ITEM 1A. RISK FACTORS.
An investment in our common shares involves risk. You should carefully consider the specific factors described below, together with the cautionary statements under the caption "Forward - Looking Statements" in Item 7 of this Report and the other information included in this report, before purchasing our common shares. The risks described below 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 following risks actually occurs, our business, financial condition, or results of operations could be adversely affected. Further, it is possible that certain of the risks, if they occur, could provide Western with the ability to terminate our merger agreement. In either case, the trading price of our common shares could decline, and you may lose all or part of your investment.
WE HAVE DEBT THAT COULD ADVERSELY AFFECT OUR OPERATIONS.
As of December 31, 2006, our total debt was approximately $325,000,000 and our stockholders' equity was approximately $484,000,000. We currently have a $175,000,000 revolving credit facility. At December 31, 2006, we had approximately $50,000,000 of direct borrowings and $28,000,000 of letters of credit outstanding and $97,000,000 of availability, subject to borrowing base limitations. Our level of debt may have important consequences to you. Among other things, it may:
- limit our ability to use our cash flow, or obtain additional financing, for future working capital, capital expenditures, acquisitions or other general corporate purposes;
- restrict our ability to pay dividends;
- require a substantial portion of our cash flow from operations to make debt service payments;
- limit our flexibility to plan for, or react to, changes in our business and industry conditions;
- place us at a competitive disadvantage compared to our less leveraged competitors; and
- increase our vulnerability to the impact of adverse economic and industry conditions and, to the extent of our outstanding debt under our floating rate debt facilities, the impact of increases in interest rates.
We cannot assure you that we will continue to generate sufficient cash flow or that we will be able to borrow funds under our senior secured revolving credit facility in amounts sufficient to enable us to service our debt or meet our working capital and capital expenditure requirements. If we cannot do so, due to borrowing base restrictions or otherwise, we may be required to sell assets, reduce capital expenditures, refinance all or a portion of our existing debt or obtain additional financing. We cannot assure you that we will be able to refinance our debt, sell assets or borrow more money on terms acceptable to us, if at all. In addition, our ability to incur additional debt will be restricted under the covenants contained in our senior credit facilities and our senior subordinated note indentures.
OUR DEBT INSTRUMENTS IMPOSE RESTRICTIONS ON US THAT MAY ADVERSELY AFFECT OUR ABILITY TO OPERATE OUR BUSINESS.
The indentures governing our existing debt securities contain covenants that, among other things, restrict our ability to:
- create liens;
- incur or guarantee debt;
- pay dividends;
- repurchase shares of our common stock;
- sell certain assets or subsidiary stock;
- engage in certain mergers;
- engage in certain transactions with affiliates; or
- alter our current line of business.
In addition, our senior secured credit facility contains other and more restrictive covenants. We also must comply with specified financial covenants in our senior secured credit facility, including maintaining a minimum consolidated net worth, a minimum consolidated interest coverage ratio, and a maximum consolidated funded indebtedness to total capitalization percentage. Our ability to comply with these covenants may be affected by events beyond our control, and we cannot assure you that our future operating results will be sufficient to comply with the covenants. Our failure to comply with the financial covenants or the other restrictions contained in our senior credit facility could result in a default, which could cause that debt (and by reason of cross-default
provisions, debt under our indentures) to become immediately due and payable. If we cannot repay those amounts, the lenders under our senior secured credit facility could proceed against the collateral granted to them to secure that debt. If those lenders accelerate the payment of the senior secured credit facility, we cannot assure you that our assets would be sufficient to pay that debt and our debt under our indentures.
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 from BP Corporation North America Inc. and BP Products North America Inc. (collectively, "BP"). 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 BP for losses incurred in connection with or related to the liabilities and obligations we have assumed. We only have limited indemnification rights against BP.
Environmental obligations assumed by us include BP's responsibilities related to the Yorktown refinery under a consent decree among various parties covering many locations (the "Consent Decree"). 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 have substantially completed the modifications required by the Consent Decree, and have expended approximately $24,000,000 through the end of 2006. We expect to expend approximately $1,000,000 through 2008 for the remaining equipment modifications.
In connection with the Yorktown acquisition, we also assumed BP's obligations under an administrative order issued in 1991 by EPA under the Resource Conservation and Recovery Act. In August 2006, we agreed to the terms of an administrative consent order with EPA, pursuant to which we will implement a cleanup plan for the refinery.
Our most current estimate of expenses associated with the EPA order is between approximately $30,000,000 ($22,500,000 of which we believe is subject to reimbursement by BP) and $40,000,000 ($32,500,000 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 from August 2006. We believe that between approximately $12,000,000 and $16,000,000 of this amount will be incurred over an initial four-year period, and additional expenditures of between approximately $12,000,000 and $16,000,000 will be incurred over the following four-year period, with the remainder thereafter. These estimates assume that EPA will agree with the design and specifications of our cleanup plan. These estimates also could change as a result of factors such as changes in costs of labor and materials. We currently have $2,755,000 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 and also reflects expenditures previously incurred in connection with this matter. BP's total liability for reimbursement under the refinery purchase agreement, including liability for environmental claims, is limited to $35,000,000.
As part of the consent order cleanup plan, the facility's underground sewer system will be cleaned, inspected and repaired as needed. 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, as well as sewer system inspection and repair, will be completed approximately seven to eight years after EPA approves our cleanup plan and authorizes its implementation.
IF WE CANNOT MAINTAIN AN ADEQUATE SUPPLY OF FEEDSTOCKS AT OUR CINIZA AND BLOOMFIELD REFINERIES, OUR OPERATING RESULTS MAY BE ADVERSELY AFFECTED.
The primary feedstock for our Four Corners refineries is Four Corners Sweet, a locally produced, high quality crude oil. We supplement the crude oil used at our refineries with other feedstocks. These other feedstocks currently include locally produced natural gas liquids and condensate as well as other feedstocks produced outside of the Four Corners area.
These 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 partially offset 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 declined from approximately 72% in 2002 to approximately 60% in 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. We have begun testing the pipeline and taking other actions related to placing it in service. Unless currently
unanticipated obstacles are encountered, we anticipate that the pipeline will become operational in the second quarter of 2007 with crude oil arriving at the refineries before the end of the second quarter.
If additional crude oil or other refinery feedstocks become available in the future via the new pipeline or otherwise, we may increase production runs at our Four Corners refineries depending on the demand for finished products and the refining margins attainable. We continue to assess short-term and long-term options to address the continuing decline in Four Corners crude oil production. The options being considered include:
- evaluating potentially economic sources of crude oil produced outside the Four Corners area, including ways to reduce raw material transportation costs to our refineries;
- evaluating ways to encourage further production in the Four Corners area;
- changes in operation/configuration of equipment at one or both refineries to further the integration of the two refineries, and reduce fixed costs; and
- with sufficient further decline in raw material supply, the temporary, partial or permanent discontinuance of operations at one or both refineries.
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.
We have pipeline systems for gathering and delivering crude oil to our refineries and for natural gas liquids. If we cannot use either the crude oil pipeline system or the natural gas liquids pipeline, this could have a material adverse effect on our business, financial condition or results of operation. Certain rights-of-way for our crude oil pipeline system must be renewed periodically, including some that have expired, which are in the process of renewal, and others that expire in the next few years. We expect that substantial lead time will be required to negotiate and complete renewal of these rights-of-way and that the costs of renewal for certain of the rights-of-way may be significant. Our inability to successfully renew these rights-of-way would negatively impact our ability to use the crude oil pipeline system, which could have a material adverse effect on our business.
THE VOLATILITY OF CRUDE OIL PRICES AND REFINED PRODUCT PRICES MAY ADVERSELY AFFECT OUR BUSINESS, FINANCIAL CONDITION AND OPERATING RESULTS.
Our cash flow from operations depends primarily on producing and selling quantities of refined products at refinery margins sufficient to cover fixed and variable expenses. In recent years, crude oil costs and prices of refined products have fluctuated substantially. These costs and prices depend on numerous factors beyond our control, including:
- the supply of and demand for crude oil, gasoline and other refined products;
- changes in the economy;
- changes in the level of foreign and domestic production of crude oil and refined products;
- worldwide political conditions;
- the extent of government regulations; and
- local factors, including market conditions, pipeline capacity, and the level of operations of other refineries in our markets.
Our crude oil requirements are supplied from sources that include major oil companies, large independent producers, and smaller local producers. In February 2004, we entered into a long-term crude oil supply agreement with Statoil Marketing and Trading (USA), Inc., which we believe will provide a significant proportion of our Yorktown refinery's crude oil needs. We began taking supplies of acidic crude oil at our Yorktown refinery beginning in February 2004. Following various upgrades at the refinery, which took place in the third quarter of 2004, the volumes processed have increased. The term of this agreement expires when we have received the total volumes of crude oil committed to be provided by Statoil, which we believe will be in approximately 2009. Except for this long-term supply agreement with Statoil, our crude oil supply contracts are generally relatively short-term contracts with market-responsive pricing provisions. An increase in crude oil prices would adversely affect our operating margins if we cannot pass along the increased cost of raw materials to our customers.
Our sale prices for refined products are influenced by the commodity price of crude oil. Generally, an increase or decrease in the price of crude oil results in a corresponding increase or decrease in the price of gasoline and other refined products. The timing of the relative movement of the prices, however, as well as the overall change in product prices, could reduce profit margins and could have a significant impact on our refining and marketing operations, earnings and cash flows. In addition, we maintain inventories of crude oil, intermediate products, and refined products, the values of which are subject to rapid fluctuation in market prices. Price level changes during the period between purchasing
feedstocks and selling the manufactured refined products could have a significant effect on our operating results. Any long-term adverse relationships between costs and prices could impact our ability to generate sufficient operating cash flows to meet our working capital needs. Furthermore, because of the significantly greater volume of products produced and sold by our Yorktown refinery, as compared to our other operations, we have a much larger exposure to volatile refining margins than we had in the past.
OUR INDUSTRY IS HIGHLY COMPETITIVE, AND WE MAY NOT BE ABLE TO COMPETE EFFECTIVELY AGAINST LARGER COMPETITORS WITH GREATER RESOURCES.
We operate in a highly competitive industry. Many of our competitors are large, integrated oil companies that, because of their more diverse operations, larger refineries, stronger capitalization and better brand name recognition, are better able to withstand volatile industry conditions than we are, including shortages or excesses of crude oil or refined products or intense price competition. The refineries operated by our competitors are typically larger and more efficient than our refineries. As a result, these refineries may have lower per barrel processing costs. Mergers between large integrated oil companies, and upgrades to competitors' refineries have resulted, and in the future may result, in increased competition for our refineries.
THE COMPLETION OF CERTAIN PIPELINE PROJECTS COULD RESULT IN INCREASED COMPETITION BY INCREASING THE AMOUNT OF REFINED PRODUCTS AVAILABLE IN THE ALBUQUERQUE, EL PASO, TUCSON, AND PHOENIX MARKET AREAS AND OTHER MARKET AREAS.
We are aware of a number of actions, proposals or industry discussions regarding product pipeline projects that could impact portions of our marketing areas. The Longhorn pipeline, which began operations in August 2004, runs from Houston, Texas to El Paso, Texas. In El Paso, the Longhorn pipeline connects to the Plains pipeline that delivers to Albuquerque, New Mexico and to the Kinder-Morgan pipeline that delivers to Phoenix and Tucson, Arizona. In addition, product transported through the Longhorn pipeline can be brought to our Four Corners refineries' markets by truck. Further, there is a proposal to increase the volume of product that can be transported from El Paso to Albuquerque on the Plains pipeline, and there are plans to increase the volume of product that can be transported from El Paso to Phoenix and Tucson on the Kinder-Morgan pipeline. The Longhorn pipeline and the completion of some or all of these other projects could result in increased competition by increasing the amount of refined products potentially available in these markets, as well as improving competitor access to these areas. It also could result in new opportunities for us, as we are a net purchaser of refined products in some of these areas.
THE COMPLETION OF CERTAIN PROJECTS AND REFINERY IMPROVEMENTS COULD RESULT IN INCREASED COMPETITION IN THE FOUR CORNERS AREA.
Portions of our marketing area may be impacted by competitors' plans, as well as plans of our own, for expansion projects and refinery improvements that could increase the production of refined products in New Mexico. In addition, we anticipate that lower quality crude oils, which are typically less expensive to acquire, can and will be processed by our competitors as a result of refinery improvements. These developments could result in increased competition in our market areas.
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.
As previously discussed in our Annual Report on Form 10-K for 2005 and Quarterly Reports on Form 10-Q for the quarters ended March 31, 2006, June 30, 2006, and September 30, 2006, a fire occurred at our Yorktown refinery on November 25, 2005. Repairs related to this fire were completed in April 2006.
Our property insurance covered a significant portion of the costs of repairing the Yorktown refinery and our business interruption insurance reimbursed us for a portion of the financial impact of the fire. As of December 31, 2006, we had received $89,000,000 of insurance proceeds consisting of $27,700,000 for property claims and $61,300,000 for business interruption claims. No more proceeds will be received as all of our claims have been resolved with our insurance carriers.
On September 30, 2006, a fire occurred at our Yorktown refinery in the processing unit required to produce ultra low sulfur diesel fuel. Repairs to the unit cost approximately $12,000,000 and were completed in January 2007. The unit was returned to operation in February 2007. Until the unit became operational, we sold more heating oil than otherwise would be the case, which was a less profitable product than ultra low sulfur diesel.
We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the ultra low sulfur diesel unit. We also have business interruption insurance coverage
that should cover a significant portion of the financial impact of the fire after the policy's 45-day waiting period is exceeded.
On October 5, 2006, a pump failure in the alkylation unit at our Ciniza refinery resulted in a fire at the refinery. The fire caused damage to the alkylation unit and an associated unit. The alkylation unit produces high octane blending stock for gasoline. Repairs to the affected units cost approximately $6,400,000 and the unit was restarted in mid- December of 2006. We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the unit. We do not anticipate making a claim under our business interruption insurance.
On December 26, 2006, a fire occurred in a process heater in the distillate hydrotreater ("DHT") unit at the Ciniza refinery. The DHT unit is used to manufacture ultra low sulfur diesel fuel. Instrumentation and electrical cabling associated with the DHT unit and other process units also were damaged. All of the process units in the refinery were shutdown for safety reasons. Repairs have been made that have enabled us to restart all of the units at the refinery except for the portion of the DHT unit damaged in the fire. We currently expect that the rest of the DHT unit will be returned to service in early April.
We currently expect that repairs to, and/or replacement of, the units, instrumentation and cabling damaged by the fire will cost approximately $6,700,000. We do not anticipate receiving any insurance proceeds related to these repairs as the cost of the repairs has not exceeded the associated $10,000,000 deductible of our current property insurance coverage. In addition, we do not anticipate making a claim under our business interruption insurance.
OUR OPERATIONS ARE SUBJECT TO VARIOUS HAZARDS THAT ARE NOT FULLY INSURED, AND OUR INSURANCE PREMIUMS COULD INCREASE.
Our operations are subject to normal hazards of operations, including fire, explosion and weather-related perils. We maintain various insurance coverages, including business interruption insurance, which are subject to certain deductibles. We are not fully insured against certain risks because such risks are not fully insurable, coverage is unavailable or premium costs, in our judgment, do not justify the expenditures. Any such event that causes a loss for which we are not fully insured could have a material and adverse effect on our business, financial condition and operating results.
In November 2006, we renewed our property insurance coverage and our business interruption insurance coverage. Primarily due to the fires experienced at our refineries in 2005 and 2006, the cost of such coverage increased by approximately $12,000,000 per year. In addition, our deductible for property insurance was increased to $10,000,000. Our deductible for business interruption insurance also was increased to $10,000,000 and the waiting period was lengthened to a minimum of 90 days.
We also agreed with our insurance carriers that the maximum amount that we can recover for the fires that occurred at Yorktown and Ciniza in September and October of 2006 is an aggregate of $30,000,000 unless we agree to an additional increase in our recently revised insurance premiums.
If we experience any more insurable events, our annual premiums could increase further or insurance may not be available at all. Such increases or the unavailability of coverage could have a material and adverse effect on our business, financial condition and operating results.
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 rules pursuant to the Clean Air Act that require refiners to reduce the sulfur content of gasoline and highway diesel fuel, and to reduce the benzene content of gasoline. We are incurring substantial costs to comply with EPA's sulfur rules and may incur substantial costs to comply with the benzene rules. Some refiners began producing gasoline that satisfies low sulfur gasoline standards, known as Tier II standards, in 2004, with most refiners required to be in full compliance for all production in 2006. Most refiners also were required to begin producing highway diesel fuel that satisfies ultra low sulfur diesel standards by June 2006. All refiners and importers must be in full compliance with the new diesel standards by the end of 2010.
We currently anticipate that we will spend between approximately $195,000,000 to $220,000,000 to comply with EPA's low sulfur standards at our Yorktown refinery, excluding costs related to the damage to the refinery's ultra low sulfur diesel unit caused by the September 30, 2006 fire at the refinery. Through December 31, 2006, we have spent approximately $90,000,000 at Yorktown for equipment modifications to
comply with these low sulfur standards. There are a number of factors that could affect our cost of compliance with the low sulfur standards. In particular, engineering and construction companies are busy and are charging a premium for their services. Additionally, costs of materials, such as steel and concrete, have increased as a result of demand. These factors could continue to impact our compliance costs.
We currently anticipate that we will spend between approximately $50,000,000 to $60,000,000 to comply with EPA's low sulfur standards at our Four Corners refineries, with the exception of costs associated with the production of diesel fuel sold for certain non-highway purposes and any additional costs associated with the crude oil we will be obtaining when the 16" pipeline is operational. Through December 31, 2006, we have spent approximately $43,000,000 at our Four Corners refineries. There are a number of factors that could affect our cost of compliance with the low sulfur standards. In particular, the quality and quantity of the additional crude oil we will be obtaining from the 16-inch pipeline may impact these costs. As a result of this factor alone, the costs that we actually incur to comply with the low sulfur standards at our Four Corners refineries may be substantially different from our estimates. Furthermore, engineering and construction companies are busy and are charging a premium for their services. Additionally, costs of materials, such as steel and concrete, have increased as a result of demand. These factors could continue to impact our compliance costs.
