-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SY7Q2SazWl4puaZz8dj3MexP3YA6KXAQk909vtaU7yg3ICbMslCOSZ7LzpH3/tIQ y/J1p6BEAJrMLNLocLF/lQ== 0000856465-06-000003.txt : 20060504 0000856465-06-000003.hdr.sgml : 20060504 20060504135614 ACCESSION NUMBER: 0000856465-06-000003 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20060331 FILED AS OF DATE: 20060504 DATE AS OF CHANGE: 20060504 FILER: COMPANY DATA: COMPANY CONFORMED NAME: GIANT INDUSTRIES INC CENTRAL INDEX KEY: 0000856465 STANDARD INDUSTRIAL CLASSIFICATION: PETROLEUM REFINING [2911] IRS NUMBER: 860642718 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-10398 FILM NUMBER: 06807451 BUSINESS ADDRESS: STREET 1: 23733 N SCOTTSDALE RD CITY: SCOTTSDALE STATE: AZ ZIP: 85255 BUSINESS PHONE: 4805858888 MAIL ADDRESS: STREET 1: 23733 N SCOTTSDALE RD CITY: SCOTTSDALE STATE: AZ ZIP: 85255 10-Q 1 firstqtr2006-edgar.txt GIANT INDUSTRIES, INC. FIRST QUARTER FORM 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED MARCH 31, 2006 [ ] 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 May 1, 2006: 14,642,212 shares. GIANT INDUSTRIES, INC. AND SUBSIDIARIES INDEX PART I - FINANCIAL INFORMATION...................................... 1 Item 1 - Financial Statements....................................... 1 Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005 (Unaudited)........... 1 Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2006 and 2005 (Unaudited)..... 2 Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2006 and 2005 (Unaudited)................................................ 3-4 Notes to Condensed Consolidated Financial Statements (Unaudited)................................................ 5-33 Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations.............. 34-57 Item 3 - Quantitative and Qualitative Disclosures About Market Risk.......................................... 58 Item 4 - Controls and Procedures.................................... 58 PART II - OTHER INFORMATION.......................................... 59 Item 1 - Legal Proceedings.......................................... 59 Item 1A - Risk Factors............................................... 59-64 Item 4 - Submission of Matters to a Vote of Security Holders........ 65 Item 6 - Exhibits and Reports on Form 8-K........................... 66 SIGNATURE............................................................ 67 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)
March 31, December 31, 2006 2005 --------- ------------ ASSETS Current assets: Cash and cash equivalents............................. $ 84,483 $ 164,280 Receivables, net...................................... 162,412 142,125 Inventories........................................... 124,359 124,105 Prepaid expenses and other............................ 11,564 10,449 Deferred income taxes................................. 1,559 1,396 --------- --------- Total current assets................................ 384,377 442,355 --------- --------- Property, plant and equipment........................... 826,478 764,788 Less accumulated depreciation and amortization.......... (300,354) (297,962) --------- --------- 526,124 466,826 --------- --------- Goodwill................................................ 50,588 50,607 Other assets............................................ 28,692 24,684 --------- --------- $ 989,781 $ 984,472 ========= ========= LIABILITIES AND STOCKHOLDERS' EQUITY Current liabilities: Accounts payable...................................... $ 166,493 $ 139,710 Accrued expenses...................................... 59,917 68,798 --------- --------- Total current liabilities........................... 226,410 208,508 --------- --------- Long-term debt.......................................... 274,990 274,864 Deferred income taxes................................... 72,834 76,834 Other liabilities....................................... 26,485 24,430 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, 18,394,192 and 18,366,077 shares issued............................ 184 184 Additional paid-in capital............................ 218,391 216,917 Retained earnings..................................... 208,853 221,203 Unearned compensation related to restricted stock..... (1,912) (2,014) --------- --------- 425,516 436,290 Less common stock in treasury - at cost, 3,751,980 shares.................................... (36,454) (36,454) --------- --------- Total stockholders' equity.......................... 389,062 399,836 --------- --------- $ 989,781 $ 984,472 ========= ========= See accompanying notes to Condensed Consolidated Financial Statements. 1
GIANT INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited) (In thousands, except per share data)
Three Months Ended March 31, ------------------------ 2006 2005 ---------- ---------- Net revenues..................................................... $ 863,025 $ 711,726 ---------- ---------- Cost of products sold (excluding depreciation and amortization).. 810,552 625,790 Operating expenses............................................... 52,688 46,244 Depreciation and amortization.................................... 9,567 10,970 Selling, general and administrative expenses..................... 10,006 7,799 Net gain on the disposal/write-down of assets.................... (640) (13) Gain from insurance settlement due to fire incident.............. (2,853) (3,492) ---------- ---------- Operating (loss)/income.......................................... (16,295) 24,428 Interest expense................................................. (4,682) (6,993) Amortization of financing costs.................................. (399) (504) Interest and investment income................................... 1,602 120 ---------- ---------- (Loss)/earnings from continuing operations before income taxes... (19,774) 17,051 (Benefit)/provision for income taxes............................. (7,424) 6,993 ---------- ---------- (Loss)/earnings from continuing operations....................... (12,350) 10,058 Loss from discontinued operations, net of income tax benefit of $4.............................................. - (7) ---------- ---------- Net (loss)/earnings.............................................. $ (12,350) $ 10,051 ========== ========== Net (loss)/earnings per common share: Basic Continuing operations........................................ $ (0.85) $ 0.81 Discontinued operations...................................... - - ---------- ---------- $ (0.85) $ 0.81 ========== ========== Assuming dilution Continuing operations........................................ $ (0.85) $ 0.80 Discontinued operations...................................... - - ---------- ---------- $ (0.85) $ 0.80 ========== ========== See accompanying notes to Condensed Consolidated Financial Statements. 2
GIANT INDUSTRIES, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) (In thousands)
Three Months Ended March 31, ----------------------- 2006 2005 --------- --------- Cash flows from operating activities: Net (loss)/earnings................................................... $ (12,350) $ 10,051 Adjustments to reconcile net (loss)/earnings to net cash provided by operating activities: Depreciation and amortization from continuing operations.............. 9,567 10,970 Amortization of financing costs....................................... 399 504 Compensation expense related to restricted stock award................ 102 - Deferred income taxes................................................. (4,163) 5,417 Deferred crude oil purchase discounts................................. 165 306 Payments to deferred compensation plan................................ (1,358) - Net gain on the disposal of assets from continuing operations......... (640) (13) Gain from insurance settlement due to fire incident................... (2,853) (3,492) Changes in operating assets and liabilities (Increase) in receivables........................................... (27,284) (35,291) (Increase) in inventories........................................... (239) (25,278) (Increase)/decrease in prepaid expenses............................. (1,035) 4,194 (Increase) in other assets.......................................... (3,194) (264) Increase in accounts payable........................................ 23,177 47,866 (Decrease)/increase in accrued expenses............................. (13,830) 7,423 Increase in other liabilities....................................... 2,038 622 --------- --------- Net cash (used in)/provided by operating activities..................... (31,498) 23,015 --------- --------- Cash flows from investing activities: Purchase of property, plant and equipment............................. (59,697) (12,826) Proceeds from insurance settlement of fire incident................... 9,850 3,492 Proceeds from sale of property, plant and equipment and other assets.. 1,539 981 Funding of restricted cash escrow funds............................... - (21,883) --------- --------- Net cash used in investing activities................................... (48,308) (30,236) --------- --------- Cash flows from financing activities: Proceeds from line of credit.......................................... - 15,000 Payments on line of credit............................................ - (15,000) Net proceeds from issuance of common stock............................ - 22,328 Proceeds from exercise of stock options............................... 9 64 Deferred financing costs.............................................. - (5) --------- --------- Net cash provided by financing activities............................... 9 22,387 --------- --------- Net (decrease)/increase in cash and cash equivalents.................... (79,797) 15,166 Cash and cash equivalents: Beginning of period................................................. 164,280 23,714 --------- --------- End of period....................................................... $ 84,483 $ 38,880 ========= ========= 3
Significant Noncash Investing and Financing Activities. In the first quarter of 2006, we contributed 25,115 newly issued shares of our common stock, valued at $1,465,000, to our 401(k) plan as a discretionary contribution for the year 2005. We also capitalized approximately $2,046,000 of interest as part of construction in progress. At March 31, 2006, approximately $20,657,000 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 2005, we transferred $118,000 of property, plant and equipment to other assets. 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 group distributes 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 months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. 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, 2005. 5 We have made certain reclassifications to our 2005 financial statements and notes to conform to the financial statement classifications used in the current year. 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, 2005. On January 1, 2006, we adopted Statement of Financial Accounting Standard ("SFAS") 123R, "Share-Based Payment", that requires us to measure the cost of employee services received in exchange for stock options granted using the fair value method and amortize such costs over the vesting period of such arrangements. The adoption of SFAS 123R had no material impact on our financial statements for the quarter ended March 31, 2006. In prior years, we accounted 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, as permitted by SFAS No. 123, ?Accounting for Stock- Based Compensation?. We used 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 SFAS No. 123 to stock-based employee compensation for the three months ended March 31, 2005.
