sales Barrels (BPD)..... 70,936 53,585 68,430 62,391 Average Crude Oil Costs ($/Bbl).......... $ 58.05 $ 38.43 $ 50.75 $ 35.27 Refining Margins ($/Bbl)................. $ 11.25 $ 6.01 $ 8.52 $ 5.93 Retail Group Operating Data: (Continuing operations only) Fuel Gallons Sold (000's).................. 42,529 41,244 123,409 116,664 Fuel Margins ($/gal)....................... $ 0.21 $ 0.18 $ 0.16 $ 0.18 Merchandise Sales ($ in 000's)............. $ 38,285 $ 36,276 $ 105,898 $ 101,378 Merchandise Margins........................ 27% 20% 27% 23% Operating Retail Outlets at Period End..... 124 124 124 124 Wholesale Group Operating Data: Phoenix Fuel: Fuel Gallons Sold (000's)................ 118,844 119,253 360,054 356,439 Fuel Margins ($/gal)..................... $ 0.08 $ 0.05 $ 0.07 $ 0.05 Lubricant Sales ($ in 000's)............. $ 8,247 $ 7,933 $ 25,686 $ 22,635 Lubricant Margins........................ 28% 13% 17% 13% Dial Oil**: Fuel Gallons Sold (000's)................ 24,963 - 24,963 - Fuel Margins ($/gal)..................... $ 0.12 - $ 0.12 - Lubricant Sales ($ in 000's)............. $ 5,833 - $ 5,833 - Lubricant Margins........................ 13% - 13% - Merchandise Sales ($ in 000's)........... $ 2,241 - $ 2,241 - Merchandise Margins*..................... 26% - 26% - Operating Retail Outlets at Period End... 12 - 12 - *Includes only retail store merchandise sales. **Statistics presented are from date July 12, 2005 date of acquisition.
44 RECONCILIATIONS TO AMOUNTS REPORTED UNDER GENERALLY ACCEPTED ACCOUNTING PRINCIPLES REFINING GROUP -------------- Refining Margin --------------- Refining margin is the difference between average net sales prices and average cost of products produced per refinery sourced sales barrel of refined product. Refining margins for each of our refineries and all of our refineries on a consolidated basis are calculated as shown below.
Three Months Ended Nine Months Ended September 30, September 30, ------------------- ----------------------- 2005 2004 2005 2004 -------- -------- ---------- ---------- AVERAGE PER BARREL ------------------ Four Corners Operation Net sales........................................... $ 83.48 $ 53.68 $ 70.60 $ 50.29 Less cost of products............................... 65.40 45.54 57.39 40.75 -------- -------- ---------- ---------- Refining margin..................................... $ 18.08 $ 8.14 $ 13.21 $ 9.54 ======== ======== ========== ========== Yorktown Operation Net sales........................................... $ 72.52 $ 47.67 $ 61.42 $ 43.45 Less cost of products............................... 61.27 41.66 52.90 37.52 -------- -------- ---------- ---------- Refining margin..................................... $ 11.25 $ 6.01 $ 8.52 $ 5.93 ======== ======== ========== ========== Consolidated Net sales........................................... $ 75.71 $ 49.75 $ 64.15 $ 45.52 Less cost of products............................... 62.47 43.00 54.24 38.50 -------- -------- ---------- ---------- Refining margin..................................... $ 13.24 $ 6.75 $ 9.91 $ 7.02 ======== ======== ========== ========== 45 Three Months Ended Nine Months Ended September 30, September 30, ------------------- ----------------------- 2005 2004 2005 2004 -------- -------- ---------- ---------- Reconciliations of refined product sales from produced products sold per barrel to net revenues Four Corners Operations Average sales price per produced barrel sold........ $ 83.48 $ 53.68 $ 70.60 $ 50.29 Times refinery sourced sales barrels per day........ 29,096 28,412 29,002 27,072 Times number of days in period...................... 92 92 273 274 -------- -------- ---------- ---------- Refined product sales from produced products Sold (000's)...................................... $223,462 $140,314 $ 558,979 $ 373,038 ======== ======== ========== ========== Yorktown Operations Average sales price per produced barrel sold........ $ 72.52 $ 47.67 $ 61.42 $ 43.45 Times refinery sourced sales barrels per day........ 70,936 53,585 68,430 62,391 Times number of days in period...................... 92 92 273 274 -------- -------- ---------- ---------- Refined product sales from produced products Sold (000's)...................................... $473,274 $235,005 $1,147,411 $ 742,784 ======== ======== ========== ========== Consolidated (000's) Sum of refined product sales from produced products sold*.................................... $696,736 $375,319 $1,706,390 $1,115,822 Purchased product, Transportation and other revenues 49,706 60,118 146,199 150,401 -------- -------- ---------- ---------- Net revenues........................................ $746,442 $435,437 $1,852,589 $1,266,223 ======== ======== ========== ========== *Includes inter-segment net revenues.