ULTRA LOW SULFUR DIESEL PRODUCTION
The ultra low sulfur diesel units at our Yorktown and Ciniza refineries have been completed, and we believe insurance proceeds, less our $1,000,000 deductible, will cover the repairs necessary at our Yorktown refinery following the September 2006 fire in the Yorktown ultra low sulfur diesel unit. We are making ultra low sulfur diesel at our Bloomfield refinery, but may make additional modifications related to the production of this fuel in the future.
Diesel fuel sold for certain non-highway purposes must comply with the ultra low sulfur diesel standards beginning in June 2010. We have already made, are in the process of making, or will make the equipment modifications at our Yorktown and Ciniza refineries that should enable us to satisfy this requirement. Additional equipment modifications, however, will be necessary at our Bloomfield refinery. Our planning has not progressed to the point where an accurate estimate of these Bloomfield costs can be made.
In March 2003, EPA approved a compliance plan for our Yorktown refinery that provided us with temporary relief from the low sulfur gasoline standards at this refinery. The compliance plan allowed us to postpone certain capital expenditures for up to three years from the date when they otherwise would have been made. In return, under the original compliance plan, we were to produce 100% ultra low sulfur diesel for highway use by June 1, 2006, and to comply with the Tier II gasoline standards by January 1, 2008.
Our Yorktown refinery was not able to meet the June 1, 2006 date specified in the compliance plan for the production of 100% ultra low sulfur diesel for highway use as a result of: (1) the combined effects of Hurricanes Katrina and Rita on the availability of contractors and hardware as well as other similar effects; and (2) the time and effort required to repair damage resulting from the 2005 fire. Accordingly, we applied for temporary relief from the ultra low sulfur diesel standards, which EPA granted. EPA imposed a number of conditions on us in return for relieving us from the June 1, 2006 deadline. These conditions include a requirement that we must produce specified volumes of ultra low sulfur highway diesel at the refinery. Additionally, we have purchased diesel credits in connection with diesel fuel production that does not satisfy the ultra low sulfur diesel standards. We have spent approximately $1,000,000 on credits to date.
Although we began producing ultra low sulfur diesel fuel at our Yorktown refinery in early August, on September 30, 2006, a fire occurred in the Yorktown ultra low sulfur diesel processing unit. The affected unit was shut down. Following repair, the ultra low sulfur diesel processing unit resumed production in February 2007. This temporary closure of the ultra low sulfur diesel processing unit will affect our ability to satisfy the EPA condition that we produce specified volumes of ultra low sulfur diesel fuel which, among other things, could require that we purchase more diesel credits for use at Yorktown in the future. At this time we cannot estimate whether we will be required by EPA to purchase additional diesel credits or whether EPA will impose any new or modified conditions.
We may sell more high sulfur heating oil and less diesel fuel at Yorktown than otherwise would be the case as a result of the Yorktown compliance plan, including any additional conditions imposed on us by EPA as a result of our failing to meet the June 1, 2006 ultra low sulfur diesel requirements. At most times, high sulfur heating oil sells for a lower margin than ultra low sulfur diesel fuel. This could have an impact on our results of operation.
The Yorktown compliance plan requires us to provide EPA with reports 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.
LOW SULFUR GASOLINE PRODUCTION
We are in the process of making modifications to our refineries to comply with the standards required for the production of Tier II gasoline.
Under the compliance plan for our Yorktown refinery, we must comply with the Tier II gasoline standards by January 1, 2008. Although the project timetable is tight, we believe that we are on schedule to produce Tier II gasoline at Yorktown by that date. Our Ciniza and Bloomfield refineries are already subject to the Tier II gasoline standards and will need to use gasoline credits until refinery modifications are completed that would enable their gasoline production to satisfy the Tier II standards. These modifications are currently planned to be completed in 2007. If our planned refinery modifications do not reduce gasoline sulfur levels to the required standards, it is possible that some credits would have to be used even after such modifications are completed. Furthermore, we may decide not to incur the expense of producing only Tier II gasoline at these refineries, which would also require us to use credits in order to comply with the Tier II standards.
Both our Ciniza and Bloomfield refineries have generated gasoline credits in connection with 2005 and 2006 operations. While our credits generated in 2005 expired at the end of 2006, we may be able to use the 2006 credits to satisfy the Tier II gasoline standards until the planned refinery modifications at these refineries are completed. If these credits are insufficient, we would need to purchase gasoline credits from third parties. We may also need to purchase gasoline credits once our credits are used up for any gasoline that we produce after our refinery modifications are completed that does not satisfy the Tier II gasoline standards.
We anticipate that, beginning in 2008, we should be able to generate sufficient gasoline credits at our Yorktown refinery to cover any need to acquire credits for our Ciniza and Bloomfield refineries. There can be no assurance, however, that this will be the case as, among other things, we currently are uncertain of the amount of gasoline that will be produced at our Ciniza and Bloomfield refineries that will not satisfy the Tier II gasoline standards. This uncertainty is caused by, among other things, our lack of knowledge regarding how efficient our planned modifications to the refineries will be in reducing the sulfur content of gasoline and how the quality and quantity of any crude oil transported to these refineries through our new 16-inch pipeline will affect our ability to manufacture Tier II gasoline.
BENZENE REGULATIONS
EPA adopted regulations in the first quarter of 2007 requiring the benzene content of gasoline to be reduced beginning in 2011. We anticipate that we will need to make equipment modifications to our refineries to comply with these regulations and also may need to purchase benzene credits. We have not fully evaluated the impact of the regulations on our operations, but anticipate that our compliance costs could be substantial.
OUR OPERATIONS ARE INHERENTLY SUBJECT TO DISCHARGES OR OTHER RELEASES OF PETROLEUM OR HAZARDOUS SUBSTANCES FOR WHICH WE MAY FACE SIGNIFICANT LIABILITIES.
Our operations, as with others in the businesses in which we operate, are inherently subject to spills, discharges or other releases of petroleum or hazardous substances that may give rise to liability to governmental entities or private parties under federal, state or local environmental laws, as well as under common law. Spills, discharges or other releases of contaminants have occurred from time to time during the normal course of our operations, including releases associated with our refineries, pipeline and trucking operations, as well as releases at gasoline service stations and other petroleum product distribution facilities we have operated and are operating. We cannot assure you that additional spills, discharges and other releases will not occur in the future, that future action will not be taken in connection with past incidents (including at the Yorktown refinery), that governmental agencies will not assess penalties against us in connection with any past or future discharges or incidents, or that third parties will not assert claims against us for damages allegedly arising out of any such past or future discharges or incidents.
WE ARE INVOLVED IN A NUMBER OF MTBE LAWSUITS.
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, Pennsylvania, and New Mexico. Due to our historical operations in New Mexico, including retail sites, we potentially have greater risk in connection with the New Mexico litigation than in the litigation in the Eastern states where we have only operated since 2002 and have no retail operations. We intend to vigorously defend these lawsuits. If, however, we are found liable in any of these lawsuits, such determination could have a material and adverse effect on our business, financial condition and operating results.
OUR MERGER WITH WESTERN MAY NOT OCCUR OR COULD BE SET ASIDE.
On August 26, 2006, we entered into an Agreement and Plan of Merger (the "Plan of Merger") with Western and New Acquisition Corporation
("Merger Sub"). On November 12, 2006, we entered into an Amendment No. 1 to Agreement and Plan of Merger (the "Amendment") with Western and Merger Sub. The Plan of Merger and Amendment are collectively referred to as the "Agreement". If the transaction closes, Western will acquire all of our outstanding shares of common stock for $77.00 per share and we will be merged with Merger Sub and become a wholly-owned subsidiary of Western. The transaction has been approved by our Board of Directors and the Board of Directors of Western. The closing of the transaction is subject to various conditions, including compliance with the pre-merger notification requirements of the Hart-Scott-Rodino Act (the "HSR Act"), and approval by our stockholders. Our stockholders approved the transaction on February 27, 2007. The transaction is not subject to any financing conditions.
We and Western filed pre-merger notifications with the U.S. antitrust authorities pursuant to the HSR Act on September 7, 2006 and, in accordance with the original merger agreement, requested "early termination" of the required waiting period. We were not granted early termination, and on or about October 10, 2006, the Federal Trade Commission requested additional information concerning the merger from us and Western. On December 26 and December 28, 2006, respectively, Western and we certified to the Federal Trade Commission substantial compliance with the request for additional information. The Federal Trade Commission subsequently took the position that there was an omission in Western's original HSR Act filing and advised that it would take the position that the initial HSR Act 30-day waiting period had not yet commenced unless we and Western entered into an agreement to provide additional information pursuant to a letter request from the Federal Trade Commission staff. We and Western entered into such an agreement with the Federal Trade Commission on February 20, 2007 in which we agreed: (i) to respond to additional information requests; (ii) not to certify substantial compliance with the information requests until March 13, 2007; and (iii) not to close our merger with Western until 30 days after we and Western certify substantial compliance.
On November 22, 2006, Timothy Bisset filed a class action complaint in Arizona state court against us, our directors and Western in connection with our merger. Among other things, Mr. Bisset alleges that we and our directors breached our fiduciary duty in voting to amend the Plan of Merger on November 12, 2006 to provide for, among other things, a lower acquisition price of $77.00 per share. Mr. Bisset also alleges that Western aided and abetted this breach of fiduciary duty. Among other things, Mr. Bisset alleges that he and other public stockholders of our common stock are entitled to enjoin the proposed amended transaction or, alternatively, to recover damages in the event the transaction is completed.
We believe that amending our merger agreement was in the best interest of our stockholders. Since the original merger was announced on August 28, 2006, a number of unanticipated events occurred that resulted in a dispute between us and Western regarding the merger. Western asserted that fires at our refineries, changes in our insurance program, increases
in our anticipated capital expenditures, other regulatory issues and related costs of compliance, and other events and changes constituted a "material adverse effect" under the merger agreement and also violated various representations, warranties and covenants in the merger agreement, thereby giving Western the right to terminate the merger transaction in its entirety. After extensive consideration, we concluded that the interests of our stockholders were best served by avoiding litigation over this dispute by amending the merger agreement in a way that reduced the merger consideration but at the same time eliminated virtually all of Western's closing conditions and allowed us a 30-day "go-shop" period to see if we could obtain a better price for our stockholders. Accordingly, we think Mr. Bisset's lawsuit is without merit and intend to vigorously defend it.
We expect to complete our merger with Western during the second quarter of 2007. We cannot specify when, or assure you that, we and Western will satisfy or waive all conditions to the merger. Further, there can be no assurance that the Federal Trade Commission, state antitrust authorities, or Mr. Bisset, will not seek injunctive relief to prevent the merger from taking place.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
We are a party to ordinary routine litigation incidental to our business. We also incorporate by reference the discussion of legal proceedings contained in Items 1 and 2 under the headings "Regulatory and Environmental Matters" and "Rights-of-Way", the discussion contained in Item 1A, the discussions regarding "Low Sulfur Fuels and Settlement Agreements Expenditures" and "Environmental, Health and Safety" contained in Item 7, and the information in Note 17, "Commitments and Contingencies", to the Company's Consolidated Financial Statements in Item 8.
ITEM 4.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
We held a special meeting of stockholders on February 27, 2007. Proxies for the meeting were solicited under Regulation 14A. Our stockholders were asked to vote on a proposal to adopt the Agreement and Plan of Merger dated as of August 26, 2006, by and among Western Refining, Inc., New Acquisition Corporation and Giant Industries, Inc., as amended by Amendment No. 1 to Agreement and Plan of Merger dated as of November 12, 2006, and approve the merger.
The proposal was approved. The vote was as follows:
Shares Voted "For" Shares Voted "Against" Shares Voted "Abstaining" - ------------------ ---------------------- ------------------------- 10,636,636 199,101 140,216
PART II
ITEM 5.
ITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock is traded on the New York Stock Exchange. The high and low sales prices for our common stock for each full quarterly period as reported on the New York Stock Exchange Composite Tape for the last two fiscal years are as follows:
Quarter Ended High Low - ------------- ------- ------- December 31, 2006.............................. $ 81.45 $ 74.20 September 30, 2006............................. $ 82.30 $ 64.49 June 30, 2006.................................. $ 76.97 $ 56.09 March 31, 2006................................. $ 71.00 $ 52.44 December 31, 2005.............................. $ 60.50 $ 47.80 September 30, 2005............................. $ 59.74 $ 35.90 June 30, 2005.................................. $ 36.49 $ 25.52 March 31, 2005................................. $ 31.81 $ 23.54
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, as described below.
We have issued 8% Senior Subordinated Notes due 2014 (the "8% Notes") and 11% Senior Subordinated Notes due 2012 (the "11% Notes"). The 8% Notes were issued under an Indenture dated May 3, 2004 (the "8% Indenture") and the 11% Notes were issued under an Indenture dated May 14, 2002 (the "11% Indenture", and collectively with the 8% Indenture, the "Indentures"). Both Indentures are among the Company, its subsidiaries, as guarantors, and The Bank of New York, as trustee. The Indentures contain a number of covenants, one of which governs our ability to pay dividends and to purchase our common stock.
Also see the Capital Structure discussion in Management's Discussion and Analysis of Financial Condition and Results of Operations included in Item 7.
On February 27, 2007, there were 208 stockholders of record for our common stock.
At December 31, 2006, retained earnings available for dividends under the most restrictive terms of the Indentures were approximately $119,827,000.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table summarizes our recent financial information. This selected financial data should be read with Management's Discussion and Analysis of Financial Condition and Results of Operations in Item 7, and the Consolidated Financial Statements and related notes thereto, included in Item 8:
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.
RETAIL GROUP
FUEL MARGIN
Fuel margin is the difference between fuel sales less cost of fuel sales divided by number of gallons sold.
WHOLESALE GROUP(1)
FUEL MARGIN
Fuel margin is the difference between fuel sales less cost of fuel sales divided by number of gallons sold.
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.
ITEM 7.
ITEM 7. 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. Our refining group operates two refineries in the Four Corners area of New Mexico and one refinery in Yorktown, Virginia. Our refining group sells its products to numerous wholesale distributors and retail chains. Our retail group operated 155 service stations at December 31, 2006. This includes 12 service stations acquired in the Dial Oil Co. ("Dial") transaction on July 12, 2005, whose results of operations had previously been included in the wholesale group from the date of the acquisition, and 21 operating convenience stores acquired from Amigo Petroleum Company ("Amigo") in August 2006. Our retail group sells petroleum products and merchandise 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 the event our merger with Western does not close. Until the merger closes, however, we are subject to the terms of our agreement with Western discussed below. In our view, the most important of these objectives are:
- improving the operating reliability of our refineries;
- 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.
On August 26, 2006, we entered into an Agreement and Plan of Merger (the "Plan of Merger") with Western and New Acquisition Corporation ("Merger Sub"). On November 12, 2006, we entered into an Amendment No. 1 to Agreement and Plan of Merger (the "Amendment") with Western and Merger Sub. The Plan of Merger and Amendment are collectively referred to as the "Agreement". If the transaction closes, Western will acquire all of our outstanding shares of common stock for $77.00 per share and we will be merged with Merger Sub and become a wholly-owned subsidiary of Western. The transaction has been approved by our board of directors and the board of directors of Western. The closing of the transaction is subject to various conditions, including compliance with the pre-merger notification requirements of the Hart-Scott-Rodino Act (the "HSR Act"), and approval by our stockholders. Our stockholders approved the transaction on February 27, 2007. The transaction is not subject to any financing conditions.
Pursuant to the Agreement, we are required to conduct our business in the ordinary course, subject to certain covenants. Among other things, we agreed to take reasonable steps to preserve intact our business organization and goodwill, certain limitations on making capital expenditures, and certain limitations on acquiring new assets and disposing of existing assets. As a result, our pursuit of the above objectives is subject to compliance with the terms of the Agreement.
We and Western filed pre-merger notifications with the U.S. antitrust authorities pursuant to the HSR Act on September 7, 2006. We and Western subsequently entered into an agreement with the Federal Trade Commission on February 20, 2007 in which we agreed: (i) to respond to additional information requests; (ii) not to certify substantial compliance with the information requests until March 13, 2007; and (iii) not to close our merger with Western until 30 days after we and Western certify substantial compliance. Additionally, on November 22, 2006, Timothy Bisset filed a class action complaint against us, our directors and Western in connection with our merger. Among other things, Mr. Bisset alleges that he and other public stockholders of our common stock are entitled to enjoin the proposed amended transaction or, alternatively, to recover damages in the event the transaction is completed. For a further discussion of these matters, see the discussion in our Risk Factors section in Item 1A regarding the possibility that our merger may not occur or could be set aside.
We expect to complete our merger with Western during the second quarter of 2007. We cannot specify when, or assure you that, we and Western will satisfy or waive all conditions to the merger. Further, there can be no assurance that the Federal Trade Commission, state antitrust authorities, or Mr. Bisset, will not seek injunctive relief to prevent the merger from taking place.
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 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, "Organization and Significant Accounting Policies", to our Consolidated Financial Statements included in Item 8. 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 (see Note 17);
- assessing the possible impairment of long-lived assets (see Notes 4 and 5);
- accounting for asset retirement obligations (see Note 7);
- accounting for our pension and post-retirement benefit plans (see Note 13); and
- accounting for inventories (see Note 2).
CONTINGENCIES, INCLUDING ENVIRONMENTAL REMEDIATION AND LITIGATION LIABILITIES
We have recorded various environmental remediation liabilities described in more detail in Note 17, "Commitments and Contingencies", to our Consolidated Financial Statements in Item 8. For the most part, these liabilities result from:
- past operations, including liabilities arising out of changes in environmental laws; and
- liabilities assumed in connection with acquired assets.