Three Months Ended March 31, 2005 ------------------ (In thousands, except per share data) Net earnings, as reported................... $10,051 Deduct: Total stock-based employee compensation expense determined under the fair value based method for all awards, net of related tax effect................................ (17) ------- Pro forma net earnings...................... $10,034 ======= Earnings per share: Basic - as reported....................... $ 0.81 ======= Basic - pro forma......................... $ 0.81 ======= Diluted - as reported..................... $ 0.80 ======= Diluted - pro forma....................... $ 0.80 =======
6 Current Pronouncements In November 2004, The Financial Accounting Standards Board ("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. The adoption of SFAS 151 had no material impact on our financial statements for the quarter ended March 31, 2006. In March 2006, the Emerging Issues Task Force (?EITF?) reached a tentative conclusion in EITF Issue No. 06-3, "How Taxes Collected From Customers and Remitted to Governmental Authorities Should Be Presented in the Income Statement (That is, Gross Versus Net Presentation)" that the presentation of taxes on either a gross or net basis within the scope of this EITF Issue is an accounting policy decision requiring disclosure pursuant to APB Opinion No. 22, "Disclosure of Accounting Policies". The provision of this EITF Issue is to be applied to financial reports for interim and annual reporting periods beginning after December 15, 2006. We currently report consolidated revenues and cost of products sold on a net basis and as such, no further disclosures are deemed necessary in our financial statements. In March 2006, the FASB issued a proposal that would require employers to recognize the overfunded or underfunded positions of defined benefit post-retirement plans, including pension plans ("plans"), in their balance sheets. The proposal also would require that employers measure plan assets and obligations as of the date of their financial statements. The proposed statement would be effective for fiscal years ending after December 15, 2006. We have not yet evaluated the impact this proposed statement would have on our financial statements. 7 NOTE 2 ? INVENTORIES: Our inventories consist of the following:
March 31, December 31, 2006 2005 --------- ------------ (In thousands) First-in, first-out ("FIFO") method: Crude oil............................ $ 54,743 $ 77,188 Refined products..................... 136,564 97,150 Refinery and shop supplies........... 14,078 13,790 Merchandise.......................... 6,616 7,259 Retail method: Merchandise.......................... 9,256 8,982 -------- -------- Subtotal........................... 221,257 204,369 Adjustment for last-in, first-out ("LIFO") method............ (96,898) (80,264) -------- -------- Total.............................. $124,359 $124,105 ======== ========
The portion of inventories valued on a LIFO basis totaled $73,426,135 and $76,299,000 at March 31, 2006 and December 31, 2005, 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 March 31, 2006 and 2005, net earnings and diluted earnings per share would have been higher as follows:
Three Months Ended March 31, ----------------------- 2006 2005 ----------- ---------- (In thousands, except per share data) Net earnings.......................... $10,396 $7,752 Diluted earnings per share............ $ 0.71 $ 0.62
8 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. 9 NOTE 3 - GOODWILL AND OTHER INTANGIBLE ASSETS: At March 31, 2006 and December 31, 2005, we had goodwill of $50,588,000 and $50,607,000, respectively. The changes in the carrying amount of goodwill for the three months ended March 31, 2006 are as follows:
Refining Retail Wholesale Group Group Group Total ----------------- ------- ----------------- ------- Four Phoenix Dial Yorktown Corners Fuel Oil -------- ------- ------- ------- (In thousands) Balance as of January 1, 2006.......... $ 21,028 $ 125 $ 4,414 $ 14,736 $ 10,304 $ 50,607 Goodwill written off related to the sale of retail unit................. - - (19) - - (19) -------- ------- ------- -------- -------- -------- Balance as of March 31, 2006........... $ 21,028 $ 125 $ 4,395 $ 14,736 $ 10,304 $ 50,588 ======== ======= ======= ======== ======== ========
A summary of the intangible assets that are included in "Other Assets" in the Condensed Consolidated Balance Sheets at March 31, 2006 and December 31, 2005 is presented below:
March 31, 2006 December 31, 2005 ------------------------------------ ------------------------------------ Gross Net Gross Net Carrying Accumulated Carrying Carrying Accumulated Carrying Value Amortization Value Value Amortization Value -------- ------------ -------- -------- ------------ -------- (In thousands) Amortized intangible assets: Rights-of-way..................... $ 3,844 $ 2,910 $ 934 $ 3,729 $ 2,870 $ 859 Contracts......................... 1,376 1,257 119 1,376 1,227 149 Licenses and permits.............. 1,096 535 561 1,096 503 593 ------- ------- ------- ------- ------- ------- 6,316 4,702 1,614 6,201 4,600 1,601 ------- ------- ------- ------- ------- ------- Unamortized intangible assets: Liquor licenses................... 8,363 - 8,363 8,335 - 8,335 ------- ------- ------- ------- ------- ------- Total intangible assets............. $14,679 $ 4,702 $ 9,977 $14,536 $ 4,600 $ 9,936 ======= ======= ======= ======= ======= =======
10 Intangible asset amortization expense for the three months ended March 31, 2006 and March 31, 2005 was approximately $102,000 and $109,000, respectively. Estimated amortization expense for the rest of this fiscal year and the next five fiscal years is as follows: 2006 Remainder.................... $ 309,000 2007.............................. 263,000 2008.............................. 221,000 2009.............................. 219,000 2010.............................. 94,000 2011.............................. 45,000 11 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 March 31, ------------------ 2006 2005 ------ ------ (In thousands) Net revenues.................................. $ - $ - ------ ------ Net operating income/(loss)................... $ - $ (11) ------ ------ Gain/(loss) before income taxes............... $ - $ (11) ------ ------ Net earnings/(loss)........................... $ - $ (7)
In the first quarter of 2006, we sold a piece of land and recorded a gain of approximately $117,000. During the first quarter of 2005, we transferred a closed store from property, plant and equipment to assets held for sale. This store was sold in April 2005. 12 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 $361,000 as of March 31, 2006. 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 ARO as used in SFAS No. 143. Conditional ARO 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 ARO 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 ARO. We applied FIN 47 as of December 31, 2005. We identified the following ARO's: 1. Landfills -- pursuant to Virginia law, the two solid waste management facilities at our Yorktown refinery must satisfy closure and post-closure care and financial responsibility requirements. 2. Crude Pipelines -- our right-of-way agreements generally require that pipeline properties be returned to their original condition when the agreements are no longer in effect. This means that the pipeline surface facilities must be dismantled and removed and certain site reclamation performed. We do not believe these right-of-way agreements will require us to remove the underground pipe upon taking the pipeline permanently out of service. Regulatory requirements, however, may mandate that such out-of-service underground pipe be purged. 3. Storage Tanks -- we have a legal obligation under applicable law to remove or close in place 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. We identified the following conditional ARO: 13 1. Refinery Piping and Heaters -- we have a legal obligation to properly remove or dispose of materials that contain asbestos which surround certain refinery piping and heaters. The following table reconciles the beginning and ending aggregate carrying amount of our ARO's for the three months ended March 31, 2006 and the year ended December 31, 2005.
March 31, December 31, 2006 2005 --------- ------------ (In thousands) Liability beginning of year........... $2,625 $2,272 Liabilities incurred.................. - 322 Liabilities settled................... - (150) Accretion expense..................... 5 181 ------ ------ Liability end of period............... $2,630 $2,625 ====== ======
Our ARO's are recorded in "Other Liabilities" on our Condensed Consolidated Balance Sheets. 14 NOTE 6 - LONG-TERM DEBT: Our long-term debt consists of the following:
March 31, December 31, 2006 2005 --------- ------------ (In thousands) 11% senior subordinated notes, due 2012, net of unamortized discount of $2,803 and $2,882, interest payable semi-annually..................... $127,198 $127,119 8% senior subordinated notes, due 2014, net of unamortized discount of $2,208 and $2,255, interest payable semi-annually..................... 147,792 147,745 -------- -------- Total $274,990 $274,864 ======== ========
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. 15 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 March 31, 2006, retained earnings available for dividends under the most restrictive terms of the indentures were approximately $72,276,000. 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. We also have a senior secured revolving facility (the "Credit Facility") with a group of banks. The term of the Credit Facility expires in June 2010. The Credit Facility is primarily a working capital and letter of credit facility. 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. The interest rate applicable to the Credit Facility is based on various short-term indices. At March 31, 2006, this rate was approximately 6.4% per annum. We are required to pay a quarterly commitment fee of .25% per annum of the unused amount of the facility. At March 31, 2006, there were no direct borrowings outstanding under the Credit Facility. At March 31, 2006, there were, however, $16,406,000 of irrevocable letters of credit outstanding, primarily to crude oil suppliers, insurance companies, and regulatory agencies. At December 31, 2005, there were no direct borrowings and $66,771,000 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: - accounts receivable; - inventory; - contracts; - chattel paper; 16 - 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, each as defined in the Credit Facility. 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. 17 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 March 31, ---------------------- 2006 2005 ---------- ---------- Service cost..................................... $ 376,103 $ 339,131 Interest cost.................................... 173,109 167,780 Expected return on plan assets................... (114,020) (69,345) Amortization of prior service cost............... 73 (26,618) Amortization of net loss......................... - 14,992 ---------- ---------- Net periodic benefit cost........................ $ 435,265 $ 425,940 ========== ==========
Yorktown Retiree Medical Plan ---------------------- Three Months Ended March 31, ---------------------- 2006 2005 ---------- ---------- Service cost..................................... $ 78,639 $ 54,924 Interest cost.................................... 74,914 55,166 Amortization of net loss......................... 24,887 4,001 ---------- ---------- Net periodic benefit cost........................ $ 178,440 $ 114,091 ========== ==========
18 NOTE 8 - EARNINGS PER SHARE: The following table sets forth the computation of basic and diluted (loss)/earnings per share:
Three Months Ended March 31, ---------------------- 2006 2005 ---------- ---------- Numerator (In thousands) (Loss)/earnings from continuing operations....... $ (12,350) $ 10,058 Loss from discontinued operations................ - (7) ---------- ---------- Net (loss)/earnings.............................. $ (12,350) $ 10,051 ========== ==========
Three Months Ended March 31, ---------------------- 2006 2005 ---------- ---------- Denominator Basic - weighted average shares outstanding...... 14,582,228 12,381,540 Effect of dilutive stock options................. -* 197,661 ---------- ---------- Diluted ? weighted average shares outstanding.... 14,582,228 12,579,201 ========== ========== *The additional shares would be antidilutive due to the net loss.