46
Three Months Ended Nine Months Ended September 30, September 30, ------------------- ----------------------- 2005 2004 2005 2004 -------- -------- ---------- ---------- Reconciliation of average cost of products per produced barrel sold to total cost of products sold (excluding depreciation and amortization) Four Corners Operations Average cost of products per produced barrel sold... $ 65.40 $ 45.54 $ 57.39 $ 40.75 Times refinery sourced sales barrels per day........ 29,096 28,412 29,002 27,072 Times number of days in period...................... 92 92 273 274 -------- -------- ---------- ---------- Cost of products for produced products Sold (000's)...................................... $175,065 $119,037 $ 454,388 $ 302,272 ======== ======== ========== ========== Yorktown Operations Average cost of products per produced barrel sold... $ 61.27 $ 41.66 $ 52.90 $ 37.52 Times refinery sourced sales barrels per day........ 70,936 53,585 68,430 62,391 Times number of days in period...................... 92 92 273 274 -------- -------- ---------- ---------- Cost of products for produced products Sold (000's)...................................... $399,855 $205,376 $ 988,246 $ 641,409 ======== ======== ========== ========== Consolidated (000's) Sum of refined cost of produced products sold....... $574,920 $324,413 $1,442,634 $ 943,681 Purchased product, transportation and other cost of products sold..................................... 41,174 53,588 121,835 130,778 -------- -------- ---------- ---------- Total cost of products sold (excluding depreciation and amortization)................................... $616,094 $378,001 $1,564,469 $1,074,459 ======== ======== ========== ==========
47 RETAIL GROUP ------------ Fuel Margin ----------- Fuel margin is the difference between fuel sales less cost of fuel sales divided by number of gallons sold.
Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 110,975 $ 78,445 $ 281,469 $ 213,438 Less cost of fuel sold............................ 102,168 71,048 261,123 191,973 ---------- ---------- ---------- ---------- Fuel margin....................................... $ 8,807 $ 7,397 $ 20,346 $ 21,465 Number of gallons sold............................ 42,529 41,244 123,409 116,664 Fuel margin per gallon............................ $ 0.21 $ 0.18 $ 0.16 $ 0.18 Reconciliation of fuel sales to net revenues (000's) Fuel sales........................................ $ 110,975 $ 78,445 $ 281,469 $ 213,438 Excise taxes included in sales.................... (15,640) (15,325) (46,006) (42,071) ---------- ---------- ---------- ---------- Fuel sales, net of excise taxes................... 95,335 63,120 235,463 171,367 Merchandise sales................................. 38,285 36,276 105,898 101,378 Other sales....................................... 3,894 3,550 11,952 11,115 ---------- ---------- ---------- ---------- Net revenues...................................... $ 137,514 $ 102,946 $ 353,313 $ 283,860 ========== ========== ========== ========== Reconciliation of fuel cost of products sold to total cost of products sold (excluding depreciation and amortization) (000's) Fuel cost of products sold........................ $ 102,168 $ 71,048 $ 261,123 $ 191,973 Excise taxes included in cost of products sold.... (15,640) (15,325) (46,006) (42,071) ---------- ---------- ---------- ---------- Fuel cost of products sold, net of excise taxes... 86,528 55,723 215,117 149,902 Merchandise cost of products sold................. 27,888 28,982 77,170 77,643 Other cost of products sold....................... 3,065 2,803 9,494 8,787 ---------- ---------- ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 117,481 $ 87,508 $ 301,781 $ 236,332 ========== ========== ========== ==========
48 WHOLESALE GROUP --------------- Fuel Margin ----------- Fuel margin is the difference between fuel sales less cost of fuel sales divided by number of gallons sold. Phoenix Fuel ------------
Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 286,471 $ 206,048 $ 760,266 $ 595,312 Less cost of fuel sold............................ 276,874 199,959 736,263 576,416 ---------- ---------- ---------- ---------- Fuel margin....................................... $ 9,597 $ 6,089 $ 24,003 $ 18,896 Number of gallons sold............................ 118,844 119,253 360,054 356,439 Fuel margin per gallon............................ $ 0.08 $ 0.05 $ 0.07 $ 0.05 Reconciliation of fuel sales to net revenues (000's) Fuel sales........................................ $ 286,471 $ 206,048 $ 760,266 $ 595,312 Excise taxes included in sales.................... (33,357) (41,622) (119,503) (122,107) ---------- ---------- ---------- ---------- Fuel sales, net of excise taxes................... 253,114 164,426 640,763 473,205 Lubricant sales................................... 8,247 7,933 25,686 22,635 Other sales....................................... 1,101 966 3,402 2,784 ---------- ---------- ---------- ---------- Net revenues...................................... $ 262,462 $ 173,325 $ 669,851 $ 498,624 ========== ========== ========== ========== Reconciliation of fuel cost of products sold to total cost of products sold excluding (depreciation and amortization) (000's) Fuel cost of products sold........................ $ 276,874 $ 199,959 $ 736,263 $ 576,416 Excise taxes included in cost of products sold.... (33,357) (41,622) (119,503) (122,107) ---------- ---------- ---------- ---------- Fuel cost of products sold, net of excise taxes... 243,517 158,337 616,760 454,309 Lubricant cost of products sold................... 5,942 6,885 21,268 19,669 Other cost of products sold....................... 259 231 724 343 ---------- ---------- ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 249,718 $ 165,453 $ 638,752 $ 474,321 ========== ========== ========== ==========