We record liabilities if environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. We do not discount environmental liabilities to their present value. In general, we record environmental liabilities without consideration of potential recoveries from third parties, although we do take into account amounts that others are contractually obligated to pay us. We employ independent consultants or our internal environmental personnel to investigate and assemble pertinent facts, recommend an appropriate remediation plan in light of regulatory standards, assist in estimating remediation costs based on existing technologies, and complete remediation according to approved plans. If we do not use consultants, we estimate remediation costs based on the knowledge and experience of our employees having responsibility for the remediation project. Because of the uncertainty involved in our various remediation efforts and the period of time our efforts may take to complete, estimates are based on current regulatory standards. We update our estimates as needed to reflect changes in the facts known to us, available technology, or applicable laws. We often make subsequent adjustments to estimates, which may be significant, as more information becomes available to us, as the requirements of government agencies are changed or clarified, or as other circumstances change.
We record liabilities for litigation matters when it is probable that the outcome of litigation will be adverse and damages can be reasonably estimated. We estimate damages based on the facts and circumstances of each case, our knowledge and experience, and the knowledge and experience of others with whom we may consult.
IMPAIRMENT OF LONG-LIVED ASSETS
We review the carrying values of our long-lived assets, including goodwill and other intangibles, for possible impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be recoverable. For assets held for sale, we report long-lived assets at the lower of the carrying amount or fair value less cost to sell. For assets held and used, we use an undiscounted cash flow methodology to assess their recoverability. If the sum of the expected future cash flows for these assets is less than their carrying value, we record impairment losses. Goodwill and certain intangible assets with indefinite lives are also subject to an annual impairment test. Changes in current economic conditions, assumptions regarding the timing and amounts of cash flows, or fair market value estimates could result in additional write-downs of these assets in the future. For a discussion of our impairment of long-lived assets, see Notes 4, "Goodwill and Other Intangible Assets", and 5, "Assets Held for Sale, Discontinued Operations and Asset Disposals", to our Consolidated Financial Statements in Item 8.
ASSET RETIREMENT OBLIGATIONS
We have legal obligations associated with the retirement of some of our long-lived assets. These obligations are related to:
- some of our solid waste management facilities;
- some of our crude pipeline right-of-way agreements;
- some of our underground and above-ground storage tanks; and
- some of our refinery piping and heaters, that are wrapped in material containing asbestos.
We use a discounted cash flow model to calculate the fair value of the asset retirement obligations. Key assumptions we use in estimating the fair value of these obligations are:
- settlement date occurs at the end of the economic useful life; and
- settlement prices are estimated using consultant proposals and third-party contractor invoices for substantially equivalent work and a market risk premium to cover uncertainties and unforeseeable circumstances.
Changes in current economic conditions, assumptions regarding the timing and amounts of cash flows, or fair market value estimates could result in a change in the obligation in the future.
For a discussion of our asset retirement obligations, see Note 7, "Asset Retirement Obligations", to our Consolidated Financial Statements in Item 8.
PENSION AND POST-RETIREMENT PLANS
We have a defined benefit retirement plan ("Cash Balance Plan") and a post-retirement medical plan ("Retiree Medical Plan") for our Yorktown employees.
The plan obligations and related assets of our pension and post- retirement plans are presented in Note 13, "Pension and Post-retirement Benefits", to our Consolidated Financial Statements. Plan assets, which consist of equity and debt securities, are valued using market prices. Plan obligations and the annual pension and post-retirement medical expense are determined by independent actuaries and are based on a number of assumptions. The key assumptions used in measuring the plan obligations include:
- discount rate;
- long-term rate of return on plan assets; and
- healthcare cost trend rates.
Changes in our actuarial assumptions used in calculating our pension and other post-retirement benefit liability and expense can have a significant impact on our earnings and financial position. We review these assumptions on an annual basis and adjust them as necessary.
The following chart reflects the sensitivities that a change in certain actuarial assumptions for our Cash Balance Plan would have had on the 2006 projected benefit obligation, our 2006 reported pension liability on our Consolidated Balance Sheet, and our 2006 reported pension expense on our Consolidated Statement of Operations:
Increase/(Decrease) -------------------------------------- Impact on Projected Impact on Actuarial Assumption(a) Benefit Obligation Pension Expense - ----------------------- ------------------- --------------- Discount rate: Increase 1%.................. $(2,560,000) $(390,000) Decrease 1%.................. 2,710,000 290,000 Expected long-term rate of return on plan assets: Increase 1%.................. - (54,000) Decrease 1%.................. - 54,000 - ------- (a) Each fluctuation assumes that the other components of the calculation are held constant.
The following chart reflects the sensitivities that a change in certain actuarial assumptions for our Retiree Medical Plan would have had on the 2006 accumulated post-retirement benefit obligation on our Consolidated Balance Sheet and our 2006 reported post-retirement benefit expense on our Consolidated Statement of Operation:
Increase/(Decrease) ------------------------------------- Impact on Impact on Accumulated Other Post-retirement Post-retirement Benefit Obligation Benefit Expense ------------------ --------------- Actuarial Assumption(a) - ----------------------- Discount rate: Increase 1%..................... $ (810,000) $(120,000) Decrease 1%..................... 1,020,000 150,000 Health care cost trend rate(b): Increase 1%..................... 470,000 90,000 Decrease 1%..................... (420,000) (80,000) - ------- (a) Each fluctuation assumes that the other components of the calculation are held constant. (b) This assumes a 1% change in the initial and ultimate health care cost trend rate.
INVENTORIES
Our inventories are stated at the lower of cost or market. Costs for crude oil and refined products produced by the refineries are determined by the last-in, first-out ("LIFO") method. Under this method, the most recent acquisition costs are charged to cost of sales, and inventories are valued at the earliest acquisition costs. We selected this method because we believe it more accurately reflects the cost of our current sales. The use of this method results in reported earnings that can differ significantly from those that might be reported under a different inventory method such as the first-in, first-out ("FIFO") method. Under the FIFO method, the earliest acquisition costs are charged to cost of sales and inventories are valued at the latest acquisition costs. In addition, the use of the LIFO inventory method may result in increases or decreases to cost of sales in years that inventory volumes decline as the result of charging cost of sales with LIFO inventory costs generated in prior periods. In periods of rapidly declining prices, LIFO inventories may have to be written down to market value due to the higher costs assigned to LIFO volumes in prior periods. Market value is determined based on estimated selling prices less applicable refining, transportation and other selling costs, generally for the month subsequent to the end of the reporting period. This topic is further discussed in Note 2, "Inventories", to our Consolidated Financial Statements included in Item 8.
The Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board ("FASB"), under Issue No. 04-13, "Accounting for Purchases and Sales of Inventory with the Same Counterparty", reached a consensus in September 2005 that some or all of such buy/sell arrangements should be accounted for at historical cost pursuant to the guidance in paragraph 21(a) of Accounting Principles Board ("APB") Opinion No. 29, "Accounting for Nonmonetary Transactions". Our buy/sell arrangements with a counterparty are reported on a net basis and, accordingly, we believe we are in compliance with this EITF. The net proceeds for these type of transactions were approximately $9,000,000, $11,000,000 and $7,000,000 in 2006, 2005, and 2004, respectively.
In November 2004, 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 on January 1, 2006 did not have a material impact on our financial statements.
In December 2004, the FASB issued SFAS 153, "Exchanges of Nonmonetary Assets - An Amendment of APB Opinion 29". The basic principle in Opinion 29 provides that nonmonetary exchanges should be measured based on the
fair value of the assets exchanged. The guidance in that opinion, however, provides an exception to this principle if the exchange involves similar productive assets. This statement amends Opinion 29 to eliminate the exception for nonmonetary exchanges of similar productive assets and replaces it with a general exception for exchanges of nonmonetary assets that do not have commercial substance. A nonmonetary exchange has commercial substance if the future cash flows of the entity are expected to change significantly as a result of the exchange. The adoption of SFAS 153 on January 1, 2006 did not have a material impact on our financial statements.
RESULTS OF OPERATIONS
Our recent financial information is summarized in Selected Financial Data in Item 6. The following discussion of our Results of Operations should be read in conjunction with the Consolidated Financial Statements and related notes thereto included in Item 8, primarily Note 16.
Below is operating data for our operations:
(1) Refinery margin decreased from $8.72 per barrel in 2005 to $3.95 per barrel in 2006 as a result of the fires that occurred in November 2005 and September 2006.
(2) For the year ended December 31, 2006, includes statistics from 21 retail stores acquired from Amigo in August 2006 and 12 retail stores acquired from Dial in July 2005. For the year ended December 31, 2005, includes statistics from 12 retail stores acquired from Dial in July 2005. (3) For the year ended December 31, 2006, includes statistics from Dial and Amigo's wholesale operations that were acquired in July 2005 and August 2006, respectively. For the year ended December 31, 2005, includes statistics from Dial's wholesale operations that were acquired in July 2005.
The comparability of our continuing results of operations for the year ended December 31, 2006 with the year ended December 31, 2005 is affected by, among others, the following factors:
- weaker net refining margins for our Yorktown refinery in 2006, due primarily to the following:
- 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 late April 2006; and
- the need to sell feedstocks for the unit damaged in the fire at a lower margin as compared to sales of finished products while the refinery was operating at less than full capacity;
- the processing of relatively high cost feedstocks in a declining crude oil and finished products market, particularly late in the third quarter;
- the purchase of relatively higher priced crude oil during a portion of the year because a supplier had a disruption in its operations;
- relatively higher costs that began in the late spring and ended in November for a blending component;
- -	delays in putting the ultra low sulfur diesel ("ULSD") unit into operation;
- the Yorktown fire on September 30, 2006 that resulted in a shutdown of the processing unit required to produce ULSD;
- the Ciniza fire on October 5, 2006 that resulted in a temporary shutdown of the alkylation unit and an associated unit; and
- the Ciniza fire on December 26, 2006 that damaged the DHT unit and various instrumentation and cabling at the refinery.
These factors were partially offset by the following positive factors:
- stronger net refining margins for our Four Corners refineries for the year ended December 31, 2006, due to, among other things:
- increased sales in our higher margin markets; and
- favorable market conditions in certain of our market areas;
- a recorded pre-tax gain of $82,003,000 as a result of insurance proceeds received related to the fire at our Yorktown refinery in 2005.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2006 AND DECEMBER 31, 2005
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
Our earnings from continuing operations before income taxes decreased $38,932,000 for the year ended December 31, 2006. This decrease was primarily due to the following:
- a $124,164,000 decrease in operating income before corporate allocations recorded by our Yorktown refinery operations;
- a $3,688,000 decrease in operating income before corporate allocations at our Four Corners refinery operations due to lower sales volume as a result of the fires mentioned above and higher operating costs, partially offset by higher margins; and
- a $27,209,000 increase in operating expenses primarily due to higher employee, maintenance and insurance costs at our refineries, the addition of Amigo's operations in August 2006 and the inclusion of Dial's operations for the full year in 2006 versus a partial year in 2005.
These factors were partially offset by the following:
- higher operating income before corporate allocations of $3,420,000 from our retail segment as a result of certain acquisitions;
- a $78,315,000 increase in gain recorded as a result of the 2005 Yorktown fire;
- lower interest expense due to an increase in interest capitalized to our long-term constructions projects, and a refinancing of a portion of our long-term debt that occurred in the second quarter of 2005; and
- a $2,082,000 decrease in costs associated with early debt extinguishment that occurred in 2005.
YORKTOWN REFINERY
Our Yorktown refinery operated at an average throughput rate of approximately 59,500 barrels per day in 2006, compared to 61,000 barrels per day in 2005.
Revenues for our Yorktown refinery increased in 2006 primarily due to an increase in finished product prices.
Refining margins for 2006 were $3.95 per barrel as compared to $8.72 per barrel for the same period in 2005. This decrease in refining margins was primarily due to the following:
- 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 late April 2006; and
- the need to sell feedstocks for the unit damaged in the fire at a lower margin as compared to sales of finished products while the refinery was operating at less than full capacity;
- the processing of relatively high cost feedstocks in a declining crude oil and finished products market, particularly late in the third quarter;
- the purchase of relatively higher priced crude oil because a supplier had a disruption in its operations;
- relatively higher costs that began in the late spring and ended in November for a blending component;
- delays in initially putting the ULSD unit into operation; and
- the September 2006 fire in the ULSD unit.
Operating expenses for our Yorktown refinery increased in 2006 due to higher purchased fuel costs, insurance costs, maintenance and employee costs, partially offset by decreases in utilities and costs for chemicals and catalyst.
Depreciation and amortization expense increased in 2006 primarily due to depreciation of additional assets that were put into service in 2006.
FOUR CORNERS REFINERIES
Our Four Corners refineries operated at an average throughput rate of approximately 27,500 barrels per day in 2006 and 29,400 barrels per day in 2005.
Revenues increased in 2006 primarily due to an increase in finished product prices.
Refining margins in 2006 were $15.72 per barrel as compared to $14.03 per barrel for the same period in 2005. The increase in 2006 was primarily due to favorable market conditions.
Operating expenses increased in 2006 primarily due to increased employee costs, and higher rental costs, maintenance costs, chemical and catalyst costs, and insurance costs in connection with our operations.
RETAIL GROUP
Revenues for our retail group increased in 2006 primarily due to (i) an increase in finished product selling prices, (ii) an increase in fuel volumes sold, (iii) the addition of Amigo's 21 convenience stores, and (iv) the inclusion of Dial's 12 convenience stores for the full year in 2006 versus a partial year in 2005.
Average fuel margin was $0.19 per gallon in 2006 and $0.20 per gallon in 2005. Fuel volumes sold in 2006 increased by 15% as compared to the same period a year ago due to improved market conditions and the inclusion of Amigo's 21 convenience stores and Dial's 12 convenience stores.
Average merchandise margin remained constant at 27% in 2006 and 2005.
Operating expenses increased in 2006 as compared with the same period in 2005, primarily due to the addition of Amigo's 21 operating convenience stores in August 2006, the inclusion of Dial's 12 convenience stores for the full year in 2006 versus a partial year in 2005 as a result of the July 2005 acquisition, and higher bank charges as a result of higher fuel volumes and prices.
Depreciation and amortization expense decreased in 2006 as compared to the same period in 2005 due to a reduction in amortization for our leasehold improvements and due to certain assets being fully depreciated in 2006.
WHOLESALE GROUP
Gasoline and diesel fuel volumes sold by our wholesale group increased in 2006 as compared to the same period in 2005 primarily due to the addition of Dial's and Amigo's businesses to our operations and favorable market conditions. Average gasoline and diesel fuel margins were $0.06 per gallon and $0.07 per gallon in 2006 and 2005, respectively. The decrease in average fuel and diesel fuel margins was primarily due to higher costs of products.
Revenues for our wholesale group increased in 2006 primarily due to higher price per gallon sold, the addition of Dial's business and Amigo's assets to our operations, and favorable market conditions. Operating expenses for our wholesale group increased in 2006 primarily due to higher fuel costs, higher employee payroll and benefit costs, and the addition of Dial's and Amigo's businesses to our operations.
Depreciation and amortization expense for our wholesale group increased in 2006 primarily due to the addition of Dial's and Amigo's businesses to our operations.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A)
For the year ended December 31, 2006, SG&A expenses increased approximately $4,348,000 or 10% to $49,521,000 from $45,173,000 in the comparable 2005 period. The increase was primarily due to higher employee and outside services costs and the addition of Dial's operations to our business, partially offset by lower management incentive bonus accruals.
INTEREST EXPENSE
For the year ended December 31, 2006, interest expense decreased approximately $5,313,000 or 22% to $19,172,000 from $24,485,000 in the comparable 2005 period. This decrease was primarily due to a $4,891,000 increase in interest capitalized to our long-term construction projects.
NET LOSS ON THE DISPOSAL/WRITE-DOWN OF ASSETS
For the year ended December 31, 2006, we recorded a net loss of $723,000 on the disposal and write-down of assets. This loss was primarily due to a write-down of $877,000 of assets at Ciniza that was related to the December 2006 fire. We do not anticipate receiving any insurance proceeds related to this fire because the deductible threshold was not met. This loss was partially offset by net gains of $154,000 on sales of assets in the ordinary course of business. For the year ended December 31, 2005, we recorded a net loss of $1,009,000 on the disposal of assets. This loss was primarily due to a write-down of $1,284,000 relating to our secondary crude tower at Ciniza, partially offset by gains of $275,000 on sales of assets in the ordinary course of business.
INCOME TAXES FROM CONTINUING OPERATIONS
The effective tax rate for the year ended December 31, 2006 was approximately 38.3%. The effective tax rate for the year ended December 31, 2005 was approximately 39.9%. The decrease in effective tax rate was primarily due to tax credits for small business refiners that were recognized in 2006.
DISCONTINUED OPERATIONS
Discontinued operations include the operations of some of our retail service station/convenience stores. See Note 5, "Assets held for Sale, Discontinued Operations and Asset Disposals", to our Consolidated Financial Statements included in Item 8 for additional information relating to these operations.
OUTLOOK
We believe that our current refining margins are stronger than the same time last year, as demand for gasoline and diesel has been strong at Yorktown and in our Four Corners' market. In our retail operations, we are continuing to achieve growth in both fuel volumes and merchandise sales on a comparable store basis. While fuel margins started the year stronger than typically seen in the winter months, recent increases in fuel costs have eroded fuel margins to lower levels than we realized at the same time last year. Merchandise margins are, however, comparable to the prior year level. In our wholesale operations, we are continuing to experience growth in fuel volumes in our historical business as well as from the recent acquisition of Empire. Margins, so far, are slightly lower compared to the same time last year. Our businesses are very volatile and there can be no assurance that currently existing conditions will continue for any of our business segments.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2005 AND DECEMBER 31, 2004
EARNINGS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES
Our earnings from continuing operations before income taxes increased $146,055,000 for the year ended December 31, 2005. This increase was primarily due to the following:
- an increase in operating earnings before corporate allocations from our refinery operations of $111,634,000 primarily due to higher margins;
- a $8,422,000 decrease in interest expense due to our refinancing transactions in 2005;
- a decrease of $8,482,000 in costs associated with early debt extinguishment; and
- an increase in our retail and wholesale operations fuel volumes and margin as a result of improved market conditions.