19
Three Months Ended March 31, ---------------------- 2006 2005 ---------- ---------- Basic (loss)/earnings per share (Loss)/earnings from continuing operations....... $ (0.85) $ 0.81 ---------- ---------- Net (loss)/earnings.............................. $ (0.85) $ 0.81 ========== ==========
Three Months Ended March 31, ---------------------- 2006 2005 ---------- ---------- Diluted (loss)/earnings per share (Loss)/earnings from continuing operations....... $ (0.85) $ 0.80 ---------- ---------- Net (loss)/earnings.............................. $ (0.85) $ 0.80 ========== ==========
In March 2006, we contributed 25,115 newly issued shares of our common stock to our 401(k) plan as a discretionary contribution for the year 2005. In March 2005, we issued 1,000,000 shares of common stock in an underwritten public offering. 20 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 March 31, 2006, our retail group operated 122 service stations with convenience stores or kiosks. WHOLESALE GROUP Our wholesale group consists of Phoenix Fuel and Dial Oil (which was acquired on July 12, 2005). Our wholesale group primarily distributes commercial wholesale petroleum products. Our wholesale group includes several lubricant and bulk petroleum distribution plants, unmanned fleet fueling operations, 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. 21 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 months ended March 31, 2006 and 2005, are presented below. The tables pertaining to the three months ended March 31, 2005 do not include the results of Dial Oil. 22
As of and for the Three Months Ended March 31, 2006 ------------------------------------------------------------------------- Wholesale Group --------------- Refining Retail Phoenix Dial Reconciling Group Group Fuel Oil Other Items Consolidated ------------------------------------------------------------------------- (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $132,662 Yorktown operations.................. 325,544 -------- Total.............................. $458,206 $ 81,693 $201,241 $ 51,283 $ - $ - $ 792,423 Merchandise and lubricants............. - 33,312 10,276 10,288 - - 53,876 Other.................................. 10,931 4,960 327 437 71 - 16,726 -------- -------- -------- -------- -------- --------- --------- Total.............................. 469,137 119,965 211,844 62,008 71 - 863,025 -------- -------- -------- -------- -------- --------- --------- Inter-segment net revenues: Finished products...................... 92,075 - 23,640 - - (115,715) - Merchandise and lubricants............. - - - 10 - (10) - Other.................................. 5,172 - 175 210 - (5,557) - -------- -------- -------- -------- -------- --------- --------- Total.............................. 97,247 - 23,815 220 - (121,282) - -------- -------- -------- -------- -------- --------- --------- Total net revenues from continuing operations.................. $566,384 $119,965 $235,659 $ 62,228 $ 71 $(121,282) $ 863,025 ======== ======== ======== ======== ======== ========= ========= Operating income/(loss): Four Corners operations................ $ 11,233 Yorktown operations.................... (30,805) -------- Total operating (loss)/income before corporate allocation...... $(19,572) $ 990 $ 2,987 $ 1,909 $ (6,102) $ 3,493 $ (16,295) Corporate allocation..................... (2,448) (2,031) (739) (144) 5,362 - - -------- -------- -------- -------- -------- --------- --------- Operating (loss)/income from continuing operations................ $(22,020) $ (1,041) $ 2,248 $ 1,765 $ (740) $ 3,493 (16,295) ======== ======== ======== ======== ======== ========= Interest expense......................... (4,682) Amortization and write-offs of financing costs........................ (399) Investment and other income.............. 1,602 --------- Loss from continuing operations before income taxes.................... $ (19,774) ========= Depreciation and amortization: Four Corners operations................ $ 3,990 Yorktown operations.................... 2,510 -------- Total from continuing operations... $ 6,500 $ 1,969 $ 441 $ 428 $ 229 $ - $ 9,567 ======== ======== ======== ======== ======== ========= ========= Total assets............................. $628,028 $100,089 $103,276 $ 52,521 $105,867 $ - $ 989,781 Capital expenditures..................... $ 57,574 $ 814 $ 1,048 $ 156 $ 105 $ - $ 59,697
23
As of and for the Three Months March 31, 2005 ---------------------------------------------------------------- Refining Retail Phoenix Reconciling Group Group Fuel Other Items Consolidated ---------------------------------------------------------------- (In thousands) Customer net revenues: Finished products: Four Corners operations.............. $120,874 Yorktown operations.................. 314,706 -------- Total.............................. $435,580 $ 61,810 $166,741 $ - $ - $ 664,131 Merchandise and lubricants............. - 31,287 9,022 - - 40,309 Other.................................. 2,771 3,829 588 98 - 7,286 -------- -------- -------- -------- -------- --------- Total.............................. 438,351 96,926 176,351 98 - 711,726 -------- -------- -------- -------- -------- --------- Inter-segment net revenues: Finished products...................... 50,315 - 15,313 - (65,628) - Other.................................. 4,361 - - - (4,361) - -------- -------- -------- -------- -------- --------- Total.............................. 54,676 - 15,313 - (69,989) - -------- -------- -------- -------- -------- --------- Total net revenues from continuing operations.................. $493,027 $ 96,926 $191,664 $ 98 $(69,989) $ 711,726 ======== ======== ======== ======== ======== ========= Operating income/(loss): Four Corners operations................ $ 6,285 Yorktown operations.................... 17,650 -------- Total operating income/(loss) before corporate allocation...... $ 23,935 $ (1,679) $ 3,699 $ (5,043) $ 3,505 $ 24,417 Corporate allocation..................... (2,738) (1,564) (532) 4,834 - - -------- -------- -------- -------- -------- --------- Total operating income/(loss) after corporate allocation................... 21,197 (3,243) 3,167 (209) 3,505 24,417 Discontinued operations loss............. - 11 - - - 11 -------- -------- -------- -------- -------- --------- Operating income/(loss) from continuing operations................ $ 21,197 $ (3,232) $ 3,167 $ (209) $ 3,505 24,428 ======== ======== ======== ======== ======== Interest expense......................... (6,993) Amortization and write-offs of financing costs........................ (504) Investment and other income.............. 120 --------- Earnings from continuing operations before income taxes.................... $ 17,051 ========= Depreciation and amortization: Four Corners operations................ $ 4,070 Yorktown operations.................... 2,659 -------- Total from continuing operations... $ 6,729 $ 3,547 $ 516 $ 178 $ - $ 10,970 ======== ======== ======== ======== ======== ========= Total assets............................. $517,431 $105,485 $ 96,343 $ 78,249 $ - $ 797,508 Capital expenditures..................... $ 11,004 $ 780 $ 458 $ 584 $ - $ 12,826
24 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. As explained more fully below, 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, health and safety 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 uncertain nature of remediation and cleanup 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, defenses that may be available to us, and changing environmental, health and safety laws, including changing interpretations of these laws. ENVIRONMENTAL AND LITIGATION ACCRUALS We expense or capitalize environmental expenditures depending on the circumstances: - expenditures that relate to an existing environmental condition caused by past operations, and which do not result in an asset with an economic life greater than one year, are expensed; and - expenditures that relate to an existing environmental condition caused by past operations, and which result in an asset with an economic life greater than one year, are capitalized in the period incurred and depreciated over their useful life. 25 Under circumstances in which environmental expenditures, or losses associated with litigation, are anticipated or related to past events, we accrue for the liability if cleanup expenditures, administrative penalties, adverse judgments, or other liabilities are probable and the costs can be reasonably estimated. We do not accrue for future environmental expenditures associated with: - our compliance with clean air, clean water, and similar regulatory programs, including programs relating to the composition of motor fuels, that do not require us to undertake soil removal or similar cleanup activities; - our compliance with settlements, consent decrees, and other agreements with governmental authorities that do not require us to undertake soil removal or similar cleanup activities; - groundwater monitoring; or - capital projects. Expenditures for these matters are capitalized or expensed when incurred. We do not discount our environmental and litigation liabilities, and record these liabilities without consideration of potential recoveries from third parties, except that we do take into account amounts that others are contractually obligated to pay us. Subsequent adjustments to estimates, which may be significant, may be made as more information becomes available or as circumstances change. As of March 31, 2006 and December 31, 2005, we had environmental liability accruals of approximately $4,783,000 and $4,941,000, respectively, which are summarized below, and litigation accruals in the aggregate of approximately $781,000 and $990,000, respectively. 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 Consolidated Balance Sheets. 26
SUMMARY OF ACCRUED ENVIRONMENTAL CONTINGENCIES (In thousands) December 31, Increase March 31, 2005 (Decrease) Payments 2006 ------------ ---------- -------- --------- Yorktown Refinery........................... $ 3,540 $ - $ (98) $ 3,442 Bloomfield Refinery......................... 229 - - 229 Farmington Refinery......................... 570 - - 570 Bloomfield - River Terrace.................. 46 6 (11) 41 Bloomfield Tank Farm (Old Terminal)......... 42 - (4) 38 Other Projects.............................. 514 - (51) 463 ------- ------ ------ ------- Totals.................................. $ 4,941 $ 6 $ (164) $ 4,783 ======= ====== ====== =======