49 Dial Oil(1),(2) ----------
Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 52,254 $ - $ 52,254 $ - Less cost of fuel sold............................ 49,319 - 49,319 - ---------- ---------- ---------- ---------- Fuel margin....................................... $ 2,935 $ - $ 2,935 $ - Number of gallons sold............................ 24,963 - 24,963 - Fuel margin per gallon............................ $ 0.12 $ - $ 0.12 $ - Reconciliation of fuel sales to net revenues Fuel sales........................................ $ 52,254 $ - $ 52,254 $ - Lubricant and merchandise sales................... 8,575 - 8,575 - Other sales....................................... 760 - 760 - ---------- ---------- ---------- ---------- Net revenues...................................... $ 61,589 $ - $ 61,589 $ - ========== ========== ========== ========== Reconciliation of cost of fuel sold to total cost of products sold (excluding depreciation and amortization) Fuel cost of products sold,....................... $ 49,319 $ - $ 49,319 $ - Lubricant and merchandise cost of products sold... 7,166 - 7,166 - Other cost of products sold....................... - - - - ---------- ---------- ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 56,485 $ - $ 56,485 $ - ========== ========== ========== ========== (1) Statistics presented are from July 13, 2005 to September 30, 2005. (2) Dial Oil presents sales and cost of sales, net of excise taxes.
50
Three Months Ended Nine Months Ended September 30, September 30, ----------------------- ----------------------- 2005 2004 2005 2004 ---------- ---------- ---------- ---------- Consolidated ------------ Reconciliation to net revenues reported in Condensed Consolidated Statement of Earnings (000's) Net revenues - Refinery Group..................... $ 746,442 $ 435,437 $1,852,589 $1,266,223 Net revenues - Retail Group....................... 137,514 102,946 353,313 283,860 Net revenues - Wholesale Group: Net revenues - Phoenix Fuel.................... 262,462 173,325 669,851 498,624 Net revenues - Dial Oil........................ 61,589 - 61,589 - Net revenues - Other.............................. 67 154 378 486 Eliminations...................................... (122,849) (69,423) (277,411) (211,911) ---------- ---------- ---------- ---------- Total net revenues reported in Condensed Consolidated Statement of Earnings $1,085,225 $ 642,439 $2,660,309 $1,837,282 ========== ========== ========== ========== Reconciliation to cost of products sold (excluding depreciation and amortization) in Condensed Consolidated Statement of Earnings (000's) Cost of products sold - Refinery Group (excluding depreciation and amortization)....... $ 616,094 $ 378,001 $1,564,469 $1,074,459 Cost of products sold - Retail Group (excluding depreciation and amortization)....... 117,481 87,508 301,781 236,332 Cost of products sold - Wholesale Group: Cost of products sold - Phoenix Fuel (excluding depreciation and amortization)..... 249,718 165,453 638,752 474,321 Cost of products sold - Dial Oil (excluding depreciation and amortization)..... 56,485 - 56,485 - Eliminations...................................... (122,849) (69,423) (277,411) (211,911) Other............................................. 3,479 3,024 11,006 9,455 ---------- ---------- ---------- ---------- Total cost of products sold (excluding depreciation and amortization) reported in Condensed Consolidated Statement of Earnings $ 920,408 $ 564,563 $2,295,082 $1,582,656 ========== ========== ========== ==========
Our refining margin per barrel is calculated by subtracting cost of products from net sales and dividing the result by the number of barrels sold for the period. Our fuel margin per gallon is calculated by subtracting cost of fuel sold from fuel sales and dividing the result by the number of gallons sold for the period. We use refining margin per 51 barrel and fuel margin per gallon to evaluate performance, and allocate resources. These measures may not be comparable to similarly titled measures used by other companies. Investors and analysts use these financial measures to help analyze and compare companies in the industry on the basis of operating performance. These financial measures should not be considered as alternatives to segment operating income, revenues, costs of sales and operating expenses or any other measure of financial performance presented in accordance with accounting principles generally accepted in the United States of America. We believe the comparability of our continuing results of operations for the three and nine months ended September 30, 2005 with the same period in 2004 was affected by, among others, the following factors: - stronger net refining margins for our Yorktown and Four Corners refineries in 2005, due to, among other things: - increased sales in our Tier 1 market; - reduced imports of foreign gasoline and gasoline blendstocks early in 2005, due to a reduction in gasoline sulfur limits; - elimination of MTBE in Connecticut and New York; - favorable margins due to tight finished product supply in certain of our market areas; and - the processing of lower acidic crude oil costs at our Yorktown refinery, including crude oil purchased under our supply agreement with Statoil that began deliveries in late February 2004; - stronger fuel margins for our Phoenix Fuel operations, due to, among other things, tight finished product supply in our Phoenix market; - lower fuel margins per gallon for our retail group for the nine months ended September 30, 2005; and - stronger fuel margins