This increase was partially offset by the following:
- a $29,793,000 increase in operating expenses primarily due to higher purchased fuel costs and increased repairs and maintenance expenditures at our refineries.
YORKTOWN REFINERY
Our Yorktown refinery operated at an average throughput rate of approximately 61,000 barrels per day in 2005, compared to 58,900 barrels per day in 2004.
Revenues for our Yorktown refinery increased in 2005 primarily due to higher finished product prices as a result of favorable market conditions and an increase in volumes sold.
Refining margins for 2005 were $8.72 per barrel as compared to $5.60 per barrel for the same period in 2004. This increase was primarily due to increased demand, lower imports of finished products into the East Coast, lower nationwide production due to the damage to refineries done by Hurricanes Katrina and Rita, and limited refining capacity in the United States.
Operating expenses increased in 2005 primarily due to the following:
- increased maintenance costs primarily related to tank inspections and repairs and coker unit repairs;
- increased operating costs due to higher volumes, higher electrical costs, and higher purchased costs of natural gas; and
- increased chemical and catalyst costs, primarily related to higher cost catalyst required to meet more stringent sulfur reduction requirements.
Depreciation and amortization expense increased in 2005 primarily due to the amortization of certain refinery turnaround costs and depreciation of additional capitalized costs incurred in 2004.
As discussed more fully under the heading Raw Material Supply in Items 1 and 2 of Part I, in February 2004, we entered into a long-term crude oil supply agreement with Statoil. We believe our ability to process this higher acid crude oil will reduce our crude oil costs, improve our high-value product output, and contribute significantly to higher earnings. We believe this agreement will improve our competitiveness and reduce the impact of pricing volatility on our refinery margins.
FOUR CORNERS REFINERIES
Our Four Corners refineries operated at an average throughput rate of approximately 29,400 barrels per day in 2005 and 28,300 barrels per day in 2004.
Revenues increased in 2005 primarily due to significantly higher finished product prices as a result of favorable market conditions and an increase in volumes sold.
Refining margins in 2005 were $14.03 per barrel as compared to $8.96 per barrel for the same period in 2004. The increase in 2005 was primarily due to increased demand, lower imports of finished products into the West Coast, lower nationwide production due to the damage to refineries done by Hurricanes Katrina and Rita, and limited refining capacity in the United States.
Operating expenses increased in 2005 primarily due to increased employee costs, higher purchased fuel costs, and increased repairs and maintenance expenditures.
Depreciation and amortization expense for our Four Corners refineries increased in 2005 primarily due to additional depreciable assets that were placed in service during the fourth quarter of 2004.
RETAIL GROUP
Revenues for our retail group increased in 2005 primarily due to an increase in finished product selling prices and an increase in fuel volumes sold.
Average fuel margin was $0.19 per gallon in 2005 as compared to $0.18 per gallon for the same period in 2004 primarily due to improved market conditions. Fuel volumes sold in 2005 increased by 4% as compared to the same period a year ago due to improved market conditions.
Average merchandise margin was 27% in 2005 as compared to 24% in 2004. The increase in merchandise margins was primarily due to, among other factors, lower rebates in 2004.
Operating expenses for our retail group increased in 2005 primarily due to an increase in higher employee costs, bank charges and additional rent expenses incurred in our operations.
Depreciation and amortization expense for our retail group increased in 2005 primarily due to additional amortization of our leasehold improvements.
WHOLESALE GROUP
Gasoline and diesel fuel volumes sold by our wholesale group increased due to the addition of Dial's operations in July 2005. Average gasoline and diesel fuel margins for wholesale group were $0.07 per gallon for 2005 and were $0.05 per gallon for 2004 due to favorable market conditions.
Revenues for our wholesale group increased in 2005 primarily due to an increase in finished product selling prices as a result of improved market conditions.
Our wholesale group finished product margins increased in 2005 as compared to 2004 primarily due to improved market conditions.
Operating expenses for our wholesale group increased in 2005 as compared to 2004 primarily as a result of higher transportation costs.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES (SG&A)
For the year ended December 31, 2005, SG&A expenses increased approximately $7,339,000 or 19% to $45,173,000 from $37,834,000 in the comparable 2004 period. The increase was primarily due to:
- higher management incentive bonuses associated with improved company financial performance; and
- additional expenses incurred in relation to our 401(k) plan.
These increases were partially offset by:
- a reduction in costs related to our self-insured health plan due to improved claims experience; and
- lower legal costs as a result of legal expense reimbursements from our insurance carriers.
INTEREST EXPENSE
For the year ended December 31, 2005, interest expense decreased approximately $8,422,000 or 26% to $24,485,000 from $32,907,000 in the comparable 2004 period as a result of our refinancing transactions in 2005. See Note 8 to our Consolidated Financial Statements included in Item 8 for a further description of these transactions.
NET LOSS ON THE DISPOSAL/WRITE-DOWN OF ASSETS
For the year ended December 31, 2005, we recorded a net loss of $1,009,000 on the disposal of assets. This loss was primarily due to a write-down of $1,284,000 relating to our secondary crude tower at Ciniza, partially offset by gains of $275,000 on sales of assets in the ordinary course of business. For the year ended December 31, 2004, we recorded a net loss of $161,000 on the disposal of assets. This included losses totaling $65,000 on the sale of vacant land and losses totaling $96,000 incurred as a result of sales and write-downs of other assets in the ordinary course of business.
INCOME TAXES FROM CONTINUING OPERATIONS
The effective tax rate for the year ended December 31, 2005 was approximately 39.9%. The effective tax rate for the year ended December 31, 2004 was approximately 39.5%.
DISCONTINUED OPERATIONS
Discontinued operations include the operations of some of our retail service station/convenience stores. See Note 5 to our Consolidated Financial Statements included in Item 8 for additional information relating to these operations.
LIQUIDITY AND CAPITAL RESOURCES
CAPITAL STRUCTURE
At December 31, 2006 we had long-term debt of $325,387,000. At December 31, 2005 our long-term debt was $274,864,000.
The amount at December 31, 2006 includes:
- $150,000,000 before discount, of 8% Senior Subordinated Notes due 2014;
- $130,001,000 before discount, of 11% Senior Subordinated Notes due 2012; and
- $50,000,000 on our revolving credit facility.
The amount at December 31, 2005 includes:
- $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 December 31, 2006, our long-term debt was 40.2% of total capital. At December 31, 2005, it was 40.7%. Our net debt (long-term debt, net of current portion less cash and cash equivalents) to total capitalization (long-term debt, net of current portion less cash and cash equivalents plus total stockholders' equity) percentage at December 31, 2006, was 38.8%. At December 31, 2005, this percentage was 21.7%. The increase is primarily due to lower cash and cash equivalent balances and higher long- term debt outstanding at December 31, 2006.
At December 31, 2006, we had a $175,000,000 revolving credit facility that we entered into on June 27, 2005. This facility matures in 2010 and the maximum amount that we may borrow is $175,000,000. In connection with this facility, we incurred financing costs that have been deferred and are being amortized over the term of the facility. For a further discussion of this matter, see Note 8 to our Consolidated Financial Statements included in Item 8.
The credit facility is primarily a working capital and letter of credit facility. At December 31, 2006, we had borrowings of $50,000,000 under the facility and $27,832,000 of letters of credit outstanding. At December 31, 2005, we had no direct borrowings outstanding under the previous facility and $66,771,000 of letters of credit outstanding.
As described in more detail in Note 8 to our Consolidated Financial Statements included in Item 8, 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 our lenders accelerate the payment of the credit facility, we cannot provide assurance that our assets would be sufficient
to pay that debt and other debt or that we would be able to refinance such debt or borrow more money on terms acceptable to us, if at all. Our ability to comply with the covenants, and other terms and conditions, of the indentures and the credit facility may be affected by many events beyond our control. For example, higher than anticipated capital expenditures or a prolonged period of low refining margins could have a negative impact on our ability to borrow funds and to make expenditures and could have an adverse impact on compliance with our covenants. We cannot provide assurance that our operating results will be sufficient to allow us to comply with the covenants.
Our level of debt and these covenants may, among other things:
- limit our ability to use cash flow, or obtain additional financing, for future working capital needs, capital expenditures, acquisitions or other general corporate purposes;
- restrict our ability to pay dividends or purchase shares of our common stock;
- require a substantial portion of our cash flow from operations to make interest payments;
- limit our flexibility to plan for, or react to, changes in business and industry conditions;
- place us at a competitive disadvantage compared to less leveraged competitors; and
- increase our vulnerability to the impact of adverse economic and industry conditions and, to the extent of our outstanding debt under our floating rate debt facilities, the impact of increases in interest rates.
If we are unable to:
- generate sufficient cash flow from operations;
- borrow sufficient funds to service our debt; or
- meet our working capital and capital expenditure requirements,
then, due to borrowing base restrictions, increased letter of credit requirements, or otherwise, we may be required to:
- sell assets;
- reduce capital expenditures;
- refinance all or a portion of our existing debt; or
- obtain additional financing.
We cannot provide assurance that we will be able to do any of these things on terms acceptable to us, or at all.
We presently have senior subordinated ratings of "B3" from Moody's Investor Services and "B-" from Standard & Poor's.
CASH FLOW FROM OPERATIONS
Our cash flow from operations depends primarily on producing and selling quantities of refined products at margins sufficient to cover fixed and variable expenses. In recent years, crude oil costs and prices of refined products have fluctuated substantially. These costs and prices depend on numerous factors, including:
- the supply of and demand for crude oil, gasoline and other refined products;
- changes in the U.S. economy;
- changes in the level of foreign and domestic production of crude oil and refined products;
- worldwide political conditions;
- the extent of government laws; and
- local factors, including market conditions, pipeline capacity, and the level of operations of other refineries in our markets.
Our crude oil requirements are supplied from sources that include major oil companies, large independent producers, and smaller local producers. Except for our long-term supply agreement with Statoil, our crude oil supply contracts are generally relatively short-term contracts. These contracts generally contain market-responsive pricing provisions. An increase in crude oil prices could adversely affect our operating margins if we are unable to pass along the increased cost of raw materials to our customers.
Our sale prices for refined products are influenced by the commodity price of crude oil. Generally, an increase or decrease in the price of crude oil results in a corresponding increase or decrease in the price of gasoline and other refined products. The timing of the relative movement of the prices, however, as well as the overall change in product prices, could reduce profit margins and could have a significant impact on our refining and marketing operations, earnings, and cash flows. In addition, we maintain inventories of crude oil, intermediate products, and refined products, the values of which are subject to rapid fluctuation in market prices. Price level changes during the period between purchasing feedstocks and selling the manufactured refined products could have a significant effect on our operating results. Any long-term adverse relationships between costs and prices could impact our ability to generate sufficient operating cash flows to meet our working capital needs.
Moreover, the industry is highly competitive. Many of our competitors are large, integrated oil companies which, because of their more diverse operations, larger refineries, stronger capitalization and better brand name recognition, may be better able than we are to withstand volatile industry conditions, including shortages or excesses of crude oil or refined products or intense price competition at the wholesale and retail levels. Because some of our competitors' refineries are larger and more efficient than our refineries, these refineries may have lower per barrel crude oil refinery processing costs. Further, in 2007, our operating costs will be increasing reflecting, among other things, increased insurance premiums, anticipated increases in refinery personnel, and potential increases in utility costs for our Four Corners refineries.
Our ability to borrow funds under our current revolving credit facility could be adversely impacted by low product prices that could reduce our borrowing base related to eligible accounts receivable and inventories. In addition, the structuring of the Statoil supply agreement results in a lower availability of funds under the borrowing base calculation of our credit facility. Because of the terms of the Statoil agreement, however, our borrowing needs have been reduced. Our debt instruments also contain restrictive covenants that limit our ability to borrow funds if certain thresholds are not maintained. See the discussion above in Capital Structure for further information relating to these loan covenants.
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 and our anticipated borrowing capacity, we believe that we will have sufficient working capital to meet our needs over the next 12-month period. As previously discussed, however, we expect to complete our merger with Western during the second quarter of 2007. We cannot specify when, or assure you that, we and Western will satisfy or waive all conditions to the merger. Further, there can be no assurance that a third party will not seek injunctive relief to prevent the merger from taking place.
WORKING CAPITAL
Working capital at December 31, 2006 consisted of current assets of $429,287,000 and current liabilities of $222,135,000, or a current ratio of 1.93:1. 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. 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, including available funds from our revolving line of credit, to meet our needs over the next 12-month period. As noted above, however, we expect to complete our merger with Western during the second quarter of 2007. We cannot specify when, or assure you that, we and Western will satisfy or waive all conditions to the merger. Further, there can be no assurance that a third party will not seek injunctive relief to prevent the merger from taking place.
CAPITAL EXPENDITURES AND RESOURCES
Cash used for capital expenditures totaled approximately $232,964,000 for the year ended December 31, 2006 and $70,659,000 for the year ended December 31, 2005. Expenditures for 2006 were primarily for building and revamping our refinery units to comply with the low sulfur fuel regulatory requirements, the Yorktown consent decree, rebuilding the various affected units due to the fires discussed above, and various projects in conjunction with the re-commissioning of the crude oil pipeline running from Jal, New Mexico to Bisti, New Mexico that we acquired in 2005. For a further discussion of these matters, see the related discussions in Risk Factors in Item 1A and in Note 17 to our Consolidated Financial Statements in Item 8. Expenditures for 2005 were primarily for building and revamping our refinery units to comply with the low sulfur fuel regulatory requirements and the Yorktown consent decree.
We received proceeds of approximately $4,069,000 from the sale of property, plant and equipment and other assets in 2006 and $4,526,000 in 2005. Proceeds received in 2006 primarily were from the sale of property in the ordinary course of business and the sale of four stores that were classified as asset held for sale. We also received $89,000,000 of insurance proceeds in 2006 due to the November 2005 fire incident at Yorktown and $3,688,000 of insurance proceeds in 2005 due to the March 2004 fire incident at Ciniza.
On August 1, 2005, we acquired an idle crude oil pipeline running from Jal, New Mexico to Bisti, New Mexico and related assets from Texas- New Mexico Pipe Line Company. This pipeline is connected to our existing pipeline network that directly supplies crude oil to the Bloomfield and Ciniza refineries. We have begun testing the pipeline and taking other actions related to placing it in service. Unless currently unanticipated obstacles are encountered, we anticipate the pipeline will become operational before the end of the second quarter of 2007. In order to operate the pipeline, we will have to obtain approximately 750,000 barrels of linefill.
On July 12, 2005, we acquired 100% of the common shares of Dial Oil Co. ("Dial"). We funded this acquisition with cash on hand. Dial is a
wholesale distributor of gasoline, diesel and lubricants in the Four Corners area of the Southwest. Dial also owns and operates 12 service stations/convenience stores. Dial's assets include bulk petroleum distribution plants, cardlock fueling locations, and a fleet of truck transports.
In May 2006, we acquired a lubricating business in El Paso, Texas. We funded this acquisition with cash on hand. The assets acquired primarily include lubricants inventory, fixed assets, and miscellaneous receivables. The acquisition was accounted for using the purchase method of accounting whereby the total purchase price has been preliminarily allocated to tangible and intangible assets acquired based on the fair market values on the date of acquisition.
In August 2006, we acquired certain assets from Amigo. We funded this acquisition with cash on hand. These acquired assets include 25 convenience stores, two bulk petroleum distribution plants, and a transportation fleet. The acquisition was accounted for using the purchase method of accounting whereby the total purchase price has been preliminarily allocated to tangible and intangible assets acquired based on the fair market values on the date of acquisition.
On January 2, 2007, we acquired 100% of the common shares of Empire Oil Co. ("Empire"). We funded this acquisition with cash on hand. Empire is a wholesale distributor of gasoline, diesel, and lubricants in Southern California. Empire's assets include a bulk petroleum distribution plant, cardlock fueling locations, and a fleet of truck transports.
We continue to monitor and evaluate our assets and may sell additional non-strategic or underperforming assets that we identify as circumstances allow and to the extent permitted under the Western agreement. We also continue to evaluate potential acquisitions in our strategic markets, including retail lease arrangements, as well as projects that enhance the efficiency and safety of our operations.
We have budgeted up to approximately $250,000,000 for capital expenditures in 2007 excluding any potential acquisitions. Of this amount, approximately $136,000,000 is for the completion of projects that were started in 2006. Approximately $110,000,000 of the $136,000,000 is budgeted for capital projects to produce motor fuel that will comply with low sulfur standard, approximately $7,000,000 is budgeted for capital projects due to the September 2006 Yorktown refinery fire incident and approximately $1,200,000 is budgeted for capital projects due to the October 2006 Ciniza fire incident. We believe a significant amount of the fire-related expenditures will be reimbursed by insurance. We also have budgeted $6,700,000 for capital projects related to the December 2006 Ciniza fire. We do not anticipate receiving any insurance proceeds from this fire. In addition, approximately $48,000,000 is budgeted for non- discretionary projects that are required by law or regulation or to maintain the physical integrity of existing assets. Another $54,000,000 is budgeted for discretionary projects to sustain or enhance the current level of operations, increase earnings associated with existing or new businesses, and to expand existing operations. Our budget also includes $6,000,000 for capital expenditure contingencies.
Much of the capital currently budgeted for environmental compliance is integrally related to operations or to operationally required projects. We do not specifically identify capital expenditures on the basis of whether they are for environmental as opposed to economic purposes. With respect to our operating expenses for environmental compliance, while records are not kept specifically identifying or allocating such expenditures, we believe that we incur significant operating expense for such purposes. For further discussion of projects that we will be undertaking in order to comply with environmental requirements and associated capital expenditures, including our plans to comply with the previously discussed low sulfur standards, see the related discussions under the caption Regulatory and Environmental Matters included in Items 1 and 2, in Risk Factors in Item 1A, below under the caption Low Sulfur Fuels and Settlement Agreements Expenditures, and in Note 17 to our Consolidated Financial Statements in Item 8.
We continue to investigate other capital improvements to our existing facilities. The amount of capital projects that are actually undertaken in 2007, and in future years, will depend on, among other things, general business conditions and results of operations, and the limits imposed by the Western Agreement.