Approximately $4,320,000 of our environmental accrual is for the following projects discussed below: - $3,442,000 and $229,000, respectively, for environmental obligations assumed in connection with our acquisitions of the Yorktown refinery and the Bloomfield refinery; - $570,000 for the remediation of the hydrocarbon plume that appears to extend no more than 1,800 feet south of our inactive Farmington refinery; - $41,000 for remediation of the river terrace area of the Bloomfield refinery; and - $38,000 for remediation of hydrocarbon contamination on and adjacent to the 5.5 acres that we own in Bloomfield, New Mexico. The remaining $463,000 of the accrual relates to: - closure of certain solid waste management units at the Ciniza refinery; - closure of the Ciniza refinery land treatment facility including post-closure expenses; and - amounts for smaller remediation projects. 27 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, however, 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, subject to certain limitations. For a further discussion of this matter, refer to Note 17, ?Commitments and Contingencies?, in our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. Certain environmental matters relating to the Yorktown refinery are discussed below. YORKTOWN 1991 ORDER In connection with the Yorktown acquisition, we 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 cleanup measures, including the construction of an on-site corrective action management unit that would be used to consolidate hazardous solid materials associated with these measures. These proposed actions relate to soil, sludge, and remediation wastes relating to solid waste management units. Groundwater in the aquifers underlying the refinery, and surface water and sediment in a small pond and tidal salt marsh on the refinery property also are addressed in the RA/CMS. Based on the RA/CMS, EPA issued a proposed cleanup plan for public comment in December 2003 setting forth preferred corrective measures for remediating soil, groundwater, sediment, and surface water contamination at the refinery. Following the public comment period, EPA issued its final remedy decision and response to comments in April 2004. EPA currently is developing the administrative consent order pursuant to which we will implement our cleanup plan. 28 Our most current estimate of expenses associated with the order is between $25,000,000 ($17,500,000 of which we believe is subject to reimbursement by BP) and $27,000,000 ($19,500,000 of which we believe is subject to reimbursement by BP). 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 between approximately $9,500,000 and $10,500,000 of this amount will be incurred over an initial four-year period, and additional expenditures of approximately $7,500,000 will be incurred over the following four-year period, with the remainder thereafter. We currently have $3,442,000 recorded as an environmental liability for this project, which reflects our belief that BP is responsible for reimbursing us for expenditures on this project that exceed this amount. As part of the cleanup 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 construction of the corrective action management unit and related remediation work will be completed approximately five to seven years after EPA approves our cleanup plan and authorizes its implementation. We have preliminarily estimated that the balance of the sewer work will cost between approximately $1,500,000 and $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 do not know whether any cleanup will be required in connection with this capital project and, accordingly have not recorded a liability for this matter. BLOOMFIELD REFINERY ENVIRONMENTAL OBLIGATIONS In connection with the acquisition of the Bloomfield refinery, we assumed certain environmental obligations including the seller's obligations under an administrative order issued by EPA in 1992 pursuant to the Resource Conservation and Recovery Act. As of March 31, 2006, we had $229,000 recorded as an environmental liability for this project. For a further discussion of this matter, refer to Note 17, ?Commitments and Contingencies?, in our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. 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 property. Our environmental consulting firms identified several areas of contamination in the soils and shallow 29 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. As of March 31, 2006, we had $570,000 recorded as an environmental liability for this project. 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, we completed construction of an underground barrier with a pollutant extraction and collection system in the second quarter of 2005. 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. Construction of the bioventing system was completed in January 2006. As of March 31, 2006, we had $41,000 recorded as an environmental liability for this project. 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. 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 $20,000 in expenses from 2006 through early 2008 to continue remediation, including groundwater monitoring and testing, until natural attenuation has completed the process of groundwater remediation. 30 YORKTOWN CONSENT DECREE In addition to the 1991 Order discussed above, in connection with the acquisition of the Yorktown refinery, we also assumed BP's Yorktown refinery responsibilities under a consent decree among various parties covering many locations (the "Consent Decree"). 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 $14,045,000 of this amount through the first quarter of 2006. Since our expenditures for this matter do not involve soil removal or similar cleanup activities, we have not recorded an environmental liability for this project and will capitalize or expense expenditures when incurred. For a further discussion of this matter, refer to Note 17, ?Commitments and Contingencies?, in our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. 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 plan. In March 2006, we reached a settlement with OCD in the form of a consent order and paid a civil penalty of $30,000. The settlement requires that we apply for a discharge plan modification. The discharge plan modification must include a comprehensive action plan for the investigation and remediation of contaminated soil and groundwater at the refinery. Until this plan is completed and a remediation plan is approved by the two agencies with regulatory oversight, OCD and New Mexico Hazardous Waste Bureau, we cannot reasonably estimate the cost of any associated remediation activities. FOUR CORNERS REFINERIES - SETTLEMENT AGREEMENTS In July 2005, we reached an administrative settlement with New Mexico Environment Department and EPA in the form of consent agreements that resolved certain alleged violations of our air quality regulations at our Ciniza and Bloomfield refineries. Our settlement does not require us to undertake soil removal or similar cleanup activities and accordingly, we have not recorded an environmental liability for this matter and will capitalize or expense expenditures when incurred. For a further discussion of this matter, refer to Note 17, ?Commitments and Contingencies?, in our Consolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2005. 31 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. Since we do not anticipate incurring any cleanup costs in connection with this matter, we have not recorded an environmental liability for this project. 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 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 were named as a defendant in two new MTBE lawsuits filed in Massachusetts in the first quarter of 2006. We intend to vigorously defend these lawsuits. Since we have yet to determine if a liability is probable, and we cannot reasonably estimate the amount of any loss associated with this matter, we have not recorded a liability for these lawsuits. 32 YORKTOWN REFINERY INCIDENT On November 25, 2005, a fire occurred at our Yorktown refinery. Damage was primarily done to the gas plant that supports the fluid catalytic cracker ("FCC"), a unit that alters the molecular composition of materials sent into the unit in order to produce gasoline, diesel, fuel oil, heating oil, and other products. Some piping and instrumentation cables for other operating units in the refinery were also damaged by the fire. All of the units at the refinery were shut down to assess the scope of work needed to return the refinery to safe and efficient operations. The refinery was brought back to operation in two stages. Certain units, including the crude unit, began operations in January 2006. The gas plant and the FCC returned to operation in April 2006, and the refinery has returned to its normal operating level of approximately 62,000 barrels per day. We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the Yorktown refinery. We also have business interruption insurance coverage for the financial impact of the fire after the policy?s 45-day waiting period is exceeded. As of March 31, 2006, we have received $9,850,000 of insurance proceeds for property claims filed and recorded a gain of $2,853,000 as a result of the fire. We expect to receive additional amounts on our property insurance claims, and we have not yet received any insurance proceeds for claims filed under our business interruption insurance coverage. We believe that these reimbursements will have a significant impact on our 2006 earnings. 33 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 122 service stations at March 31, 2006. Our retail group sells its petroleum products and merchandise to consumers in New Mexico, Arizona and Southern Colorado. Our wholesale group distributes commercial wholesale petroleum products primarily in Arizona and New Mexico. In order to maintain and improve our financial performance, 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 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 costs 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 are reported. In order to apply 34 these principles, policies, and procedures, we must make judgments, assumptions, and estimates based on the best available information at the time. Actual results may differ based on the accuracy of the information utilized and subsequent events, some of which we may have little or no control over. In addition, the methods used in applying the above may result in amounts that differ considerably from those that would result from the application 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, 2005. 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 2006. 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 Item 8 of our Annual Report on Form 10-K for the year ended December 31, 2005. 35 Below is operating data for our operations:
Three Months Ended March 31, ----------------------- 2006 2005 ---------- ---------- Refining Group Operating Data: Four Corners Operations: Crude Oil/NGL Throughput (BPD)........... 29,122 28,810 Refinery Sourced Sales Barrels (BPD)..... 28,471 28,559 Average Crude Oil Costs ($/Bbl).......... $ 62.30 $ 47.46 Refining Margins ($/Bbl)................. $ 10.84 $ 7.86 Yorktown Operations: Crude Oil/NGL Throughput (BPD)........... 37,589 65,740 Refinery Sourced Sales Barrels (BPD)..... 33,466 62,726 Average Crude Oil Costs ($/Bbl).......... $ 59.02 $ 44.96 Refining Margins ($/Bbl)................. $ (3.50) $ 6.78 Retail Group Operating Data: (Continuing operations only) Fuel Gallons Sold (000's).................. 40,386 39,469 Fuel Margins ($/gal)....................... $ 0.14 $ 0.11 Merchandise Sales ($ in 000's)............. $ 33,312 $ 31,287 Merchandise Margins........................ 27% 27% Operating Retail Outlets at Period End..... 122 125 Wholesale Group Operating Data: Phoenix Fuel: Fuel Gallons Sold (000's)................ 120,681 120,865 Fuel Margins ($/gal)..................... $ 0.06 $ 0.06 Lubricant Sales ($ in 000's)............. $ 9,564 $ 8,412 Lubricant Margins........................ 14% 14% Dial Oil: Fuel Gallons Sold (000's)................ 25,942 - Fuel Margins ($/gal)..................... $ 0.14 - Lubricant Sales ($ in 000's)............. $ 8,080 - Lubricant Margins........................ 11% - Merchandise Sales* ($ in 000's).......... $ 2,219 - Merchandise Margins*..................... 30% - Operating Retail Outlets at Period End... 12 - *Includes only retail store merchandise sales.