per gallon for our retail group for the three months ended September 30, 2005. EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES Our earnings from continuing operations before income taxes increased $68,469,000 for the three months ended September 30, 2005, compared to the same period in 2004. This increase was primarily due to the following factors: - an increase in operating income before corporate allocations from our refinery operations of $65,454,000 primarily due to higher volumes and margins realized; - an increase in Phoenix Fuel's operating income before corporate allocations of $4,425,000 primarily due to increased fuel margins per gallon sold; and - the implementation of our debt reduction strategy that resulted in the following: - a $1,390,000 or 19% decrease in interest expense; and - a reduction of $614,000 in financing costs amortization. 52 Our earnings from continuing operations before income taxes increased $104,486,000 for the nine months ended September 30, 2005, compared to the same period in 2004. This increase was primarily due to the following factors: - an increase in operating income before corporate allocations from our refinery operations of $80,315,000 primarily due to higher volumes and margins realized; - an increase in Phoenix Fuel's operating income before corporate allocations of $5,865,000 primarily due to increased fuel margins per gallon sold; and - the implementation of our debt reduction strategy that resulted in the following: - a $6,063,000 or 24% decrease in interest expense; - a decrease of $8,793,000 in non-recurring costs associated with early debt extinguishment; and - a reduction of $5,429,000 in financing costs amortization. This increase was offset by, among other things, the following: - higher selling, general and administrative expenses as a result of higher management incentive accruals and additional expenses incurred in relation to our 401(k) plan. YORKTOWN REFINERY Our Yorktown refinery operated at an average throughput rate of approximately 68,201 barrels per day in the third quarter of 2005 compared to 53,991 barrels per day in the third quarter of 2004. For the nine months ended September 30, 2005 and 2004, the average throughput rate was 67,472 and 60,918 barrels per day, respectively. Refining margins for the third quarter of 2005 were $11.25 per barrel and were $6.01 for the third quarter of 2004. Refining margins for the nine months ended September 30, 2005 and 2004 were $8.52 and $5.93 per barrel, respectively. Revenues for our Yorktown refinery increased for the three and nine months ended September 30, 2005 primarily due to higher finished product prices as a result of favorable market conditions. Cost of products sold for our Yorktown refinery increased for the three and nine months ended September 30, 2005 primarily due to higher crude oil prices, as a result of global economic conditions. Operating expenses for our Yorktown refinery increased for the three months ended September 30, 2005 due in part to the following: - higher employee and maintenance costs to meet our processing needs; - higher fuel and electricity costs; and - higher chemical and catalyst costs, primarily due to additional costs required to meet more stringent sulfur reduction requirements. 53 Operating expenses for our Yorktown refinery increased for the nine months ended September 30, 2005 due in part to the following: - higher purchased costs to meet our processing needs; - higher fuel and electricity costs; and - higher chemical and catalyst costs, primarily due to additional costs required to meet more stringent sulfur reduction requirements. Depreciation and amortization expense for our Yorktown refinery increased for the three and nine months ended September 30, 2005 due in part to the amortization of certain refinery turnaround costs and depreciation of additional capitalized costs incurred in 2004. FOUR CORNERS REFINERIES Our Four Corners refineries operated at an average throughput rate of approximately 29,867 barrels per day in the third quarter of 2005, compared to 29,271 barrels per day in the third quarter of 2004. For the nine months ended September 30, 2005 and 2004, the average throughput rate was 29,500 and 28,010 barrels per day, respectively. Refining margins for the third quarter of 2005 were $18.08 per barrel and were $8.14 for the third of 2004. Refining margins for the nine months ended September 30, 2005 and 2004 were $13.21 and $9.54 per barrel, respectively. Revenues for our Four Corners refineries increased for the three and nine months ended September 30, 2005 primarily due to an increase in finished product prices as a result of favorable market conditions and an increase in volumes sold. Cost of products sold for our Four Corners refineries increased for the three and nine months ended September 30, 2005 primarily due to higher average crude oil costs as a result of global market conditions and an increase in volumes sold. Operating expenses for our Four Corners refineries increased for the three and nine months ended September 30, 2005 primarily due to higher employee costs, fuel costs, and additional outside services incurred in our operations. Depreciation and amortization expense for our Four Corners refineries increased for the three and nine months ended September 30, 2005 due in part to the amortization of certain refinery turnaround costs incurred in 2004. 