Changes in the tax laws and changes in federal and state environmental laws also may increase future capital and operating expenditure levels.
We intend to fund the projects described above through our operating cash flows, cash on hand, and if necessary, our revolving credit facility. If these sources are insufficient, we may need to secure additional financing, access the public debt and equity markets, or sell assets. We cannot assure you that these sources will be available.
LONG-TERM COMMITMENTS
Included in the table below is a list of our obligations to make future payments under contracts and other agreements, as well as certain other contingent commitments.
The amounts set out in the table, including payment dates, are our best estimates at this time, but may vary as circumstances change or we become aware of additional facts. The table does not include anticipated capital expenditures related to environmental compliance or anticipated environmental expenditures that are expensed when incurred. For a discussion of matters related to our identification of environmental expenditures, refer to the section of this Item 7 captioned "Capital Expenditures and Resources".
Raw material and finished product purchases were determined by multiplying contract volumes by the price determined under the contract as of December 31, 2006. The contracts underlying these calculations all have variable pricing arrangements.
The above table does not include amounts for outstanding purchase orders at December 31, 2006, amounts under contracts that are cancelable by either party upon giving notice, and amounts under agreements that are based on a percentage of sales, such as credit card processing fees.
We cannot precisely determine our future pension expenditures beyond 2007. We are obligated to make payments to the pension retirement plan each year. Not included in the table are certain retiree medical and asset retirement obligations for which annual funding is not required. Our asset retirement obligations are discussed in more detail in Note 7 to our Consolidated Financial Statements in Item 8 and our pension plan and retiree medical plan obligations are described in more detail in Note 13.
Included in the table below is a list of our commitments under our revolving credit facility.
The availability of letters of credit under our credit facility is $100,000,000. Our inability to post satisfactory letters of credit could constrain our ability to purchase feedstocks on the most beneficial terms.
LOW SULFUR FUELS AND SETTLEMENT AGREEMENTS EXPENDITURES
The following table shows amounts we anticipate spending to meet, among other things, certain low sulfur fuel regulations and to comply with environmental settlements, consent decrees, and other agreements with government authorities that require certain actions to be taken at our Yorktown and Four Corners refineries. The table does not include amounts for which environmental accruals have been established, which are instead included in the long-term commitments table above. For a further discussion of these environmental accruals, see Note 17, "Commitment and Contingencies", to our Consolidated Financial Statements in Item 8. These amounts are our best estimates at this time, but may vary as circumstances change or we become aware of additional facts.
The amounts shown in the above table are the high end of our estimated costs for these projects. We anticipate that the costs could be between the following ranges:
- Yorktown - Low Sulfur Fuels - $195,000,000 to $220,000,000 of which approximately $90,000,000 was spent through 2006;
- Four Corners - Low Sulfur Fuels - $50,000,000 to $60,000,000 of which approximately $43,000,000 was spent through 2006;
- Yorktown Consent Decree - $24,000,000 to $25,000,000 of which approximately $24,000,000 was spent through 2006;
- Four Corners Settlement Agreements - $10,000,000 to $18,000,000, of which approximately $600,000 was spent through 2006; and
- Bloomfield EPA Compliance Order - $3,200,000 to $3,500,000, of which approximately $100,000 was spent through 2006.
During 2006, our estimate of the costs associated with the low sulfur fuels projects increased primarily as a result of the following:
- increased costs for contractors and manufactured products as a result of increased demand arising from, among other things, the fact that the low sulfur fuels regulations apply to the entire industry, and the need to repair damage in the Gulf Coast caused by Hurricanes Katrina and Rita;
- the scope of the projects at each of the refineries increasing, including the decision to use a higher capacity gasoline treating unit with a higher sulfur removal capability at our Yorktown refinery; and
- an increase in the cost of steel and concrete.
For a more detailed description of these matters, including further information regarding our estimates and associated risks and the anticipated timing of the expenditures, please see the related discussions under the caption Regulatory, Environmental and Other Matters included in Items 1 and 2, in Risk Factors in Item 1A, and in Note 17, "Commitment and Contingencies", to our Consolidated Financial Statements in Item 8.
CASH REQUIREMENTS
We believe we will have sufficient resources to meet our working capital requirements, including that necessary for capital expenditures and debt service, over the next 12-month period because of:
- the current operating environment for all of our operations;
- current cash balances; and
- availability of funds under our revolving credit facility.
As noted above, however, we expect to complete our merger with Western during the second quarter of 2007. We cannot specify when, or assure you that, we and Western will satisfy or waive all conditions to the merger. Further, there can be no assurance that a third party will not seek injunctive relief to prevent the merger from taking place.
DIVIDENDS
We currently do not pay dividends on our common stock. Our 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 our board of directors, existing debt covenants, and the terms of the Western Agreement. The Western Agreement prohibits us from paying dividends without the consent of Western.
RISK MANAGEMENT
We are exposed to various market risks, including changes in certain commodity prices and interest rates. To manage the volatility relating to 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. We also are prohibited from using derivative financial instruments by the terms of the Western Agreement.
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 December 31, 2006, there were $50,000,000 in 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.
In November 2006, we renewed our property insurance coverage and our business interruption insurance coverage. Primarily due to the fires experienced at our refineries in 2005 and 2006, the cost of such coverage increased by approximately $12,000,000. In addition, our deductible for property insurance was increased to $10,000,000. Our deductible for business interruption insurance also was increased to $10,000,000 and the waiting period was lengthened to a minimum of 90 days. We also agreed with our insurance carriers that the maximum amount that we can recover for the fires that occurred at Yorktown and Ciniza in September and October of 2006 is an aggregate of $30,000,000 unless we agree to an additional increase in our recently revised insurance premiums.
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 relating to the environment, health and safety 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, distributed, sold, handled, used, released or disposed of by us or by our predecessors.
Applicable laws and regulations govern the investigation and remediation of contamination at our current and former properties, as well as at third-party sites to which we sent wastes for disposal. We may be held liable for contamination existing at current or former properties, notwithstanding that a prior operator of the site, or other third party, caused the contamination. We also may 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 currently are 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 substances, the number of other potentially responsible parties involved, various defenses that may be available to us, and changing environmental, health and safety laws and 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. For a further discussion of environmental, health and safety matters affecting our operations, see the discussion of these matters contained in Items 1 and 2 under the heading Regulatory and Environmental Matters, in Risk Factors in Item 1A, and in Note 17, "Commitment and Contingencies", to our Consolidated Financial Statements.
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 cleanup 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 17, "Commitment and Contingencies", to our Consolidated Financial Statements.
In May 2006, we entered into a consent order with the Environmental Protection Agency and paid a civil penalty of $75,000 to settle an Administrative Compliance Order related to our Bloomfield refinery. For a further discussion of this settlement, see Note 17, "Commitments and Contingencies", to our Consolidated Financial Statements.
In June 2006, we received a draft administrative compliance order from the New Mexico Environment Department related to soil and groundwater contamination at our Bloomfield refinery. For a further discussion of this draft order, see Note 17, "Commitments and Contingencies", to our Consolidated Financial Statements.
In August 2006, we entered into a final administrative consent order with EPA, pursuant to which we will implement the agreed-upon corrective action measures to address certain contaminants at our Yorktown refinery. For a further discussion of this matter, see Note 17, "Commitments and Contingencies", to our Consolidated Financial Statements.
As of December 31, 2006 and 2005, we had environmental liability accruals of approximately $3,991,000 and $4,941,000, respectively, and litigation accruals in the aggregate of approximately $185,000 and $990,000, respectively. The environmental liability accruals summarized in the table below are recorded in the current and long-term sections of our Consolidated Balance Sheets. Environmental accruals are recorded in the current and long-term sections of our Consolidated Balance Sheets. See Note 17, "Commitments and Contingencies", to our Consolidated Financial Statements in Item 8 for: (i) a more detailed discussion of the more significant of these projects, as well as of other significant environmental commitments and contingencies; and (ii) how we record environmental liabilities.
OTHER
In October 2004, the President of the United States 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 ultra low sulfur regulations adopted by the Environmental Protection Agency. The deduction is taken in the year the capital expenditure is made. We were able to use this deduction in 2006 and expect to be able to use it in future years. Small refiners also are allowed to claim a credit against income tax of five cents on each gallon of ultra low sulfur diesel fuel they produce, up to a maximum of 25% of the capital costs incurred to comply with the regulations. We were able to use this credit in 2006 and expect to be able to use it in future years.
In August 2005, the President signed the Energy Policy Act of 2005 (the "Energy Act"). Under the Energy Act, refiners are allowed to deduct for tax purposes 50% of the cost of capital expenditures that increase the capacity of an existing refinery by at least 5%. The deduction is taken in the year the capital expenditure is made. We may be able to take this deduction in future years if we have refinery projects that increase capacity. The Energy Act also requires that most refiners, blenders, and importers use more ethanol in their fuels, with an industry-wide target of 4 billion gallons in 2006 that increases to 7.5 billion gallons in 2012. Each refinery that has less than 75,000 barrels per day of crude oil capacity, however, is exempted from participation in this requirement until 2011. All of our refineries qualify for the exemption.
In August 2006, the President signed the Pension Protection Act of 2006 (the "Pension Act"). We currently believe the Pension Act will have minimal impact on our benefit programs.
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.
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 risk that the Western transaction will not close on schedule or at all, including the risk that the Federal Trade Commission or state antitrust authorities will enjoin our merger transaction or take other action that will prevent the merger from occurring and the risk that we will be precluded from merging as a result of the class action lawsuit that has been filed against us;
- 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;
- the risk that amounts that we must pay to third parties in connection with the operation of our facilities may substantially increase, including potential pipeline tariff increases and potential electricity rate increases;
- 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;
- continuing shortages of qualified personnel and contractors, including engineers and truck drivers;
- 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 (such as proposed legislation designed to increase the use of biodiesel and proposed legislation and proposed regulations designed to increase the amount of ethanol added to gasoline), the impact of any legislation designed to reduce greenhouse gases, the impact of any
windfall profit, price gouging, or other legislation that may be adopted in reaction to the price of motor fuel at the retail level, the impact of any legislation that may restrict our ability to sell alcoholic beverages at our convenience stores, and the impact of any minimum wage legislation that may be adopted;
- unplanned or extended shutdowns in refinery operations;
- the risk that our discontinuance of the use of MTBE in 2006 will continue to require us to purchase more expensive blending components for our Yorktown refinery;
- 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, including liability for which we do not have insurance coverage;
- the occurrence of events that cause losses for which we are not fully insured;
- the risk that we will not be able to obtain insurance coverage in future years at affordable premiums, or under reasonable terms, or at all;
- the risk that costs associated with environmental projects and other ongoing 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 current plans for the production of low sulfur fuels at our refineries (including the possible use of catalyst) may not work as anticipated, requiring us to spend more money to produce these fuels than currently anticipated;
- the risk that we will not continue to qualify to produce and use diesel and gasoline credits under EPA's low sulfur programs;
- the risk that we will need to purchase more diesel credits for our Yorktown refinery than currently anticipated;
- the risk that the cost of diesel credits needed for our Yorktown refinery will be greater than anticipated;
- the risk that we will not produce sufficient quantities of ultra low sulfur diesel to comply with our Yorktown compliance plan, or to comply with requirements applicable to our other refineries;
- the risk that we will need to sell more high sulfur heating oil at a lower margin as a result of EPA's ultra low sulfur diesel program;
- the risk that we will need to purchase more gasoline credits for our Ciniza and Bloomfield refineries than currently anticipated;
- the risk that, beginning in 2008, we will not be able to generate sufficient gasoline credits at our Yorktown refinery to cover any need to acquire credits for our Ciniza and Bloomfield refineries;
- 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 or that we will determine that we have not properly calculated our tax liability;
- the risk that changes in manufacturer promotional programs may adversely impact our retail operations;
- the risk that we will not be able to renew pipeline rights-of-way or leases, including service station and tank leases, required in connection with our operations on affordable terms or at all;
- the risk that the cost of placing into service the crude oil pipeline that we purchased from Texas-New Mexico Pipe Line Company during the third quarter of 2005 (the "Pipeline") will be considerably more than our current estimates;
- the risk that the timetable for placing the Pipeline in service 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 Pipeline or transport through the Pipeline for processing at our Bloomfield and Ciniza refineries;
- the risk that the quality of crude oil purchased for transportation through the pipeline to our Four Corners refineries will be different than anticipated and will adversely affect our refinery operations;
- the risk that we will not receive anticipated amounts of insurance proceeds related to the 2006 fires;
- the risk that we will be required or choose to undertake additional projects to enhance the safety of our operations;
- the risk of increased costs due to the February 2007 EPA rule reducing the benzene content in gasoline beginning in 2011, either for substantial equipment modifications at all our refineries or for a combination of equipment modifications and credit purchases, including the risk that the cost of benzene credits will be greater than anticipated or that credits will not be available in sufficient quantities;
- the risk that we will not be able to qualify for the use of a corporate guaranty to demonstrate our financial ability to complete remediation actions at our refineries and as a result will be required by regulatory agencies to use other, more expensive means of providing such financial assurance, including placing substantial sums of money into escrow accounts;
- the risk that the Pension Protection Act of 2006 will have a significant impact on us; 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.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Commodity Price Risk
We are exposed to market risks related to the volatility of certain commodity prices. To manage the volatility relating to 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. We also are prohibited from using derivative financial instruments by the terms of the Western Agreement.
Interest Rate Risk
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 December 31, 2006, there were $50,000,000 in direct borrowings outstanding under this facility. If this balance of $50,000,000 is outstanding for the entire year, an increase of 1.0% in the interest rate related to this credit facility would result in an increase in our interest expense of $500,000.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Giant Industries, Inc. Scottsdale, Arizona
We have audited the accompanying consolidated balance sheets of Giant Industries, Inc. and subsidiaries (the "Company") as of December 31, 2006 and 2005, and the related consolidated statements of operations, comprehensive income, stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2006. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Giant Industries, Inc. and subsidiaries as of December 31, 2006 and 2005 and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.
As discussed in Note 7 to the financial statements, in 2005 the Company changed its method of accounting for conditional asset retirement obligations to comply with Financial Accounting Standards Board ("FASB") Interpretation 47, Accounting for Conditional Asset Retirement Obligations, and as discussed in Note 13 to the financial statements in 2006 the Company changed its method of accounting for pension and post- retirement obligations to comply with Statement of Financial Accounting Standards No. 158, Employer's Accounting for Defined Benefit Plans and Other Post-retirement Benefits, an Amendment of FASB Statements No. 87, 88, 106, and 132(R).
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company's internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission and our report dated March 1, 2007 expressed an unqualified opinion on management's assessment of the effectiveness of the Company's internal control over financial reporting and an unqualified opinion on the effectiveness of the Company's internal control over financial reporting.
/s/ Deloitte & Touche LLP
Phoenix, Arizona March 1, 2007
Significant Noncash Investing and Financing Activities by year.
In March 2006, we contributed 25,115 newly issued shares of our common stock, valued at $1,465,000, to our 401(k) plan as a supplemental contribution for the year 2005. We also capitalized approximately $8,152,000 of interest as part of construction in progress. At December 31, 2006, approximately $15,293,000 of purchases of property, plant and equipment had not been paid and, accordingly, were recorded in accounts payable and accrued liabilities. In accordance with the provisions of SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Post- retirement Plans", we reduced our long-term pension liability for our cash balance plan by $894,000 ($552,000 net-of-tax) as a result of a net actuarial gain with a corresponding credit to other comprehensive income. We also recorded an increase in our long-term pension liability by $117,000 ($72,000 net-of-tax) with a corresponding charge to other comprehensive income as a result of recognizing prior service costs related to our cash balance plan. We increased our long-term retiree medical plan liability by $1,308,000 ($649,000 net-of-tax) as a result of net actuarial losses with a corresponding charge to other comprehensive income.
In the first quarter of 2005, we transferred $118,000 of property, plant and equipment to other assets. In the second quarter of 2005, we contributed 34,196 newly issued shares of our common stock, valued at $971,000, to our 401(k) plan as a discretionary contribution for the year
2004. In connection with our acquisition activity, we assumed approximately $18,377,000 of liabilities. In the fourth quarter of 2005, we granted 41,000 shares of restricted stock to our employees. These awards are recorded as unearned compensation in stockholders' equity. See Note 10 for further information. At December 31, 2005, approximately $10,636,000 of purchases of property, plant and equipment had not been paid and, accordingly, were accrued in accounts payable and accrued liabilities. In accordance with Financial Interpretation 47, "Accounting for Conditional Asset Retirement Obligations", we recorded an ARO liability of $147,000, and assets of $64,000 and related accumulated depreciation of $30,000. We also recorded a cumulative adjustment of $68,000, net of tax. During 2005, we also capitalized approximately $3,261,000 of interest as part of construction in progress.
In the first quarter of 2004, we contributed 49,046 newly issued shares of our common stock, valued at $900,000, to our 401(k) plan as a discretionary contribution for the year 2003. During 2004, we reclassed approximately $2,774,000 from assets held for sale to inventory and property, plant and equipment. We also capitalized approximately $161,000 of interest as part of construction in progress in 2004. In the second quarter of 2004, we issued $150,000,000 of 8% Senior Subordinated Notes at a discount of $2,435,000.
The accompanying notes are an integral part of these consolidated financial statements.
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES:
ORGANIZATION
Giant Industries, Inc., through our subsidiary Giant Industries Arizona, Inc. and its subsidiaries, refines and sells petroleum products. We do this:
- 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 units:
- our refining group;
- our retail group; and
- our wholesale group.
See Note 16 for a further discussion of business segments and Notes 5 and 19 for recent dispositions and acquisitions.