36 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 March 31, ----------------------- 2006 2005 ---------- ---------- AVERAGE PER BARREL - ------------------ Four Corners Operation Net sales........................................... $ 76.39 $ 59.15 Less cost of products............................... 65.55 51.29 ---------- ---------- Refining margin..................................... $ 10.84 $ 7.86 ========== ========== Yorktown Operation Net sales........................................... $ 62.11 $ 52.63 Less cost of products............................... 65.61 45.85 ---------- ---------- Refining margin..................................... $ (3.50) $ 6.78 ========== ========== Consolidated Net sales........................................... $ 68.68 $ 54.67 Less cost of products............................... 65.59 47.55 ---------- ---------- Refining margin..................................... $ 3.09 $ 7.12 ========== ==========
37
Three Months Ended March 31, ----------------------- 2006 2005 ---------- ---------- Reconciliations of refined product sales from produced products sold per barrel to net revenues Four Corners Operations Average sales price per produced barrel sold.......... $ 76.39 $ 59.15 Times refinery sourced sales barrels per day.......... 28,471 28,559 Times number of days in period........................ 90 90 ---------- ---------- Refined product sales from produced products Sold* (000's)....................................... $ 195,741 $ 152,034 ========== ========== Yorktown Operations Average sales price per produced barrel sold.......... $ 62.11 $ 52.63 Times refinery sourced sales barrels per day.......... 33,466 62,726 Times number of days in period........................ 90 90 ---------- ---------- Refined product sales from produced products Sold* (000's)....................................... $ 187,072 $ 297,114 ========== ========== Consolidated (000's) Sum of refined product sales from produced products sold*...................................... $ 382,813 $ 449,148 Purchased product, transportation and other revenues.. 183,571 43,879 ---------- ---------- Net revenues.......................................... $ 566,384 $ 493,027 ========== ========== *Includes inter-segment net revenues.
38
Three Months Ended March 31, ----------------------- 2006 2005 ---------- ---------- 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... $ 65.55 $ 51.29 Times refinery sourced sales barrels per day........ 28,471 28,559 Times number of days in period...................... 90 90 ---------- ---------- Cost of products for produced products sold (000's)...................................... $ 167,965 $ 131,831 ========== ========== Yorktown Operations Average cost of products per produced barrel sold... $ 65.61 $ 45.85 Times refinery sourced sales barrels per day........ 33,466 62,726 Times number of days in period...................... 90 90 ---------- ---------- Cost of products for produced products sold (000's)...................................... $ 197,613 $ 258,839 ========== ========== Consolidated (000's) Sum of refined cost of produced products sold....... $ 365,578 $ 390,670 Purchased product, transportation and other cost of products sold............................. 175,210 36,398 ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................... $ 540,788 $ 427,068 ========== ==========
39
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 March 31, ----------------------- 2006 2005 ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 97,177 $ 76,697 Less cost of fuel sold............................ 91,485 72,209 ---------- ---------- Fuel margin....................................... $ 5,692 $ 4,488 Number of gallons sold............................ 40,386 39,469 Fuel margin per gallon............................ $ 0.14 $ 0.11 Reconciliation of fuel sales to net revenues (000's) Fuel sales........................................ $ 97,177 $ 76,697 Excise taxes included in sales.................... (15,484) (14,887) ---------- ---------- Fuel sales, net of excise taxes................... 81,693 61,810 Merchandise sales................................. 33,312 31,287 Other sales....................................... 4,960 3,829 ---------- ---------- Net revenues...................................... $ 119,965 $ 96,926 ========== ========== Reconciliation of fuel cost of products sold to total cost of products sold (excluding depreciation and amortization) (000's) Fuel cost of products sold........................ $ 91,485 $ 72,209 Excise taxes included in cost of products sold.... (15,484) (14,887) ---------- ---------- Fuel cost of products sold, net of excise taxes... 76,001 57,322 Merchandise cost of products sold................. 24,239 22,785 Other cost of products sold....................... 4,015 3,068 ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 104,255 $ 83,175 ========== ==========
40
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 March 31, ----------------------- 2006 2005 ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 270,312 $ 222,887 Less cost of fuel sold............................ 263,362 215,434 ---------- ---------- Fuel margin....................................... $ 6,950 $ 7,453 Number of gallons sold............................ 120,681 120,865 Fuel margin per gallon............................ $ 0.06 $ 0.06 Reconciliation of fuel sales to net revenues (000's) Fuel sales........................................ $ 270,312 $ 222,887 Excise taxes included in sales.................... (45,431) (40,832) ---------- ---------- Fuel sales, net of excise taxes................... 224,881 182,055 Lubricant sales................................... 9,564 8,412 Other sales....................................... 1,214 1,197 ---------- ---------- Net revenues...................................... $ 235,659 $ 191,664 ========== ========== Reconciliation of fuel cost of products sold to total cost of products sold excluding (depreciation and amortization) (000's) Fuel cost of products sold........................ $ 263,362 $ 215,434 Excise taxes included in cost of products sold.... (45,431) (40,832) ---------- ---------- Fuel cost of products sold, net of excise taxes... 217,931 174,602 Lubricant cost of products sold................... 8,179 7,242 Other cost of products sold....................... 216 332 ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 226,326 $ 182,176 ========== ==========
41
Dial Oil(1) - ----------- Three Months Ended March 31, ----------------------- 2006 2005 ---------- ---------- (in 000's except fuel margin per gallon) Fuel sales........................................ $ 51,283 $ - Less cost of fuel sold............................ 47,567 - ---------- ---------- Fuel margin....................................... $ 3,716 $ - Number of gallons sold............................ 25,942 - Fuel margin per gallon............................ $ 0.14 $ - Reconciliation of fuel sales to net revenues (000's) Fuel sales........................................ $ 51,283 $ - Lubricant and merchandise sales................... 10,298 - Other sales....................................... 647 - ---------- ---------- Net revenues...................................... $ 62,228 $ - ========== ========== Reconciliation of cost of fuel sold to total cost of products sold (excluding depreciation and amortization)(000's) Fuel cost of products sold........................ $ 47,567 $ - Lubricant and merchandise cost of products sold... 8,730 - Other cost of products sold....................... 199 - ---------- ---------- Total cost of products sold (excluding depreciation and amortization).................. $ 56,496 $ - ========== ========== (1) Dial Oil presents sales and cost of sales, net of excise taxes.