54 RETAIL GROUP Average fuel margins were $0.21 per gallon for the three months ended September 30, 2005 as compared to $0.18 per gallon for the same period in 2004. Fuel volumes sold for the three months ended September 30, 2005 increased as compared to the same period a year ago due primarily to favorable market conditions and improved demand over the same period in 2004. Average merchandise margins were 27% for the three months ended September 30, 2005 as compared to 20% for the same period in 2004. The increase in merchandise margins was due to, among other factors, lower rebates in 2004. Average fuel margins were $0.16 per gallon for the nine months ended September 30, 2005 as compared to $0.18 per gallon for the same period in 2004. Fuel volumes sold for the nine months ended September 30, 2005 increased as compared to the same period a year ago due primarily to favorable market conditions and improved demand over the same period in 2004. Average merchandise margins were 27% for the nine months ended September 30, 2005 as compared to 23% for the same period in 2004. The increase in merchandise margins was primarily due to, among other factors, lower rebates in 2004. Revenues for our retail group increased for the three and nine months ended September 30, 2005, compared to the same periods in 2004 primarily due to an increase in fuel selling prices and an increase in fuel volumes sold. Cost of products sold for our retail group increased for the three and nine months ended September 30, 2005, compared to the same periods in 2004 primarily due to an increase in finished product purchase prices as a result of increased global demand and finished product volumes sold. Our retail fuel margin per gallon increased for the three months ended September 30, 2005 due to higher finished product purchase prices as a result of increased global demand. Our retail fuel margin per gallon decreased for the nine months ended September 30, 2005 due to higher finished product purchase prices as a result of increased global demand that could not be recovered in the market. Operating expenses increased for the three and nine months ended September 30, 2005 as compared with the same periods in 2004, primarily due to an increase in bank charges and additional rent costs for the periods in 2005 as compared to 2004. Depreciation expense increased for the nine months ended September 30, 2005 as compared to the same period in 2004 due to additional amortization for our leasehold improvements. 55 WHOLESALE GROUP Phoenix Fuel ------------ Average gasoline and diesel fuel margins for Phoenix Fuel were $0.08 per gallon for the third quarter of 2005 and were $0.05 per gallon for the third quarter of 2004. For the nine months ended September 30, 2005, gasoline and fuel volumes increased as compared to the same period in 2004. Average gasoline and diesel fuel margins were $0.07 per gallon for the nine months ended September 30, 2005 and were $0.05 per gallon for the same period in 2004 primarily due to favorable market conditions. Revenues for Phoenix Fuel increased for the three and nine months ended September 30, 2005 primarily due to higher average price per gallon sold. Cost of products sold increased for the three and nine months ended September 30, 2005 primarily due to an increase in finished product purchase prices. Phoenix Fuel's finished product margins increased for the three and nine months ended September 30, 2005 primarily as a result of favorable market conditions. Operating expenses for Phoenix Fuel increased for the three and nine months ended September 30, 2005 primarily due to higher transportation costs. Dial Oil -------- No comparative analysis is presented for Dial Oil because it was acquired in the third quarter of 2005 and no prior period statistics are included above. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A) FROM CONTINUING OPERATIONS For the three and nine months ended September 30, 2005, selling, general and administrative expenses increased by approximately $5,321,000 and $6,710,000, respectively, primarily due to higher accruals for management incentive bonuses associated with increased company financial performance and additional expenses incurred in relation to our 401(k) plan, but were partially offset by a reimbursement of legal expenses incurred in previous periods. 56 INTEREST EXPENSE FROM CONTINUING OPERATIONS For the three months ended September 30, 2005, interest expense decreased approximately $1,390,000 or 19%. For the nine months ended September 30, 2005, interest expense decreased approximately $6,063,000 or 24%. These decreases were primarily due to a reduction in our long-term debt, which was part of our debt reduction strategy implemented beginning in 2002. INCOME TAXES FROM CONTINUING OPERATIONS The effective tax rates for the three months ended September 30, 2005 and 2004 were approximately 40.8% and 42.0%, respectively. The decrease was primarily due to a reduction in effective state tax rates. The effective tax rates for the nine months ended September 30, 2005 and 2004 were approximately 41.1% and 41.2%, respectively. DISCONTINUED OPERATIONS Discontinued operations include the operations of some of our retail service station/convenience stores. See Note 4 to our Condensed Consolidated Financial Statements included in Part I, Item 1 for additional information relating to these operations. OUTLOOK Overall, we believe that our current refining fundamentals are more positive now as compared to the same time last year. Same store fuel margins and merchandise sales for our retail group are above the prior year's levels, however, fuel volumes are lower. Phoenix Fuel currently continues to see stronger margins and volumes are consistent with 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 September 30, 2005, we had long-term debt of $274,742,000. At December 31, 2004 we had long-term debt of $292,759,000. There was no current portion of long-term debt outstanding at September 30, 2005 or at December 31, 2004. The amount at September 30, 2005 includes: - $150,000,000 before discount of 8% Senior Subordinated Notes due 2014; and - $130,000,000 before discount of 11% Senior Subordinated Notes due 2012. 