On August 26, 2006, we entered into an Agreement and Plan of Merger (the "Plan of Merger") with Western Refining, Inc. ("Western") and New Acquisition Corporation ("Merger Sub"). On November 12, 2006, we entered into an Amendment No. 1 to Agreement and Plan of Merger (the "Amendment") with Western and Merger Sub. The Plan of Merger and Amendment are collectively referred to as the "Agreement". If the transaction closes, Western will acquire all of our outstanding shares of common stock for $77.00 per share, and we will be merged with Merger Sub and became a wholly-owned subsidiary of Western. The closing of the transaction is subject to various conditions, including compliance with the pre-merger notification requirements of the Hart-Scott-Rodino Act, and approval by our stockholders. Our stockholders approved the transaction on February 27, 2007. PRINCIPLES OF CONSOLIDATION
Our consolidated financial statements include the accounts of Giant Industries, Inc. and all of its subsidiaries. All intercompany accounts and transactions have been eliminated.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The preparation of our consolidated financial statements, in conformity with accounting principles generally accepted in the United States of America, requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
NET REVENUES
Our business units recognize revenues when realized and earned with all of the following criteria being met:
- persuasive evidence of an arrangement exists;
- delivery has occurred or services have been rendered;
- the seller's price to the buyer is fixed or determinable; and
- collectibility is reasonably assured.
Excise and other similar taxes are excluded from net revenues.
The Emerging Issues Task Force (EITF) of the Financial Accounting Standards Board ('FASB"), under Issue No. 04-13, Accounting for Purchases and Sales of Inventory with the Same Counterparty, reached a consensus in September 2005 that some or all of such buy/sell arrangements should be accounted for at historical cost pursuant to the guidance in paragraph 21(a) of Accounting Principles Board ("APB") Opinion No. 29, "Accounting for Nonmonetary Transactions". Our buy/sell arrangements with a counterparty are reported on a net basis and, accordingly, we believe we are in compliance with this EITF. The net proceeds for these type of transactions were approximately $9,000,000, $11,000,000 and $7,000,000 in 2006, 2005, and 2004, respectively.
STATEMENTS OF CASH FLOWS
We consider all highly liquid instruments with an original maturity of three months or less to be cash equivalents.
DERIVATIVES
Our policies for the use of derivative financial instruments set limits on quantities, require various levels of approval, and require review and reporting procedures.
We are exposed to various market risks, including changes in certain commodity prices and interest rates. To manage the volatility relating to
these normal business exposures, from time to time, we use commodity futures and options contracts to reduce price volatility, to fix margins in our refining and marketing operations, and to protect against price declines associated with our crude oil and finished products inventories. For purposes of the Statement of Cash Flows, such transactions are considered to be operating activities.
Gains and losses on all transactions that do not qualify for hedge accounting are reflected in earnings in the period that they occur.
We had no open commodity futures or options contracts at December 31, 2006 and December 31, 2005.
We have entered into purchase and supply arrangements which qualify as normal purchases and sales and are exempt from fair value recognition in the financial statements.
CONCENTRATION OF CREDIT RISK
Our 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. We maintain our cash and cash equivalents with federally insured banking institutions or other financial service providers. From time to time, balances maintained in these institutions may exceed amounts that are federally insured. All of the financial institutions we use are major banking institutions and reputable financial service providers.
TRADE RECEIVABLES
Our trade receivables result primarily from the sale of refined products, various grades of gasoline and diesel fuel, lubricants, and merchandise from our three refineries and our wholesale group. These sales are made to independent wholesalers and retailers, industrial/commercial accounts and major oil companies. In addition, our service station/convenience stores sell refined products, merchandise, and food products, some of which are purchased by the customer by use of a credit card.
We extend credit to our refining and wholesales group customers based on criteria established by our management, including ongoing credit evaluations. We usually extend credit on an unsecured basis, but we may require collateral, such as letters of credit, in some circumstances. An allowance for doubtful accounts is provided based on a number of factors that include, but are not limited to, the current evaluation of each customer's credit risk; the delinquent status of a customer's account; collection efforts made; current economic conditions; past experience and other available information. Uncollectible trade receivables are charged against the allowance for doubtful accounts when we have exhausted all
reasonable efforts to collect the amounts due, including litigation if the amounts and circumstances warrant such action. The allowance for doubtful accounts is reflected in our Consolidated Balance Sheets as a reduction of trade receivables.
Our trade receivables are pledged as collateral for borrowings under our revolving credit facility. At December 31, 2006, we had $50,000,000 of direct borrowings outstanding under the facility in place at that time.
Our major categories of trade receivables are as follows:
December 31, ---------------------- 2006 2005 -------- -------- (In thousands)
Trade................................... $171,669 $125,229 Credit cards............................ 5,672 4,054 -------- -------- $177,341 $129,283 ======== ======== INVENTORIES
Our inventories are stated at the lower of cost or market. Costs for crude oil and refined products produced by our refineries are determined by the last-in, first-out ("LIFO") method. Costs for our retail, wholesale, exchange and terminal refined products inventories and shop supplies are determined by the first-in, first-out ("FIFO") method. Costs for merchandise inventories at our retail locations are determined by the retail inventory method. See Note 2 for additional information.
PROPERTY, PLANT AND EQUIPMENT
Our property, plant and equipment are stated at cost and are depreciated on the straight-line method over the following estimated useful lives.
Buildings and improvements............................... 7-30 years Machinery and equipment.................................. 3-24 years Pipelines................................................ 30 years Furniture and fixtures................................... 2-15 years Vehicles................................................. 3-7 years
Our leasehold improvements are depreciated on the straight-line method over the shorter of the contractual lease terms or the estimated useful lives.
Routine maintenance, repairs and replacement costs are charged against earnings as incurred. Turnaround costs, which consist of complete shutdown and inspection of significant units of the refineries at
intervals of two or more years for necessary repairs and replacements, are deferred and amortized over the period until the next expected shutdown, which generally ranges from 24 to 60 months depending on the type of shutdown and the unit involved. For turnaround purposes, we divide the operating units at our Yorktown refinery into three major groups. Each of these major groups has a major turnaround approximately every five years. For our Four Corners refineries, major turnarounds are generally scheduled approximately every five years, but may be more frequent for some units. Unscheduled maintenance shutdowns also may occur at the refineries from time to time. Expenditures that materially increase values, expand capacities, or extend useful lives are capitalized. Interest expense is capitalized as part of the cost of constructing major facilities and equipment.
GOODWILL
SFAS No. 142, "Goodwill and Other Intangible Assets" requires, among other things, that goodwill not be amortized, but be tested for impairment annually, or as events and circumstances indicate. See Note 4 for applicable disclosures.
Goodwill, which results from business acquisitions, represents the excess of the purchase price over the fair value of the net assets acquired and is carried at cost less accumulated amortization and write- offs.
LONG-LIVED ASSETS
In accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", we review the carrying values of our long- lived assets for possible impairment whenever events or changes in circumstances indicate that the carrying amount of assets to be held and used may not be recoverable. For assets to be disposed of, we report long- lived assets and certain identifiable intangibles at the lower of carrying amount or fair value less cost to sell. See Note 5 for information relating to the impairment of certain assets.
ASSET RETIREMENT OBLIGATIONS
SFAS No. 143, "Accounting for Asset Retirement Obligations" ("SFAS No. 143") 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 costs ("ARC") are capitalized as part of the carrying amount of the long-lived asset. In March 2005, the FASB issued Interpretation 47, "Accounting for Conditional Asset Retirement Obligations" (FIN 47). This interpretation clarifies the term conditional asset retirement obligation as used in SFAS No. 143. Conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of
the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Clarity is also provided regarding when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. In conjunction with FIN 47, we reviewed our operations in the fourth quarter of 2005 and for the year ended December 31, 2005, we recorded an ARO liability of $147,000, ARC assets of $64,000 and related accumulated depreciation of $30,000. We also recorded a cumulative adjustment of $114,000 ($68,000 net of tax). See Note 7 for additional disclosures.
TREASURY STOCK
We have 3,751,980 shares of our common stock classified as treasury stock. These shares were acquired under a stock repurchase program and an issuer tender offer at a weighted average cost of approximately $9.72 per share. These shares are available for a number of corporate purposes including, among others, for options, bonuses, and other employee stock benefit plans.
ENVIRONMENTAL EXPENDITURES
Environmental expenditures that relate to current operations are expensed or capitalized depending on the circumstances. Expenditures that relate to an existing condition caused by past operations, and which do not result in an asset with an economic life greater than one year, are expensed. Liabilities are recorded when environmental assessments and/or remedial efforts are probable and the costs can be reasonably estimated. Environmental liabilities are not discounted to their present value and are recorded without consideration of potential recoveries from third parties, although 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. See Note 17 for disclosures relating to environmental expenditures.
INCOME TAXES
The provision for income taxes is based on earnings reported in the financial statements. Deferred income taxes are provided to reflect temporary differences between the basis of assets and liabilities for financial reporting purposes and income tax purposes, as well as the effects of tax credits. We file consolidated federal and state income tax returns for the states in which we operate, except in states that are not unitary. See Note 14 for disclosures relating to income taxes.
EARNINGS PER COMMON SHARE
Earnings per share are calculated in accordance with SFAS No. 128, "Earnings Per Share." Basic earnings per common share are computed by dividing consolidated net earnings by the weighted average number of
shares of common stock outstanding during each period. Earnings per common share assuming dilution are computed by dividing consolidated net earnings by the sum of the weighted average number of shares of common stock outstanding plus additional shares representing the exercise of outstanding common stock options and restricted stock awards issued using the treasury stock method, unless such calculation is antidilutive. See Note 15 for disclosures relating to earnings per share.
OTHER COMPREHENSIVE INCOME
Our components of other comprehensive income for the year ended December 31, 2006 include, on a net of tax basis, the net actuarial gain and unamortized prior service cost related to our cash balance plan and net actuarial loss related to our retiree medical plan. These components were recorded in accordance with the provisions of SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Post-retirement Plans - an amendment of FASB Statements No. 87, 88, 106, and 132(R)". We do not have any component of other comprehensive income for the years ended December 31, 2005 and December 31, 2004. See Note 13, "Pension and Post- Retirement Benefits", for further discussions on this topic.
GUARANTEES
We have analyzed the guarantee provided in certain of our lease arrangements under the provisions of FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("Interpretation No. 45"). As of December 31, 2006 the liability of the guarantee obligation undertaken under these arrangements was not material.
STOCK-BASED EMPLOYEE COMPENSATION
We have a stock-based employee compensation plan that is more fully described in Note 10. We account for this plan under the recognition and measurement principles of SFAS 123R, "Share-Based Payments", which we adopted on January 1, 2006. SFAS 123R requires us to measure the cost of employee services received in exchange for stock options granted using the fair value method as of the beginning of 2006. There was no material impact on our financial statements as all our stock options outstanding had vested prior to the date of adoption.
The following table illustrates the effect on net earnings and net earnings per share as if we had applied the fair value recognition provisions of SFAS No. 123, "Accounting for Stock-Based Compensation", to stock-based employee compensation for all periods presented.
On December 6, 2005, 41,000 shares of restricted stock were granted to 39 employees. These awards vest ratably over five years. In accordance with APB 25, "Accounting for Stock Issued to Employees", we recorded these awards as deferred compensation to stockholders' equity and we will amortize the deferred compensation balance over five years using the straight-line method. See Note 10 for further information.
NEW ACCOUNTING PRONOUNCEMENTS
In November 2004, 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 on January 1, 2006 did not have a material impact on our financial statements.
In March 2006, the Emerging Issues Task Force ("EITF") reached a 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". If a reporting entity reports revenue on a gross basis, then the amount of taxes included must be disclosed. This EITF Issue applies 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 necessary in our financial statements.
In June 2006, FASB issued FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes - an interpretation of SFAS 109" ("FIN 48"), which provides criteria for the recognition, measurement, presentation and disclosure of uncertain tax positions. A tax benefit from an uncertain position may be recognized only if it is "more likely than not" that the position is sustainable based on its technical merits. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We are currently assessing the impact of FIN 48 on our financial statements.
In September 2006, FASB issued FASB Staff Position ("FSP") No. AUG AIR-1, "Accounting for Planned Major Maintenance Activities", that disallowed the accrue-in-advance method for planned major maintenance activities. Our scheduled turnaround activities are considered planned major maintenance activities. Since we do not use the accrue-in-advance method of accounting for our turnaround activities, this FSP has no impact on our financial statements.
In September 2006, FASB issued SFAS 157, "Fair Value Measurements", which defines fair value, establishes a frame work for measuring fair value in GAAP, and expands disclosures about fair value measurements. This statement is effective for financial statements issued for fiscal years beginning after November 15, 2007. This statement is applied in conjunction with other accounting pronouncements that require or permit fair value measurements and, accordingly, this statement does not require any new fair value measurements. Therefore, the adoption of this SFAS 157 is not expected to have a material impact on our financial statements.
In September 2006, FASB issued SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Post-retirement Plans", which requires an employer to recognize the overfunded or underfunded position of a defined benefit post-retirement plan (other than a multiemployer plan) as an asset or a liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through other comprehensive income. With limited exceptions, this statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. We adopted this statement in 2006. Under the provisions of SFAS 158, we reduced our long-term pension liability for our cash balance plan by $894,000 ($552,000 net-of-tax) as a result of a net actuarial gain with a corresponding credit to other comprehensive income. We also recorded an increase in our long-term pension liability by $117,000 ($72,000 net-of- tax) with a corresponding charge to other comprehensive income as a result
of recognizing prior service costs related to our cash balance plan. We increased our long-term retiree medical plan liability by $1,307,000 ($807,000 net-of-tax) as a result of net actuarial losses with a corresponding charge to other comprehensive income.
NOTE 2 - INVENTORIES:
Our inventories consist of the following:
The portion of inventories valued on a LIFO basis totaled $117,933,000 and $76,299,000 at December 31, 2006 and 2005, respectively. The data in the following paragraph will facilitate comparison with the operating results of companies using the FIFO method of inventory valuation.
If inventories had been determined using the FIFO method at December 31, 2006, 2005 and 2004, net earnings and diluted earnings per share would have been (lower)/higher as follows:
Year Ended December 31, ------------------------------------------ 2006 2005 2004 ------------ ------------ ------------ Net earnings.................. $(3,193,000) $21,393,000 $17,619,000 Diluted earnings per share.... $ (0.22) $ 1.57 $ 1.55
We liquidated certain lower cost refinery LIFO inventory layers in 2006, 2005 and 2004, which resulted in an increase in our net earnings and related diluted earnings per share as follows:
Year Ended December 31, ------------------------------------------ 2006 2005 2004 ------------ ------------ ------------ Net earnings.................. $ 2,686,000 $ 2,468,000 $ 9,505,000 Diluted earnings per share.... $ 0.18 $ 0.18 $ 0.84
NOTE 3 - PROPERTY, PLANT AND EQUIPMENT:
Our property, plant and equipment, at cost, consist of the following:
NOTE 4 - GOODWILL AND OTHER INTANGIBLE ASSETS:
SFAS No. 142, "Goodwill and Other Intangible Assets," addresses financial accounting and reporting for intangible assets acquired individually or with a group of other assets (but not those acquired in a business combination) at acquisition. This statement also addresses financial accounting and reporting for goodwill and other intangible assets subsequent to their acquisition. SFAS No. 142, among other things, specifies that goodwill and certain intangible assets with indefinite lives should no longer be amortized, but instead be subject to periodic impairment testing.
We elected to conduct our annual goodwill impairment test as of the first day of each fourth fiscal quarter (October 1). For 2006, we identified six reporting units for the purpose of the annual impairment test. The reporting units consisted of two units from our refining
segment, two units from our retail segment and two units from our wholesale segment. The fair value of each reporting unit was determined using a discounted cash flow model based on assumptions applicable to each reporting unit. The fair value of the reporting units exceeded their respective carrying amounts, including goodwill. As a result, the goodwill of each reporting unit was considered not impaired.
In addition to the annual goodwill impairment test, if events and circumstances indicate that goodwill of a reporting unit might be impaired, then goodwill also will be tested for impairment when the impairment indicator arises.
The changes in the carrying amount of goodwill for the years ended December 31, 2006 and December 31, 2005 are as follows:
Certain of our retail units classified as held for sale or held and used are tested for impairment when circumstances change. No impairments were recorded in 2006 and 2005 as a result of these tests.
Liquor licenses, which are our only indefinite life intangible assets, were evaluated for impairment as required by SFAS No. 142. We believe that there are no legal, regulatory, contractual, competitive, economic or other factors limiting the useful life of our liquor licenses. If events and circumstances indicate that our liquor licenses might not be recoverable, then an impairment loss would be recognized if the carrying amount of the liquor licenses exceeds their fair value.
Intangible assets with finite lives will continue to be amortized over their respective useful lives and will be tested for impairment in accordance with SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets."
A summary of intangible assets that are included in "Other Assets" in the Consolidated Balance Sheets at December 31, 2006 and 2005 are presented below:
Intangible asset amortization expense for the years ended December 31, 2006, December 31, 2005 and December 31, 2004 were $409,000, $405,000, and $451,000, respectively. Estimated amortization expense for the next five years is as follows:
(In thousands) 2007................................................... $260,000 2008................................................... $218,000 2009................................................... $216,000 2010................................................... $ 91,000 2011................................................... $ 42,000
NOTE 5 - ASSETS HELD FOR SALE, DISCONTINUED OPERATIONS, AND ASSET DISPOSALS:
The following table contains information regarding our discontinued operations, all of which are included in our retail group and include some service station/convenience stores.
We disposed of several of our retail units in 2005 and 2004 and recorded a gain on disposal of $22,000 and $525,000, respectively. There were no impairment losses and write-downs in 2006. For 2004, we also recorded impairment losses and write-downs that were classified as discontinued operations of $497,000 on our retail units that were classified as discontinued operations. In 2004, certain retail properties and a vacant land-industrial site were reclassified to inventory and property, plant and equipment because we were unable to dispose of these properties within twelve months. We did not have assets held for sale at December 31, 2006 or December 31, 2005.
We received proceeds of $149,000 and $9,977,000 in 2005 and 2004, respectively, from the sale of our assets held for sale and retail units that were classified as discontinued operations. We also received proceeds of $3,166,000 from the sale of various properties and $1,799,000 from the sale of land that was classified as assets held for sale in 2006 and 2005, respectively.