42
Three Months Ended March 31, ----------------------- 2006 2005 ---------- ---------- Consolidated - ------------ Reconciliation to net revenues reported in Condensed Consolidated Statements of Operations (000's) Net revenues ? Refinery Group..................... $ 566,384 $ 493,027 Net revenues ? Retail Group....................... 119,965 96,926 Net revenues ? Wholesale Group: Net revenues ? Phoenix Fuel.................... 235,659 191,664 Net revenues ? Dial Oil........................ 62,228 - Net revenues ? Other.............................. 71 98 Eliminations...................................... (121,282) (69,989) ---------- ---------- Total net revenues reported in Condensed Consolidated Statements of Operation............ $ 863,025 $ 711,726 ========== ========== Reconciliation to cost of products sold (excluding depreciation and amortization) in Condensed Consolidated Statements of Operations (000's) Cost of products sold ? Refinery Group (excluding depreciation and amortization)....... $ 540,788 $ 427,068 Cost of products sold ? Retail Group (excluding depreciation and amortization)....... 104,255 83,175 Cost of products sold ? Wholesale Group: Cost of products sold ? Phoenix Fuel (excluding depreciation and amortization)..... 226,326 182,176 Cost of products sold ? Dial Oil (excluding depreciation and amortization)..... 56,496 - Eliminations...................................... (121,282) (69,989) Other............................................. 3,969 3,360 ---------- ---------- Total cost of products sold (excluding depreciation and amortization) reported in Condensed Consolidated Statements of Operations. $ 810,552 $ 625,790 ========== ==========
43 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 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 months ended March 31, 2006 with the same period in 2005 was affected by, among others, the following factors: - weaker net refining margins for our Yorktown refinery in 2006, due primarily to the Yorktown fire in the fourth quarter of 2005, which resulted in: - a complete shutdown of refinery operations from November 25, 2005 to mid-January, 2006, and a partial shutdown from mid- January, 2006 to mid-April, 2006; - the need to sell feedstocks for the FCC at a lower margin as compared to sales of finished products while the refinery was operating at less than full capacity; and - timing issues with respect to the receipt of the bulk of anticipated insurance proceeds. These negative factors were partially offset by the positive following factors: - stronger net refining margins for our Four Corners refineries in 2006, due to, among other things: - increased sales in our Tier 1 market; and - favorable margins due to tight finished product supply in certain of our market areas; - - receipt of $9,850,000 in insurance proceeds and the resulting gain of $2,853,000 as a result of the Yorktown fire discussed above, and - higher fuel margins per gallon for our retail group for the three months ended March 31, 2006. 44 EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES Our earnings from continuing operations before income taxes decreased $36,825,000 for the three months ended March 31, 2006, compared to the same period in 2005. As noted above, this decrease was primarily due to a decrease in operating income before corporate allocations from our refinery operations of $43,507,000 primarily due to lower volumes and margins realized as a result of the Yorktown fire; This decrease was partially offset by the following factors: - a $2,669,000 increase in operating income from our retail operations as a result of increased fuel margins and volumes; and - the implementation of our debt reduction strategy that resulted in a $2,311,000 or 33% decrease in interest expense. YORKTOWN REFINERY Our Yorktown refinery operated at an average throughput rate of approximately 37,589 barrels per day in the first quarter of 2006 compared to 65,740 barrels per day in the first quarter of 2005. Refining margins for the first quarter of 2006 were $(3.50) per barrel and were $6.78 for the first quarter of 2005. As noted above, this decrease in refining margins was due primarily to the disruption of our refinery operations caused by the fire and the resulting sale of feedstocks that would otherwise have been processed into higher value (higher priced) gasoline and diesel; Revenues for our Yorktown refinery decreased for the three months ended March 31, 2006 due primarily to the Yorktown fire which resulted in a shutdown of refinery operations and the resulting sale of feedstocks at a lower price as compared to gasoline and diesel products. Depreciation and amortization expense for our Yorktown refinery decreased for the three months ended March 31, 2006 due in part to certain assets being fully depreciated in 2005. FOUR CORNERS REFINERIES Our Four Corners refineries operated at an average throughput rate of approximately 29,122 barrels per day in the first quarter of 2006, compared to 28,810 barrels per day in the first quarter of 2005. Refining margins for the first quarter of 2006 were $10.84 per barrel and were $7.86 for the first quarter of 2005. 45 Revenues for our Four Corners refineries increased for the three months ended March 31, 2006 primarily due to an increase in finished product prices as a result of favorable market conditions. Operating expenses for our Four Corners refineries increased for the three months ended March 31, 2006 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 were relatively unchanged for the three months ended March 31, 2006 as compared to the same period in 2005. RETAIL GROUP Average fuel margins were $0.14 per gallon for the three months ended March 31, 2006 as compared to $0.11 per gallon for the same period in 2005. Fuel volumes sold for the three months ended March 31, 2006 increased as compared to the same period a year ago due primarily to favorable market conditions and improved demand over the same period in 2005. Average merchandise margins were 27% for each of the three months ended March 31, 2006 and March 31, 2005. Revenues for our retail group increased for the three months ended March 31, 2006, compared to the same periods in 2005, primarily due to an increase in fuel selling prices and an increase in fuel volumes sold. Our retail fuel margin per gallon increased for the three months ended March 31, 2006 due to higher finished product sales prices as a result of increased demand. Operating expenses increased for the three months ended March 31, 2006 as compared with the same periods in 2005, primarily due to an increase in employee costs as a result of a change to existing law in our primary market that required us to increase the number of employees in these areas. Depreciation expense decreased for the three months ended March 31, 2006 as compared to the same period in 2005 due to a reduction in amortization for our leasehold improvements. WHOLESALE GROUP Phoenix Fuel ------------ Average gasoline and diesel fuel margins for Phoenix Fuel were $0.06 per gallon in both the first quarter of 2006 and 2005. Revenues for Phoenix Fuel increased for the three months ended March 31, 2006 primarily due to higher average price per gallon sold. 46 Operating expenses for Phoenix Fuel increased for the three months ended March 31, 2006 primarily due to higher fuel costs and higher employee payroll and benefit 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 months ended March 31, 2006, selling, general and administrative expenses increased by approximately $2,207,000 as compared to the same period in 2005 due primarily to higher legal costs in 2006 as a result of reimbursement of legal expenses that occurred in 2005. INTEREST EXPENSE FROM CONTINUING OPERATIONS For the three months ended March 31, 2006, interest expense decreased approximately $2,311,000 as compared to the same period in 2005. 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 March 31, 2006 and 2005 were approximately 37.5% and 41.0%, respectively. The decrease was primarily due to additional tax credits associated with low sulfur diesel production in 2006. 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 currently believe that our refining fundamentals are more positive now as compared to the same time last year. Further, we anticipate that additional insurance proceeds will be received in connection with the fire at our Yorktown refinery in the fourth quarter of 2005. Same store fuel volumes for our retail group currently are above 47 the prior year's levels, however, fuel margins are lower. In addition, merchandise sales for our retail group are above the prior year?s level, while merchandise margins have remained stable. The wholesale group currently continues to see stronger margins and volumes as compared to 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 March 31, 2006, we had long-term debt of $274,990,000. At December 31, 2005, we had long-term debt of $274,864,000. There was no current portion of long-term debt outstanding at March 31, 2006 or at December 31, 2005. The amounts at March 31, 2006 and December 31, 2005 include: - $150,000,000 before discount of 8% senior subordinated notes due 2014; and - $130,001,000 before discount of 11% senior subordinated notes due 2012. At March 31, 2006, we had a $175,000,000 revolving credit facility. 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 March 31, 2006, our long-term debt was 41.4% of total capital. At December 31, 2005, it was 40.7%. 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 March 31, 2006, was 32.9%. At December 31, 2005, this percentage was 21.7%. 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 48 provide assurance that our assets would be sufficient to pay that debt and other debt or that we would be able to refinance such debt or borrow more money on terms acceptable to us, if at all. Our ability to comply with the covenants, and other terms and conditions, of the indentures and the credit facility may be affected by many events beyond our control, and we cannot provide assurance that our operating results will be sufficient to allow us to comply with the covenants. We expect to be in compliance with the covenants going forward, and we do not believe that any presently contemplated activities will be constrained. A prolonged period of low refining margins, however, would have a negative impact on our ability to borrow funds and to make expenditures and would have an adverse impact on compliance with our debt covenants. We presently have senior subordinated ratings of "B3" from Moody's Investor Services and "B-" from Standard & Poor's. CASH FLOW FROM OPERATIONS Our operating cash flow decreased by $54,513,000 for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. This resulted primarily from the net loss incurred in the first quarter of 2006 compared to the net earnings reported in the first quarter of 2005. 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 March 31, 2006 consisted of current assets of $384,377,000 and current liabilities of $226,410,000 or a current ratio of 1.70:1. At December 31, 2005, the current ratio was 2.12:1, with current assets of $442,355,000 and current liabilities of $208,508,000. 49 CAPITAL EXPENDITURES AND RESOURCES During the first quarter of 2006, we increased our budget for capital expenditures in 2006, excluding any potential acquisitions and linefill for the recently acquired pipeline, from approximately $201,000,000 to approximately $209,000,000. The increase is primarily due to the timing of budgeted expenditures on certain projects. A portion of these costs may not be spent in 2006. Net cash used in investing activities for purchases of property, plant and equipment totaled approximately $59,697,000 for the three months ended March 31, 2006 and $12,826,000 for the three months ended March 31, 2005. Expenditures made in 2006 primarily were for operational and environmental projects for the refineries. We received proceeds of approximately $1,539,000 from the sale of property, plant and equipment and other assets in the first three months of 2006 and $981,000 for the same period in 2005. In addition, we received $9,850,000 of insurance proceeds for property claims filed as a result of the fire at our Yorktown refinery that occurred in the fourth quarter of 2005. We expect to receive additional amounts on our property insurance claims and we have not yet received any insurance proceeds for claims filed under our business interruption insurance coverage. We believe that these reimbursements will have a significant impact on our 2006 earnings. 