57 The amount at December 31, 2004 includes: - $150,000,000 before discount of 8% Senior Subordinated Notes due 2014; and - $148,828,000 before discount of 11% Senior Subordinated Notes due 2012. On June 27, 2005, we amended and restated our revolving credit facility (the "Credit Facility"). The Credit Facility is a $175,000,000 revolving credit facility and is for, among other things, working capital, acquisitions, and other general corporate purposes. Under the new Credit Facility, our existing borrowing costs are reduced, certain of the covenants have been eased, and the term was extended to 2010. The availability of funds under this facility is the lesser of (i) $175,000,000, or (ii) the amount determined under a borrowing base calculation tied to eligible accounts receivable and inventories. We also have options to increase the size of the facility to up to $250,000,000. At September 30, 2005, our long-term debt was 42.6% of total capital. At December 31, 2004, it was 57.5%. Our net debt (long-term debt less cash and cash equivalents) to total net capitalization (long-term debt less cash and cash equivalents plus total shareholders' equity) percentage at September 30, 2005, was 32.2%. At December 31, 2004, this percentage was 55.4%. The indentures governing our notes and our credit facility 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. 58 We presently have senior subordinated ratings of "B3" from Moody's Investor Services and "B-" from Standard & Poor's. As discussed in Note 6 to our Condensed Consolidated Financial Statements included in Part I, Item 1, we completed a refinancing of a portion of our long-term debt. As part of the refinancing, we sold 1,000,000 shares of our common stock. The proceeds from this transaction were used to reduce our long-term debt in the second quarter of 2005 through the redemption of a portion of our 11% senior subordinated notes. In September 2005, we issued 1,000,000 shares of our common stock and received approximately $52,057,000, net of expenses. We intend to use the proceeds for general corporate purposes, including to test and take other actions required to place our recently acquired crude oil pipeline in service, and for possible future acquisitions. CASH FLOW FROM OPERATIONS Our operating cash flow increased by $31,154,000 for the nine months ended September 30, 2005 compared to the nine months ended September 30, 2004. This resulted primarily from an increase in net earnings for the first nine months of 2005 as compared with the same period last year. Our current cash balance is approximately $175,000,000. 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 September 30, 2005 consisted of current assets of $447,189,000 and current liabilities of $233,031,000 or a current ratio of 1.92:1. At December 31, 2004, the current ratio was 1.80:1, with current assets of $232,005,000 and current liabilities of $128,833,000. CAPITAL EXPENDITURES AND RESOURCES During the third quarter of 2005, we increased our budget for capital expenditures in 2005, excluding any potential acquisitions, from approximately $99,000,000 to approximately $102,000,000, and then further increased our budget to approximately $110,000,000. A portion of these costs may not be spent in 2005. The increase is primarily related to increased costs associated with work to be done at the Four Corners 59 refineries to comply with clean fuel regulations. Net cash used in investing activities for purchases of property, plant and equipment totaled approximately $48,390,000 (net of the Texas-New Mexico pipeline discussed below) for the nine months ended September 30, 2005 and $39,842,000 for the nine months ended September 30, 2004. Expenditures for 2005 primarily were for operational and environmental projects for the refineries, Phoenix Fuel, and retail operations. On August 1, 2005, we acquired an idle crude oil pipeline running from Jal, New Mexico to Bisti, New Mexico, and related assets from Texas- New Mexico Pipe Line Company. We estimate that we will spend approximately $2,500,000 to test the pipeline and otherwise determine how much it will cost to place it in service. We currently estimate that these costs will be approximately $15,000,000, including the previously mentioned $2,500,000. The actual cost, however, could be considerably different as our evaluation of the pipeline is at a very preliminary stage. Further, our estimated cost of placing the pipeline in service does not include the cost of crude oil that will be used to fill the pipeline, which is currently empty. We received proceeds of approximately $2,213,000 from the sale of property, plant and equipment and other assets in the first nine months of 2005 and $1,765,000 for the same period in 2004. We also received proceeds of $1,948,000 in 2005 from the sale of one closed service station/convenience store, a vacant piece of land and piece of land that was part of a fully operational convenience store. In the first nine months of 2004, we sold six stores and four pieces of land and received $9,354,000 in proceeds from such sales. 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. We continue to investigate other capital improvements to our existing facilities. The amount of capital projects that are actually undertaken in 2005 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 60 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. Our policies for the use of derivative financial instruments set limits on quantities, require various levels of approval, and require review and reporting procedures. 