NOTE 6 - ACCRUED EXPENSES:
Our accrued expenses are comprised of the following:
December 31, ---------------------- 2006 2005 --------- --------- Excise taxes................................. $ 26,058 $ 23,330 Payroll and related costs.................... 12,569 11,231 Bonus, profit sharing and retirement plan contributions......................... 12,303 14,608 Interest..................................... 3,513 3,321 Other taxes.................................. 4,152 5,901 Other........................................ 8,995 10,407 --------- --------- Total........................................ $ 67,590 $ 68,798 ========= =========
NOTE 7 - 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 ARO be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated 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 $373,000 as of December 31, 2006 and are included in "Other Assets" on our Consolidated Balance Sheets. These assets are set aside to fund costs associated with the closure of certain solid waste management facilities.
In March 2005, the FASB issued Interpretation 47, "Accounting for Conditional Asset Retirement Obligations" (FIN 47). This interpretation clarifies the term conditional asset retirement obligation as used in SFAS No. 143. Conditional asset retirement obligation refers to a legal obligation to perform an asset retirement activity in which the timing and/or method of settlement are conditional on a future event that may or may not be within the control of the entity. Accordingly, an entity is required to recognize a liability for the fair value of a conditional asset retirement obligation if the fair value of the liability can be reasonably estimated. Clarity is also provided regarding when an entity would have sufficient information to reasonably estimate the fair value of an asset retirement obligation. FIN 47 is to be applied no later than the end of fiscal years ending after December 15, 2005. In conjunction with FIN 47, we reviewed our operations in the fourth quarter of 2005 and for the year ended December 31, 2005, we recorded an ARO liability of $147,000, ARC assets of $64,000 and related accumulated depreciation of $30,000. We also recorded a cumulative adjustment of $114,000 ($68,000 net of tax).
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:
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 years ended December 31, 2006 and 2005.
December 31, ---------------------- 2006 2005 --------- --------- (In thousands) Liability beginning of year.................... $ 2,625 $ 2,272 Liabilities incurred........................... 200 322 Liabilities settled............................ (133) (150) Accretion expense.............................. 28 181 --------- --------- Liability end of period........................ $ 2,720 $ 2,625 ========= =========
Our ARO's are recorded in "Other liabilities" on our Consolidated Balance Sheets.
NOTE 8 - LONG-TERM DEBT:
Our long-term debt consists of the following: December 31, ---------------------- 2006 2005 --------- --------- (In thousands) 11% senior subordinated notes, due 2012, net of unamortized discount of $2,554 and $2,882, interest payable semi-annually................................ $ 127,447 $ 127,119 8% senior subordinated notes, due 2014, net of unamortized discount of $2,060 and $2,255, interest payable semi-annually................................ 147,940 147,745 Senior secured revolving credit facility, due 2010, floating interest rate, principal and interest payable monthly................. 50,000 - --------- --------- Total.......................................... $ 325,387 $ 274,864 ========= =========
In March 2005, we issued 1,000,000 shares of our common stock and received approximately $22,349,000, net of expenses. On May 5, 2005, we used $21,888,000 of these proceeds to redeem approximately $18,828,000 of our outstanding 11% senior subordinated notes. The amount paid to redeem the notes included interest of $978,000 to the date of redemption and redemption costs of $2,082,000. In conjunction with this transaction, we also wrote off $563,000 of deferred financing costs and $446,000 of unamortized original issue discount.
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.
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. As discussed in Note 1, "Organization and Significant Accounting Policies", we have entered into a merger Agreement with Western. We believe that the closing of the transaction contemplated by the Agreement will constitute a change in control under the indentures. In addition, pursuant to the agreement, Western has the right to require us to tender for the notes.
Western has, however, informed us that they do not intend to request that we commence a cash tender offer for these notes, but that they intend to call the 8% senior subordinated notes for redemption pursuant to their terms, including the payment of the make-whole premium, promptly after the effective time of the merger, and that they intend to call the 11% senior subordinated notes for redemption pursuant to their terms, including the payment of a scheduled prepayment premium, promptly after May 15, 2007.
At December 31, 2006, retained earnings available for dividends under the most restrictive terms of the indentures were approximately $119,827,000.
On June 27, 2005, we amended and restated our revolving credit facility (the "Credit Facility"). The Credit Facility is a $175,000,000 revolving credit facility and is for, among other things, working capital, acquisitions, and other general corporate purposes.
Under the Credit Facility, our existing borrowing costs are reduced, certain of the covenants have been eased, and the term was extended to 2010. The availability of funds under this facility is the lesser of (i) $175,000,000, or (ii) the amount determined under a borrowing base calculation tied to eligible accounts receivables and inventory. We also have options to increase the size of the facility to up to $250,000,000. At December 31, 2006, there were $50,000,000 in direct borrowings outstanding under the Credit Facility and there were approximately $27,832,000 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. At December 31, 2006, the availability of funds under the Credit Facility was $97,168,000, subject to borrowing base limitations.
The interest rate applicable to the Credit Facility is based on various short-term indices. At December 31, 2006, this rate was approximately 6.95% per annum. We are required to pay a quarterly commitment fee of 0.25% per annum of the unused amount of the facility.
The obligations under the Credit Facility are guaranteed by each of our principal subsidiaries and secured by a security interest in our personal property, including:
- accounts receivable;
- inventory;
- contracts;
- chattel paper;
- trademarks;
- copyrights;
- patents;
- license rights;
- deposits; and
- investment accounts and general intangibles.
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. We do not anticipate that any of the terms of the Credit Facility will prevent us from completing the transaction with Western described in Note 1, "Organization and Significant Accounting Policies".
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.
NOTE 9 - FINANCIAL INSTRUMENTS AND HEDGING ACTIVITY:
The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of SFAS No. 107, "Disclosures about Fair Value of Financial Instruments". Using available market information and the valuation methodologies described below, we determined the estimated fair value amounts. Considerable judgment is required, however, in interpreting market data to develop the estimates of fair value. Accordingly, the estimates presented herein may not be indicative of the amounts that we could realize in a current market exchange. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.
The carrying amounts and estimated fair values of our financial instruments are as follows:
We determined the fair value of fixed rate long-term debt by using quoted market prices, where applicable, or by discounting future cash flows using rates estimated to be currently available for debt of similar terms and remaining maturities.
We believe the carrying values of our cash and cash equivalents, receivables, accounts payable and accrued expenses approximate fair values due to the short-term maturities of these instruments. We believe the carrying value of our variable rate short-term debt instrument approximates fair value because the rate is tied to a short-term index.
HEDGING ACTIVITIES
We are exposed to various market risks, including changes in commodity prices and interest rates. To manage the volatility relating to these normal business exposures, from time to time, we use commodity futures and options contracts to reduce price volatility, to fix margins in our refining and marketing operations, and to protect against price declines associated with our crude oil and finished products inventories.
At December 31, 2006 and 2005, we had no open crude oil futures contracts or other commodity derivatives.
NOTE 10 - STOCK INCENTIVE PLANS:
Under our 1998 Stock Incentive Plan (the "1998 Plan"), shares of our common stock are authorized to be issued to deserving employees in connection with awards of options, appreciation rights, restricted shares, performance shares or performance units, all as defined in the 1998 Plan. Appreciation rights, performance shares and performance units may be settled in cash, our common shares or any combination thereof.
The total number of shares available for grant under the 1998 Plan is 2% of the total number of common shares outstanding as of the first day of each calendar year, which amount was 292,786 shares for 2007, 292,282 shares for 2006, 246,673 shares for 2005, and 175,711 shares for 2004. Grants also are subject to a 400,000 share annual limitation on the number of common shares available for the grant of options that are intended to qualify as "incentive stock options" under Section 422 of the Internal Revenue Code. Common shares available for grant in any particular calendar year that are not, in fact, granted in such year cannot be added to the common shares available for grant in any subsequent calendar year.
On December 6, 2005, 41,000 shares of restricted stock were granted to 39 employees. These awards vest ratably over a five-year period. The fair value on the date of grant was approximately $2,214,000. In accordance with APB 25, "Accounting for Stock Issued to Employees", we recorded unearned compensation in stockholders' equity on the balance sheet. This balance was computed using an assumed forfeiture rate of one employee per year, and is amortized using the straight-line method over the vesting period. In 2006 and 2005, the amounts amortized to expense were $408,000 and $30,000, respectively. In addition, in 2006, 2,900 shares of restricted stock were forfeited due to termination while 7,620 shares vested in 2006. The fair value of these vested shares on the vesting date was approximately $585,000. The fair value of the remaining 30,480 non-vested shares of restricted stock at December 31, 2006 was approximately $2,284,000.
On May 9, 2003, 140,500 incentive stock options were granted to 15 employees under the 1998 Plan. The exercise price for all of the options was $5.24, which was the closing price of our common stock on the New York Stock Exchange on the date of grant. One-half of each grant vested on May 9, 2004 and the remaining one-half vested on May 9, 2005. All of the options expire on May 8, 2013.
The 1998 Plan provides that all grants are subject to restrictions, conditions and terms more specifically described in the 1998 Plan, including, but not limited to, the exercise price for stock options and appreciation rights and time vesting requirements for all awards. In general, the 1998 Plan provides that grants of stock options and appreciation rights must expire no more than 10 years from the date of grant. In addition, all grants under the 1998 Plan are subject to forfeiture under certain circumstances, and all unvested awards may vest immediately under various circumstances defined in the 1998 Plan.
Under our 1989 Stock Incentive Plan (the "1989 Plan"), 500,000 shares of our common stock were authorized to be issued to deserving employees in the form of options and/or restricted stock. At December 31, 2006, no shares were available for future grants under the 1989 Plan because, by its terms, no new awards may be made after December 11, 1999. All of the remaining options or restricted stock granted under the 1989 Plan expired in 2003.
The following summarizes stock option transactions under the 1989 and 1998 Plans:
Weighted Average Options Outstanding At Shares Exercise Price - ---------------------- -------- ---------------- January 1, 2004........................ 524,000 $ 7.83 Exercised............................ (215,750) $ 6.72 Forfeited............................ (2,500) $ 2.85 -------- December 31, 2004...................... 305,750 $ 8.65 Exercised............................ (205,250) $ 9.40 -------- December 31, 2005...................... 100,500 $ 7.12 Exercised............................ (3,000) $ 2.85 -------- 97,500 ======== Options exercisable at December 31: 2006................................. 97,500 $ 7.26 2005................................. 100,500 $ 7.12 2004................................. 235,500 $ 9.67
The following summarizes information about stock options outstanding under the 1998 Plan at December 31, 2006:
In December 2004, the FASB issued SFAS No. 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 for reporting periods that begin after December 31, 2005. We adopted SFAS 123R on January 1, 2006. We were not required to record any compensation expense, however, because all outstanding stock options had vested prior to the adoption of SFAS 123R. The intrinsic value of stock options outstanding at December 31, 2006 was $6,600,000. The intrinsic value of stock options exercised in 2006 was approximately $166,000.
No options were granted in 2006, 2005 and 2004.
NOTE 11 - INTEREST, OPERATING LEASES AND RENT EXPENSE:
We paid interest of $26,325,000, $27,278,000, and $35,285,000 in 2006, 2005, and 2004, respectively. In accordance with SFAS 34 "Capitalization of Interest Cost", we capitalized approximately $8,152,000 and $3,261,000 of interest as part of construction in progress in 2006 and 2005, respectively.
In connection with the sale of approximately 8.5 acres of land in North Scottsdale, Arizona that included our corporate headquarters building, we entered into a ten-year agreement to lease back our corporate headquarters building in 2003.
We are committed to annual minimum rentals under noncancelable operating leases that have initial or remaining lease terms in excess of one year as of December 31, 2006 as follows:
Land, Building, Machinery and Equipment Leases ----------------- (In thousands) 2007................................................. $ 10,553 2008................................................. 9,079 2009................................................. 7,161 2010................................................. 5,698 2011................................................. 4,858 2012 - 2027.......................................... 28,106 -------- Total minimum payments required...................... $ 65,455 ========
Our total rent expense was $12,649,000, $10,655,000, and $7,813,000 for 2006, 2005, and 2004, respectively.
Our operating leases are for buildings, warehouses, cardlocks and facilities, and can contain one of the following options: (a) we can, after the initial lease term, purchase the property at the then fair value of the property or (b) we can, at the end of the initial lease term, renew
its lease at the then fair rental value for periods of 5 to 15 years. These options enable the Company to retain use of facilities in desirable operating areas. Certain of our leases contain escalation clauses that are accounted for on a straight-line basis.
NOTE 12 - 401(K) AND DEFERRED COMPENSATION PLANS:
The Company sponsors the Giant Industries, Inc. and Affiliated Companies 401(k) Plan (the "Giant 401(k)") for the benefit of our employees. In connection with the acquisition of the Yorktown refinery, on May 14, 2002, we adopted the Giant Yorktown 401(k) Retirement Savings Plan ("Yorktown 401(k)") for our Yorktown employees who met plan eligibility requirements. For purposes of eligibility and vesting, anyone who was employed by the Yorktown refinery on or before December 31, 2002, received credit for time worked for the refinery's previous owners and certain other prior employers. In March 2004, the assets in the Yorktown 401(k) were transferred into the Giant 401(k) and the plans were combined into the Giant 401(k) for administrative convenience and to reduce costs. The benefits available to Yorktown and non-Yorktown employees did not materially change as a result of this combination.
Subject to approval from our board of directors each year, we match the Yorktown employee's contributions to the Giant 401(k), subject to certain limitations and a per participant maximum contribution amount. For the years ended December 31, 2006, 2005 and 2004, we expensed $1,215,000, $1,128,000 and $1,031,000, respectively, for matching contributions to the Yorktown participants.
Subject to approval from our board of directors each year and beginning in 2005, we also match the non-Yorktown employee's contributions to the Giant 401(k), subject to certain limitations and a per participant maximum contribution amount. For the years ended December 31, 2006, 2005, and 2004, we expensed $2,913,000, $2,848,000, and $1,675,000, respectively, for matching contributions to the non-Yorktown participants.
Our matching contribution can be invested in available investment choices at the discretion of the participant.
Supplemental contributions to the Giant 401(k) on behalf of non- Yorktown employees are made at the discretion of our board of directors. For the year ended December 31, 2005, our board of directors changed the supplemental contribution from a discretionary contribution in an amount to be determined each year to a fixed contribution equal to 3% of eligible wages. Yorktown employees currently do not receive this supplemental contribution. The amounts accrued for the 2006 and 2005 supplemental contributions were $1,615,000 and $1,622,000, respectively. The 2005 supplemental contribution was funded with 25,115 newly issued shares of our common stock in March 2006. The 2006 supplemental contribution also may be funded with newly issued shares of our common stock in 2007.
For the year ended December 31, 2004, we accrued $900,000 for a discretionary contribution to the Giant 401(k), which was funded in 2005 with 34,196 newly issued shares of our common stock. All shares are allocated to eligible employees' accounts in the manner set forth in the Giant 401(k).
At December 31, 2006, the assets of the Giant 401(k) include 445,892 shares of our common stock valued at approximately $33,420,000 on December 31, 2006.
In July 2005, we acquired Dial and Dial employees immediately became eligible to participate in the Giant 401(k). Dial employees were permitted to carry over their prior years of service with Dial for eligibility and vesting purposes. The 401(k) plan sponsored by Dial was terminated prior to the acquisition. Giant is responsible for administration of the terminated Dial 401(k) plan until IRS approves the termination and the assets are distributed to the participants.
In January 2007, we acquired Empire Oil Co. ("Empire") and Empire employees immediately became eligible to participate in the Giant 401(k). Empire employees were permitted to carry over their prior years of service with Empire for eligibility and vesting purposes. The 401(k) plan sponsored by Empire was terminated prior to the acquisition. Giant is responsible for administration of the terminated Empire 401(k) plan until IRS approves the termination and the assets are distributed to the participants.
On October 31, 2005, we adopted a deferred compensation plan. The plan is an unfunded retirement restoration plan that provides for additional payments from us so that total retirement benefits for certain executives will be maintained at the levels provided in the 401(k) plan before the application of Internal Revenue Code limitations. Directors are also eligible for the plan. Participants in the plan may defer a portion of their annual salary and/or bonus to future years, and we will match a portion of the amounts deferred on a basis similar to matches in our 401(k) plan, but without regard to the annual caps applicable to the 401(k) plan. We expensed $678,000 and $264,000 in 2006 and 2005, respectively, in connection with this plan. At December 31, 2006, and December 31, 2005 the accrued liability was $2,754,000 and $621,000, respectively, and is recorded in "Other liabilities and deferred income" on our Consolidated Balance Sheets.
NOTE 13 - PENSION AND POST-RETIREMENT BENEFITS:
In connection with the acquisition of the Yorktown refinery, in 2002, we established the Giant Yorktown Cash Balance Plan ("CB Plan"). The CB Plan is a defined benefit plan for our Yorktown employees. The CB Plan is a "cash balance" retirement plan fully funded by us without employee contributions. All Yorktown employees meeting the eligibility requirements are automatically included in the CB Plan. Under the CB Plan, an account is established for each eligible employee that in general reflects pay
credits, based on a percentage of eligible pay determined by age or years of service, whichever yields the greater percentage, plus regular interest credits. Interest credits are generally equal to the greater of 5% or the 12-month average of the one-year U.S. Treasury constant maturity rates plus 1%. Yorktown employees who were covered by the BP retirement plan on July 1, 2000, are generally eligible for a grandfather provision that affects the calculation of the benefit under the plan.
We have established an investment strategy for the CB Plan that targets allocation percentages among various asset classes. This investment strategy is designed to reach long-term return goals, while mitigating against downside risk and considering expected cash flows. The current weighted average target for asset allocation is:
- equity securities: 50-70%; and
- debt securities: 30-50%
Our investment strategy is reviewed from time to time to ensure consistency with our objectives. Equity securities do not include any of our common stock.
We must pay into the CB Plan each year. The amount of our payment is based on various factors, including actuarial calculations linked to the potential retirement ages of Yorktown employees. Our payment to the CB Plan for the plan year ending December 31, 2005 was $3,078,000 and was made in September 2006. We expect to contribute approximately $2,001,000 to the CB Plan in 2007 for the plan year ending December 31, 2006.