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 2006 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. 50 RISK MANAGEMENT We are exposed to various market risks, including changes in certain commodity prices and interest rates. To manage these normal business exposures, we may, from time to time, use commodity futures and options contracts to reduce price volatility, to fix margins in our refining and marketing operations, and to protect against price declines associated with our crude oil and finished products inventories. 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 March 31, 2006, 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. 51 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 cleanup at third-party disposal sites, notwithstanding that the original disposal activities were in accordance with all applicable regulatory requirements at such time. We are currently engaged in a number of such remediation projects. Future expenditures related to compliance with environmental, health and safety laws and regulations, the investigation and remediation of contamination, and the defense or settlement of governmental or private party claims and lawsuits cannot be reasonably quantified in many circumstances for various reasons. These reasons include the uncertain nature of remediation and cleanup 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 give assurance that compliance with such laws or regulations, such investigations or cleanups, or such enforcement proceedings or private-party claims will not have a material adverse effect on our business, financial condition or results of operations. Rules and regulations implementing federal, state and local laws relating to the environment, health, and safety will continue to affect our operations. We cannot predict what new environmental, health, or safety legislation or regulations will be enacted or become effective in the future or how existing or future laws or regulations will be administered or enforced with respect to products or activities to which they have not been previously applied. Compliance with more stringent laws or regulations, as well as more vigorous enforcement policies of regulatory agencies, could have an adverse effect on our financial position and the results of our operations and could require substantial expenditures by us for, among other things: - the installation and operation of refinery equipment, pollution control systems and other equipment not currently possessed by us; - the acquisition or modification of permits applicable to our activities; and - the initiation or modification of clean-up activities. In March 2006, we entered into a consent order with the New Mexico Oil Conservation Division and paid a civil penalty of $30,000 to settle an Administrative Compliance Order related to our Bloomfield refinery. For a further discussion of this settlement, see Note 10 to our Condensed Consolidated Financial Statements, captioned "Commitments and Contingencies". 52 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 60% for the first three months of 2006. 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 53 - with sufficient further decline in raw material supply, the temporary, partial or permanent discontinuance of operations at one or both refineries. None of these options, however, may prove to be economically viable. We cannot assure you that the Four Corners crude oil supply for our Ciniza and Bloomfield refineries will continue to be available at all or on acceptable terms for the long term, 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 (?EPA?). 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. EPA has issued a rule pursuant to the Clean Air Act that requires refiners to reduce the sulfur content of gasoline and highway diesel fuel. Some refiners began producing gasoline that satisfies low sulfur gasoline standards in 2004, with most refiners required to be in full compliance for all production in 2006. Most refiners also must begin producing highway diesel fuel that satisfies low sulfur diesel standards by June 2006. All refiners and importers must be in full compliance with the new standards by the end of 2010 without exception. We currently anticipate that our Yorktown and Ciniza refineries will not be able to meet the June 2006 start date for the low sulfur diesel standards. For a further discussion of this matter, refer to the discussion under Risk Factors in Item 1A in Part II of this Report on Form 10-Q. 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. 54 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 and the impact of any windfall profit, price gouging, or other legislation that may be adopted in reaction to the current price of motor fuel at the retail level; 55 - unplanned or extended shutdowns in refinery operations; - 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; - 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 our anticipated inability to reduce the sulfur content of diesel fuel at our Yorktown and Ciniza refineries by the applicable regulatory deadline will cause us to incur substantial costs or will have other significant consequences on our operations; - 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; 56 - 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; - 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; - the risk that we will not receive the anticipated amount of insurance proceeds in connection with the fire at our Yorktown refinery in the fourth quarter of 2005; 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. 57 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. 58 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, the discussion of legal matters contained in Part I, Item 2, under the headings "Liquidity and Capital Resources - Environmental, Health and Safety" and "Liquidity and Capital Resources - Other", and the discussion of legal matters contained in Part II, Item 1A. ITEM 1A. RISK FACTORS An investment in our common shares involves risk. A discussion of these risks can be found in our Annual Report on Form 10-K for the year ended December 31, 2005 (the "Form 10-K"). Set forth below are the material changes to the risk factors disclosed in the Form 10-K. You should carefully consider the specific factors described below and in the Form 10-K, together with the cautionary statements under the caption "Forward-Looking Statements" in Item 2 of this Report and the other information included in this report, before purchasing our common shares. The risks described below and in the Form 10-K are not the only ones that we face. Additional risks that are not yet known to us or that we currently think are immaterial could also impair our business, financial condition, or results of operations. If any of the risks actually occurs, our business, financial condition, or results of operations could be adversely affected. In such case, the trading price of our common shares could decline, and you may lose all or part of your investment. WE ASSUMED LIABILITIES IN CONNECTION WITH THE ACQUISITION OF OUR YORKTOWN REFINERY We assumed certain liabilities and obligations in connection with our purchase of the Yorktown refinery in 2002. 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 Yorktown refinery or its operation. We agreed to indemnify the sellers for losses incurred in connection with or related to the liabilities and obligations we have assumed. We only have limited indemnification rights against the seller. 59 Environmental obligations assumed by us include the seller's Yorktown refinery responsibilities 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. As applicable to the Yorktown refinery, the Consent Decree requires, among other things, a 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 $14,045,000 of this amount through the first quarter of 2006. We do not anticipate any significant increase in current operating expenses when all equipment modifications required by the Consent Decree are completed. In connection with the Yorktown acquisition, we also assumed the seller's obligations under an administrative order issued in 1991 by EPA under the Resource Conservation and Recovery Act. The order requires an investigation of certain areas of the refinery and the development of measures to correct any releases of contaminants or hazardous substances found in these areas. A Resource Conservation and Recovery Act Facility Investigation was conducted and approved conditionally by EPA in 2002. Following the investigation, 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 cleanup measures, including the construction of an on-site corrective action management unit that would be used to consolidate hazardous solid materials associated with these measures. These proposed actions relate to soil, sludge, and remediation wastes relating to solid waste management units. Groundwater in the aquifers underlying the refinery, and surface water and sediment in a small pond and tidal salt marsh on the refinery property also are addressed in the RA/CMS. Based on the RA/CMS, EPA issued a proposed cleanup plan for public comment in December 2003 setting forth preferred corrective measures for remediating soil, groundwater, sediment, and surface water contamination at the refinery. Following the public comment period, EPA issued its final remedy decision and response to comments in April 2004. EPA currently is developing the administrative consent order pursuant to which we will implement our cleanup plan. 60 Our most current estimate of expenses associated with the order is between $25,000,000 ($17,500,000 of which we believe is subject to reimbursement by BP) and $27,000,000 ($19,500,000 of which we believe is subject to reimbursement by BP). We anticipate that these expenses will be incurred over a period of approximately 35 years after EPA approves our cleanup plan. We believe that between approximately $9,500,000 and $10,500,000 of this amount will be incurred over an initial four-year period, and additional expenditures of approximately $7,500,000 will be incurred over the following four-year period, with the remainder thereafter. 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 the purchase agreement for the refinery. EPA is requiring financial assurance of our ability to perform the plan, such as a certification that we satisfy certain financial tests, depositing funds into a trust, or posting a letter of credit or performance bond. If we cannot agree with EPA regarding financial assurance and, as a result, do not sign the consent order being developed by EPA, EPA has indicated it will consider its enforcement option. As part of the cleanup 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 between approximately $1,500,000 and $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 seven to eight years after EPA approves our clean-up plan and authorizes its implementation. ANY SIGNIFICANT INTERRUPTIONS IN THE OPERATIONS OF ANY OF OUR REFINERIES COULD MATERIALLY AND ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS Our refining activities are conducted at our two refinery locations in New Mexico and the Yorktown refinery in Virginia. The refineries constitute a significant portion of our operating assets, and our two New Mexico refineries supply a significant portion of our retail operations. As a result, our operations would be subject to significant interruption if any of the refineries were to experience a major accident, be damaged by severe weather or other natural disaster, or otherwise be forced to shut down. If any of the refineries were to experience an interruption in supply or operations, our business, financial condition and operating results could be materially and adversely affected. 