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 September 30, 2005, 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 similar 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. 61 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 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 clean-ups, 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. In September 2005, we received an administrative compliance order from the New Mexico Oil Conservation Division, alleging various violations of the groundwater discharge permit at our Bloomfield refinery. For a further discussion of matters related to this order, see Note 10 to our Condensed Consolidated Financial Statements, captioned "Commitments and Contingencies". In October 2005, we received an administrative compliance order from the Environmental Protection Agency ("EPA"), alleging violations of Resource Conservation and Recovery Act hazardous waste regulations due to benzene levels in our Bloomfield refinery aeration ponds. For further discussion of matters related to this order, see Note 10 to our Consolidated Financial Statements, captioned "Commitments and Contingencies". 62 OTHER 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 62% for the first nine months of 2005. 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 unless circumstances change. On August 1, 2005, we acquired an idle crude oil pipeline system that originates near Jal, New Mexico and is connected to a company-owned pipeline network that directly supplies crude oil to the Bloomfield and Ciniza refineries. When operational, the pipeline will have sufficient crude oil transportation capacity to allow us to again operate both refineries at maximum rates. Startup of the pipeline is subject to, among other things, a final engineering evaluation of the system. It currently is anticipated that the pipeline will become operational before the end of 2006. If additional crude oil or other refinery feedstocks become available in the future via the new pipeline or otherwise, we may increase production runs at our Four Corners refineries depending on the demand for finished products and the refining margins attainable. 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; - changes in operation/configuration of equipment 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, the temporary, partial or permanent discontinuance of operations at one or both refineries. 63 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, that the new pipeline will become operational, or that the additional crude oil supplies accessible via the new pipeline will be available on acceptable terms. 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. In October 2004, the President signed the American Jobs Creation Act of 2004 (the "Act"), which includes energy related tax provisions that are available to small refiners, including us. Under the Act, small refiners are allowed to deduct for tax purposes up to 75% of capital expenditures incurred to comply with the highway diesel low sulfur regulations adopted by the Environmental Protection Agency. The deduction is taken in the year the capital expenditure is made. Small refiners also are allowed to claim a credit against income tax of five cents on each gallon of low sulfur diesel fuel they produce, up to a maximum of 25% of the capital costs incurred to comply with the regulations. We may be able to use this credit in 2006. In August 2005, the President signed the Energy Policy Act of 2005 (the "Energy Act"). Under the Energy Act, refiners are allowed to deduct for tax purposes 50% of the cost of capital expenditures that increase the capacity of an existing refinery by at least 5%. The deduction is taken in the year the capital expenditure is made. We may be able to use this deduction in 2006, or future years, if we have refinery projects that increase capacity. The Energy Act also requires that most refiners, blenders, and importers use more ethanol in their fuels, with an industry- wide target of 4 billion gallons in 2006 that increases to 7.5 billion gallons in 2012. Each refinery that has less than 75,000 barrels per day of crude oil capacity, however, is exempted from participation in this requirement until 2011. All of our refineries qualify for the exemption. FORWARD-LOOKING STATEMENTS This report contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. These statements are included throughout this report. These forward- looking statements are not historical facts, but only predictions, and generally can be identified by use of statements that include phrases such as "believe," "expect," "anticipate," "estimate," "could," "plan," "intend," "may," "project," "predict," "will" and terms and phrases of similar import. 64 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. The forward-looking statements included in this report are made only as of their respective dates and we undertake no obligation to publicly update these forward-looking statements to reflect new information, future events or otherwise. In light of these risks, uncertainties and assumptions, the forward-looking events might or might not occur. 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; - 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 associated with prior acquisitions and sales of assets; - competitive pressures from existing competitors and new entrants, and other actions that may impact our markets; - our ability to adequately control capital and operating expenses; - the risk that we will be unable to draw on our lines of credit, secure additional financing, access the public debt or equity markets or sell sufficient assets if we are unable to fund anticipated capital expenditures from cash flow generated by operations; - the risk of increased costs resulting from employee matters, including increased employee benefit costs; - the adoption of new state, federal or tribal legislation or regulations; changes to existing legislation or regulations or their interpretation by regulators or the courts; regulatory or judicial findings, including penalties; as well as other future governmental actions that may affect our operations, including the impact of any further changes to government-mandated specifications for gasoline, diesel fuel and other petroleum products; - unplanned or extended shutdowns in refinery operations; 65 - the risk that future changes in operations to address issues raised by threatened or pending litigation, customer preferences, or other factors, including those related to the use of MTBE as a motor fuel additive, may have an adverse impact on our results of operations. - the risk that we will not remain in compliance with covenants, and other terms and conditions, contained in our notes and 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, including the risk that we will be unable to meet regulatory and other deadlines as a result of demands placed on engineering firms and other consultants as a result of hurricane damage to Gulf Coast refineries; - 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 will be higher than currently estimated (including costs associated with the resolution of outstanding environmental matters and costs associated with reducing the sulfur content of motor fuel) or that we will be unable to complete such projects (including motor fuel sulfur reduction projects) by applicable regulatory compliance deadlines; - the risk that we will be added as a defendant in additional MTBE lawsuits, and that we will incur substantial liabilities and substantial defense costs in connection with these suits; - the risk that tax authorities will challenge the positions we have taken in preparing our tax returns; - the risk that changes in manufacturer promotional programs may adversely impact our retail operations; - the risk that the cost of testing the crude oil pipeline that we purchased from Texas-New Mexico Pipe Line Company during the third quarter of 2005, and the cost of placing it in service, will be considerably more than our current estimates; 66 - the risk that the timetable for placing the crude oil pipeline that we purchased in the third quarter of 2005 will be different than anticipated, or that it will not be possible to place the pipeline in service at all; - the risk that it will not be possible to obtain additional crude oil at cost effective prices to either fill the crude oil pipeline that we purchased in the third quarter of 2005 or transport through the pipeline for processing at our Bloomfield and Ciniza refineries; 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 entirety 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. 67 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. ITEM 4. CONTROLS AND PROCEDURES (a) Evaluation of Disclosure Controls and Procedures Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our 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 our 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 No change in our internal control over financial reporting occurred during our most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. We are currently in the process of analyzing the internal controls over financial reporting for Dial Oil, a 100% owned subsidiary that was acquired in the third quarter of 2005. 68 PART II OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are a party to ordinary routine litigation incidental to our business. We also incorporate by reference the information regarding contingencies in Note 10 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 - Environmental, Health and Safety." ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 10.1* Seventh Amendment to the Giant Industries, Inc. and Affiliated Companies 401(k) Plan Adoption Agreement, effective September 30, 2005. 10.2* Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan. 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 July 1, 2005, we filed a Form 8-K dated July 1, 2005, regarding the entry into an amended and restated credit facility. 69 (ii) On July 13, 2005, we filed a Form 8-K dated July 13, 2005, containing a press release regarding the acquisition of Dial Oil Company. (iii) On August 4, 2005, we filed a Form 8-K dated August 4, 2005, containing a press release detailing our earnings for the quarter ended June 20, 2005. (iv) On September 9, 2005, we filed a Form 8-K dated September 9, 2005, detailing the resignation of one of our directors. (v) On September 13, 2005, we filed a Form 8-K dated September 13, 2005, containing a press release regarding an offering of shares of our stock. (vi) On October 3, 2005, we filed a Form 8-K dated October 3, 2005, regarding the entry into an amendment to our 401(k) plan. (vii) On November 4, 2005, we filed a Form 8-K dated November 4, 2005, regarding the establishment of the Giant Industries, Inc. and Affiliated Companies Deferred Compensation plan. (viii) On November 8, 2005, we filed a Form 8-K dated November 8, 2005, containing a press release detailing our earnings for the quarter ended September 30, 2005. 70 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 September 30, 2005 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: November 8, 2005 71 54 54 54