61 On November 25, 2005, a fire occurred at our Yorktown refinery. Damage was primarily done to the gas plant that supports the fluid catalytic cracker ("FCC"), a unit that alters the molecular composition of materials sent into the unit in order to produce gasoline, diesel, fuel oil, heating oil, and other products. Some piping and instrumentation cables for other operating units in the refinery were also damaged by the fire. All of the units at the refinery were shut down to assess the scope of work needed to return the refinery to safe and efficient operations. The refinery was brought back to operation in two stages. Certain units, including the crude unit, began operations in January 2006. The gas plant and the FCC returned to operation in April 2006, and the refinery has returned to its normal operating level of approximately 62,000 barrels per day. We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the Yorktown refinery. We also have business interruption insurance coverage for the financial impact of the fire after the policy?s 45-day waiting period is exceeded. We do not yet know exactly when we will be receiving payments under these policies or ultimately how much we will receive. COMPLIANCE WITH VARIOUS REGULATORY AND ENVIRONMENTAL LAWS AND REGULATIONS WILL INCREASE THE COST OF OPERATING OUR BUSINESS Our operations are subject to a variety of federal, state and local environmental, health and safety laws and regulations governing the discharge of pollutants into the soil, air and water, product specifications, the generation, treatment, storage, transportation and disposal of solid and hazardous waste and materials and employee health and safety. Violations of such laws and regulations can lead to substantial fines and penalties. Also, these laws and regulations have become, and are becoming, increasingly stringent. Moreover, we cannot predict the nature, scope or effect of legislation or regulatory requirements that could be imposed, or how existing or future laws or regulations will be administered or interpreted, 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 the regulatory agencies, could require us to make substantial expenditures for, among other things, the installation and operation of refinery equipment, pollution control systems and other equipment we do not currently possess, or the acquisition or modification of permits applicable to our activities. EPA has issued a rule pursuant to the Clean Air Act that requires refiners to reduce the sulfur content of gasoline and highway diesel fuel. Some refiners began producing gasoline that satisfies low sulfur gasoline standards in 2004, with most refiners required to be in full compliance for all production in 2006. Most refiners also must begin producing highway diesel fuel that satisfies low sulfur diesel standards by June 2006. All refiners and importers must be in full compliance with the new standards by the end of 2010. 62 We applied for temporary relief from the low sulfur gasoline standards at the Yorktown refinery. In March 2003, EPA approved our application and issued a compliance plan. This compliance plan allowed us to postpone certain capital expenditures for up to three years from the date we would otherwise have begun these expenditures. We must be in full compliance with the diesel sulfur standards by June 1, 2006, and the gasoline sulfur standards by January 1, 2008. The compliance plan requires us to provide EPA with an annual report on our adherence to the compliance plan and on our progress in meeting the low sulfur standards. If we fail to comply with the conditions set by EPA, the compliance plan could be modified or revoked. Further, EPA reserved the right to modify or revoke the compliance plan for other reasons. EPA must, however, provide us with reasonable notice of any anticipated changes in the plan and reasonable lead time to implement any modifications due to changes in the compliance plan. Modifications to or revocation of the compliance plan could increase the quantity of high-sulfur products, including product components, that do not meet the new standards. This would likely reduce our Yorktown refining earnings. With respect to the Ciniza and Bloomfield refineries, we applied for and received approval under existing regulations for an extension of the low sulfur gasoline standards until 2007, the date when the annual average sulfur content of our Four Corners gasoline must begin to be reduced. Full compliance is, however, required by 2008. In order to receive this extension of low sulfur diesel standards, we agreed to be in full compliance with the diesel sulfur standards by June 1, 2006. We are currently installing equipment and/or developing projects necessary to produce low sulfur gasoline and diesel fuel at our refineries. There are a number of factors that could affect our cost of compliance with the low sulfur standards. In particular, because these standards affect the entire industry and because of the damage to refineries caused by Hurricanes Katrina and Rita, engineering and construction companies are busy and are charging a premium for their services. The relatively short time left to comply has resulted in increased costs to expedite ordering for otherwise long delivery items and added overtime by contractors to attempt to meet the implementation schedule. Increases in metal and concrete prices have impacted, and could further impact, costs. We currently anticipate that our Ciniza and Yorktown refineries will not be able to meet the June 2006 start date for the low sulfur highway diesel standards as a result of the combined effects of Hurricanes Katrina and Rita on the availability of contractors, hardware, and other similar effects and the time and, at Yorktown, the effort required to repair damage resulting from the 2005 fire. 63 We have been in communication with EPA concerning our anticipated inability to meet the June start date at our Ciniza refinery. We are uncertain how our anticipated inability to produce low sulfur highway diesel by the start date will affect our refinery?s ability to comply with the low sulfur highway diesel standards, as we still may be able to comply with EPA?s requirements even though we are not able to initially make one hundred percent low sulfur fuel for highway use. For example, we may be able to make use of compliance period averaging, which is permitted by the low sulfur diesel standards. Additionally, it is possible that EPA will provide us with additional time to begin producing low sulfur highway diesel. At our Yorktown refinery, we will not be able to satisfy the current requirements of our compliance plan if we do not produce low sulfur highway diesel fuel by the start date. We are pursuing a modification to our compliance plan with EPA. While we currently anticipate reaching a satisfactory agreement with EPA, we cannot assure you that such an agreement will be reached. Our inability to produce low sulfur highway diesel at our Ciniza and Yorktown refineries could result in a reduction in the quantity of highway diesel fuel that we otherwise would have available for sale, and an increase in the quantity of refinery products available for sale that are not subject to the low sulfur highway diesel standards, such as non- highway diesel fuel and heating oil. Further, depending on the market for such products as compared to the market for low sulfur highway diesel, we might need to make other modifications to the refineries' operations, including reducing production. Such circumstances would likely reduce refining earnings. In addition to the consequences noted above, our inability to meet the start date may have other consequences, such as no longer qualifying us for an extension of low sulfur gasoline standards at our Four Corners refineries and/or requiring us to purchase sulfur credits. Until our discussions with EPA are concluded, we will be unable to fully evaluate the potential impact of our inability to meet the regulatory start date. At this time, however, we do not anticipate that our inability to produce low sulfur highway diesel fuel by the June start date will impact our timetable for producing low sulfur gasoline at our refineries. 64 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Our annual meeting of stockholders was held on April 10, 2006. Proxies for the meeting were solicited under Regulation 14A. There were no matters submitted to a vote of security holders other than the election of two directors and the ratification of our independent registered public accounting firm as specified in our Proxy Statement. There was no solicitation in opposition to management?s nominees to the Board of Directors. Fred L. Holliger was elected as a director of the Company. The vote was as follows: Shares Voted ?For? Shares Voted ?Withholding? - ------------------ -------------------------- 11,564,270 498,110 Brooks J. Klimley was elected as a director of the Company. The vote was as follows: Shares Voted ?For? Shares Voted ?Withholding? - ------------------ -------------------------- 11,736,054 326,326 Deloitte & Touche LLP was ratified as our independent registered public accounting firm for the Company for the year ending December 31, 2006. The vote was as follows: Shares Voted ?For? Shares Voted ?Against? Shares Voted ?Abstaining? - ------------------ ---------------------- ------------------------- 11,710,056 345,050 7,274 In addition to the two directors elected above, other members of our Board of Directors include Anthony J. Bernitsky, Larry L. DeRoin, George M. Rapport, and Donald M. Wilkinson. 65 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits: 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 February 28, 2006, we filed a Form 8-K dated February 28, 2006, containing a press release detailing our earnings for the year and quarter ended December 31, 2005. (ii) On May 4, 2006, we filed a Form 8-K dated May 4, 2006, containing a press release detailing our earnings for the quarter ended March 31, 2006. 66 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 March 31, 2006 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: May 4, 2006 67 EX-31 2 exhibit31-1.txt GIANT INDUSTRIES, INC. EXHIBIT 31-1 EXHIBIT 31.1 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Fred L. Holliger, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Giant Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 4, 2006. By: /s/ FRED L. HOLLIGER ------------------------------- Name: Fred L. Holliger Title: Chief Executive Officer EX-31 3 exhibit31-2.txt GIANT INDUSTRIES, INC. EXHIBIT 31-2 EXHIBIT 31.2 CERTIFICATION PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 I, Mark B. Cox, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Giant Industries, Inc.; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: May 4, 2006. By: /s/ MARK B. COX ------------------------------- Name: Mark B. Cox Title: Chief Financial Officer EX-32 4 exhibit32-1.txt GIANT INDUSTRIES, INC. EXHIBIT 32-1 EXHIBIT 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Giant Industries, Inc. ("Giant") on Form 10-Q for the quarter ended March 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Fred L. Holliger, Chief Executive Officer of Giant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (a) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (b) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Giant. By: /s/ FRED L. HOLLIGER ------------------------------- Name: Fred L. Holliger Title: Chief Executive Officer Date: May 4, 2006 EX-32 5 exhibit32-2.txt GIANT INDUSTRIES, INC. EXHIBIT 32-2 EXHIBIT 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of Giant Industries, Inc. ("Giant") on Form 10-Q for the quarter ending March 31, 2006, as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Mark B. Cox, Chief Financial Officer of Giant, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (a) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (b) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of Giant. By: /s/ MARK B. COX ------------------------------- Name: Mark B. Cox Title: Chief Financial Officer Date: May 4, 2006 -----END PRIVACY-ENHANCED MESSAGE-----