In connection with the acquisition of the Yorktown refinery, in 2002, we established the Giant Yorktown Retiree Medical Plan (the "RM Plan"), which is a post-retirement benefit plan for Yorktown employees. The RM Plan will pay a percentage of the medical premium for coverage under the plan. Coverage is generally available to full-time employees who are age 50 or older with 10 or more years of service. We will pay from 50% to 80% of the premium cost, depending on age and years of service. Unlike the CB Plan, we are not required to fund the RM Plan annually, and currently we do not plan to do so.
In September 2006, FASB issued SFAS 158, "Employers' Accounting for Defined Benefit Pension and Other Post-retirement Plans", which requires an employer to recognize the overfunded or underfunded position of a defined benefit post-retirement plan (other than a multiemployer plan) as an asset or a liability in its statement of financial position and to recognize changes in the funded status in the year in which the changes occur through other comprehensive income. With limited exceptions, this statement also requires an employer to measure the funded status of a plan as of the date of its year-end statement of financial position. We adopted this statement in 2006. Under the provisions of SFAS 158, we reduced our long-term pension liability for our cash balance plan by $894,000 ($552,000 net-of-tax) as a result of a net actuarial gain with a
corresponding credit to other comprehensive income. We also recorded an increase in our long-term pension liability by $117,000 ($72,000 net-of- tax) with a corresponding charge to other comprehensive income as a result of recognizing prior service costs related to our cash balance plan. We increased our long-term retiree medical plan liability by $1,308,000 ($649,000 net-of-tax) as a result of net actuarial losses with a corresponding charge to other comprehensive income.
The following table contains certain disclosures for our CB Plan and RM Plan for 2006 and 2005:
The accumulated benefit obligation for the CB Plan was $11,791,000 and $10,769,000 at December 31, 2006 and December 31, 2005, respectively. The estimated net loss that will be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $68,000 (net of tax $42,000) for our RM Plan. No other items are expected to be amortized from accumulated other comprehensive income for both plans into net periodic benefit cost over the next fiscal year.
The following table depicts the incremental effect of applying SFAS 158 on individual line items in the Statement of Financial Position at December 31, 2006:
WEIGHTED AVERAGE PLAN ASSUMPTIONS
We based our expected long-term rate of return on a review of the anticipated long-term performance of individual asset classes and consideration of the appropriate asset allocation strategy, given the anticipated requirements of the CB Plan, to determine the average rate of earnings expected on the funds invested to provide benefits. Although we consider recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate. We expect the long-term return assumption for the CB Plan will remain at 8.5% per year.
PLAN ASSETS
Our CB Plan asset allocations at December 31, 2006, and 2005, by asset category are as follows:
Percentage of Plan Assets at December 31, ----------------- Asset Category 2006 2005 - -------------- ---- ---- Equity securities............................... 71% 70% Debt securities................................. 26% 27% Other........................................... 3% 3% ---- ---- Total........................................... 100% 100% ==== ====
ASSUMED HEALTH CARE COST TREND RATES Retiree Medical Plan --------------- 2006 2005 ------ ------ Assumed health care cost trend rates at December 31: Health care cost trend rate assumed for next year: HMO............................................... 7.50% 8.50% Pre-65 Non-HMO.................................... 9.50% 10.50% Post-65 Non-HMO................................... 10.00% 11.50% Rate to which the cost trend rate is assumed to decline (the ultimate trend rate)...... 4.50% 4.50% Year that the rate reaches the ultimate trend rate.. 2012 2012
Assumed health care cost trend rates have a significant effect on the amounts reported for the RM Plan. A 1%-point change in assumed health care cost trend rates would have the following effect: 1%-Point --------------------- Increase Decrease -------- ---------- Effect on total of service and interest cost components.................................. $ 58,000 $ (52,000) Effect on post-retirement benefit obligation....... $466,000 $(420,000)
On December 8, 2003, the President signed the Medicare Prescription Drug, Improvement and Modernization Act of 2003 (The "Act"). The Act provides a federal subsidy to employers whose prescription drug benefits are actuarially equivalent to certain benefits provided by Medicare. The RM Plan is currently deemed to provide an actuarially equivalent benefit to the Medicare Part D benefit based on the current guidance for determining actuarial equivalency provided by the Centers for Medicare and Medicaid Services. As a result of the Part D subsidy, our accumulated post-retirement benefit obligation was reduced by approximately $400,000 at December 31, 2006. The following table depicts the impact of Part D subsidy on net periodic benefit cost:
NOTE 14 - INCOME TAXES:
Our provision (benefit) for income taxes from continuing operations is comprised of the following:
Year Ended December 31, --------------------------- 2006 2005 2004 ------- ------- ------- (In thousands) Current: Federal................................... $(1,021) $31,423 $ 3,198 State..................................... (626) 5,182 (1,079) ------- ------- ------- (1,647) 36,605 2,119 ------- ------- ------- Deferred: Federal................................... 42,871 24,274 6,001 State..................................... 10,170 8,267 2,564 ------- ------- ------- 53,041 32,541 8,565 ------- ------- ------- Total provision from continuing operations.. $51,394 $69,146 $10,684 ======= ======= =======
Net income taxes paid in 2006 2005 and 2004 were $9,680,000; $30,180,000; and $1,797,000 respectively.
We reconcile the difference between our provision (benefit) for income taxes and income taxes calculated using the statutory U.S. federal income tax rate for continuing operations as follows:
Year Ended December 31, --------------------------- 2006 2005 2004 ------- ------- ------- (In thousands) Income taxes at the statutory U.S. federal income tax rate of 35%............ $46,951 $60,577 $ 9,458 Increase (decrease) in taxes resulting from: State taxes, net............................ 6,204 8,742 965 Ultra low sulfur diesel credit, net......... (2,064) - - Other, net.................................. 303 (173) 261 ------- ------- ------- Total provision from continuing operations.. $51,394 $69,146 $10,684 ======= ======= =======
We record deferred income taxes to reflect temporary differences in the basis of our assets and liabilities for income tax and financial reporting purposes, as well as available tax credit carryforwards. These temporary differences result in amounts that will be taxable or deductible in future years on our tax returns. The tax effected temporary differences and credit carryforwards which comprise our deferred taxes on our balance sheet are as follows:
At December 31, 2006, we had an alternative minimum tax credit carryforward of $8,003,000 and general business credit carryforwards of $3,275,000. Alternative minimum tax credits can be carried forward indefinitely to offset future regular tax liabilities.
Federal net operating loss ("NOL") carryovers are $4,078,000 and will begin to expire in the year 2026. State net operating loss carryforwards are $39,840,000 and will begin to expire in the year 2022.
In accordance with SFAS 109, deferred tax assets should be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax assets will not be realized. The realization of deferred tax assets can be affected by, among other things, future company performance and market conditions. In making the determination of whether or not a valuation allowance was required, we considered all available positive and negative evidence and made certain assumptions. We considered the overall business environment, historical earnings, and the outlook for future years. We performed this analysis as of December 31, 2006 and
determined that there was sufficient positive evidence to conclude that it is more likely than not that our net deferred tax assets will be realized. We will assess the need for a deferred tax asset valuation allowance on an ongoing basis.
FIN 48 provides guidance on derecognition, classification, interest, penalties, interim period reporting and disclosure for uncertain tax positions. It provides that the benefit of an uncertain tax position cannot be recognized unless it is more likely than not that the position will be sustained if audited. The amount recognized is the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. We are currently evaluating the impact of FIN 48 which will be effective for years beginning after December 15, 2006. Any material effects will be reported as a separate cumulative adjustment to beginning retained earnings.
NOTE 15 - EARNINGS PER SHARE:
The following is a reconciliation of the numerators and denominators of the basic and diluted earnings per share computations as required by SFAS No. 128:
At December 31, 2006 and 2005, there were 14,639,312 and 14,614,097 shares, respectively, of our common stock outstanding.
In 2007, we may contribute newly issued shares of our common stock to fund our 401(k) plan supplemental contribution for the year ended December 31, 2006. We have not yet determined if we will make this contribution in shares of our stock and, if we do, the number of shares to contribute. In March 2006, we contributed 25,115 newly issued shares of our common stock to fund our 401(k) plan discretionary contribution for the year ended December 31, 2005.
As discussed in Note 8, we issued 1,000,000 shares in the first quarter of 2005 to redeem a portion of our outstanding debt. We also issued 1,000,000 shares in September 2005. The proceeds from these shares were used for general corporate purposes.
On December 6, 2005, we awarded 41,000 restricted shares to 39 employees, of which 2,900 restricted shares were forfeited in 2006 as a result of employees terminating their employment with us. See Note 10 for further information.
NOTE 16 - 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. 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. We also operated a travel center in New Mexico until June 19, 2003, when the travel center was sold. 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 our retail group sells. We purchase general merchandise and food products from various suppliers. At December 31, 2006, our retail group operated 155 service stations with convenience stores or kiosks.
WHOLESALE GROUP
Our wholesale group consists of Phoenix Fuel and the wholesale operations of Dial and the wholesale assets acquired from Amigo Petroleum Company ("Amigo"). (See Note 18 for further information). Our wholesale group primarily distributes commercial wholesale petroleum products. Our wholesale group includes several lubricant and bulk petroleum distribution plants, unmanned commercial fleet fueling cardlock operations, a bulk lubricant terminal facility and a fleet of finished product and lubricant delivery trucks. We purchase petroleum products for resale from other refiners and marketers as well as 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.
Operating income for each segment consists of net revenues less cost of products sold, operating expenses, depreciation and amortization, and the segment's SG&A 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.
We have also restated the tables pertaining to the years ended December 31, 2005 to conform to the current year presentation because the results of 12 service stations that were part of the Dial acquisition are currently reported in the results of operations pertaining to our retail segment but were previously reported in our wholesale segment. These restatements had no affect on our results of operations.
Disclosures regarding our reportable segments with reconciliations to consolidated totals are presented below.
NOTE 17 - COMMITMENTS AND CONTINGENCIES:
We have pending against us various legal actions, claims, assessments and other contingencies arising in the normal course of our business, including those matters described below. 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. Further, violations of such laws and regulations can lead to substantial fines and penalties.
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.
Under circumstances in which environmental assessments and/or remedial efforts are anticipated and related to past events, we accrue for
the liability if associated costs are probable and can be reasonably estimated. We record liabilities for litigation matters when it is probable that the outcome of litigation will be adverse and damages 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 clean up 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 December 31, 2006 and 2005, we had environmental liability accruals of approximately $3,991,000 and $4,941,000, respectively, which are summarized below, and litigation accruals in the aggregate of approximately $185,000 and $990,000, respectively. Environmental accruals are recorded in the current and long-term sections of our Consolidated Balance Sheets. Litigation accruals are recorded in the current section of our Consolidated Balance Sheets.
Approximately $3,584,000 of the December 31, 2006 accrual is for the following projects discussed below:
- $2,755,000 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; and
- $30,000 for remediation of hydrocarbon contamination on and adjacent to the 5.5 acres that we own in Bloomfield, New Mexico.
The remaining $407,000 of the accrual relates to:
- the 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.
YORKTOWN ENVIRONMENTAL LIABILITIES
We assumed certain liabilities and obligations in connection with our purchase of the Yorktown refinery from BP Corporation North America Inc. and BP Products North America Inc. (collectively "BP"). BP agreed to reimburse us in specified amounts for some matters. Among other things, and subject to certain exceptions, we assumed responsibility for all costs, expenses, liabilities, and obligations under environmental, health and safety laws caused by, arising from, incurred in connection with or relating to the ownership of the refinery or its operation. We agreed to reimburse BP for losses incurred in connection with or related to liabilities and obligations assumed by us. We only have limited indemnification rights against BP. Certain environmental matters relating to the Yorktown refinery are discussed below.
BP agreed to reimburse us for all losses that are caused by or relate to property damage caused by, or any environmental remediation required due to, a violation of environmental health, and safety laws during BP's operation of the refinery. In order to have a claim against BP, however, the total of all our losses must exceed $5,000,000, in which event our claim only relates to the amount exceeding $5,000,000. After $5,000,000 is reached, our claim is limited to 50% of the amount by which our losses exceed $5,000,000 until the total of all our losses exceeds $10,000,000. After $10,000,000 is reached, our claim would be for 100% of the amount by which our losses exceed $10,000,000. In applying these provisions, losses amounting to a total of less than $250,000 arising out of the same event are not added to any other losses for purposes of determining whether and
when the $5,000,000 or $10,000,000 has been reached. After the $5,000,000 or $10,000,000 thresholds have been reached, BP has no obligation to reimburse us for any losses amounting to a total of less than $250,000 arising out of the same event. Except as specified in the refinery purchase agreement, in order to seek reimbursement from BP, we were required to notify BP of a claim within two years following the closing date. Further, BP's total liability for reimbursement under the refinery purchase agreement, including liability for environmental claims, is limited to $35,000,000.
YORKTOWN 1991 ORDER
In connection with the Yorktown acquisition, we assumed BP's obligations under an administrative order issued in 1991 by EPA under the Resource Conservation and Recovery Act. In August 2006, we agreed to the terms of the final administrative consent order pursuant to which we will implement a cleanup plan for the refinery.
Our most current estimate of expenditures associated with the EPA order is between $30,000,000 ($22,500,000 of which we believe is subject to reimbursement by BP) and $40,000,000 ($32,500,000 of which we believe is subject to reimbursement by BP). We anticipate that these expenditures will be incurred over a period of approximately 35 years from August 2006. We believe that between approximately $12,000,000 and $16,000,000 of this amount will be incurred over an initial four-year period, and additional expenditures of between approximately $12,000,000 and $16,000,000 will be incurred over the following four-year period, with the remainder thereafter. These estimates assume that EPA will agree with the design and specifications of our cleanup plan. These estimates also could change as a result of factors such as changes in costs of labor and materials. We currently have $2,755,000 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 and also reflects expenditures previously incurred in connection with this matter. BP's total liability for reimbursement under the refinery purchase agreement, including liability for environmental claims, is limited to $35,000,000.
As part of the consent order cleanup plan, the facility's underground sewer system will be cleaned, inspected and repaired as needed. 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, as well as sewer system inspection and repair, will be completed approximately seven to eight years after EPA approves our cleanup plan and authorizes its implementation.
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 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 cleanup order. As of December 31, 2006, we had $570,000 recorded as an environmental liability for this project.
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. The order required the seller to investigate and propose measures for correcting any releases of hazardous waste or hazardous constituents at or from the Bloomfield refinery. EPA has delegated its oversight authority over the order to the Hazardous Waste Bureau of the New Mexico Environment Department ("NMED"). In December 2002, NMED and OCD approved a cleanup plan for the refinery, subject to various actions to be taken by us to implement the plan. We believe some of the requirements of the draft NMED order discussed below under the caption "Bloomfield Refinery - NMED Draft Order" may duplicate some of the requirements of the 1992 order. We further believe EPA will withdraw the 1992 order at the time NMED issues a final order. We currently estimate that remaining remediation expenses associated with the cleanup plan will be approximately $229,000, and that these expenses will be incurred through approximately 2018. As of December 31, 2006, we had $229,000 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, which was completed in the second quarter of 2005.
With the approval of OCD, we installed sheet piling in an area of the Bloomfield refinery known as the river terrace in 1999 to block migration of groundwater contaminants. Monitoring wells also were installed, with annual sampling results submitted to OCD. In connection with the construction of the underground barrier at the west outfall, OCD required more investigation of elevated hydrocarbon levels in the river terrace area. As a result of this investigation, 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. Since all planned capital improvements have been completed, we currently do not have any amount 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. Our remediation plan was approved by OCD in 2002. We will continue remediation until natural attenuation has completed the process of groundwater remediation. As of December 31, 2006, we had $30,000 recorded as an environmental liability for this project.
FOUR CORNERS REFINERIES - SETTLEMENT AGREEMENTS
In July 2005, we reached an administrative settlement with NMED and EPA in the form of consent agreements that resolved certain alleged violations of air quality regulations at our Ciniza and Bloomfield refineries.
In August 2005, we paid fines of $100,000 to EPA and $150,000 to NMED. We also agreed to undertake certain environmentally beneficial projects known as supplemental environmental projects at a cost of up to $600,000.
The administrative settlement is similar to the judicial consent decrees EPA has entered with other refiners as part of its national refinery enforcement program and requires that we do the following:
- implement controls to reduce emissions of nitrogen oxide, sulfur dioxide, and particulate matter from the largest emitting process units;
- upgrade leak detection and repair practices;
- minimize the number and severity of flaring events; and
- adopt strategies to ensure compliance with benzene waste requirements.
At the time of this settlement in July 2005, we estimated the compliance costs necessary for satisfying the requirements of the equipment modifications to our Four Corners refineries as between approximately $10,000,000 and $18,000,000, spread over a period of four to seven years following the date of the settlement. We have spent
approximately $600,000 through 2006 for equipment modifications required by this settlement. We anticipate that the majority of the remaining costs will be incurred in the latter portion of the four to seven year phase-in period. In addition, we estimated that on-going annual operating costs associated with these modifications could cost approximately $4,000,000 per year. These amounts were the estimated upper limits for both capital expenditures and annual operating costs. Undertaking the upper limit for one type of expenditure could result in our having to spend less than the upper limit for the other.
These estimated compliance costs were the best estimates available at the time of the July 2005 settlement. The costs that we actually incur, however, may be substantially higher than the estimates due to, among other things, changes in costs of labor, materials, and chemical additives, and changes in cost efficiencies of technologies. In light of these factors, we believe more accurate estimates of compliance costs will not be available until we are closer in time to implementation of the required projects and have further considered all operational options. The costs associated with our settlement also could be subject to reduction in the event of the temporary, partial or permanent discontinuance of operations at one or both facilities. 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.
BLOOMFIELD REFINERY - OCD COMPLIANCE ORDER
In September 2005, we received an Administrative Compliance Order from OCD alleging that: (1) we had failed to notify OCD of the west outfall discharges at our Bloomfield refinery; (2) we had allowed contaminants to enter the San Juan River from the refinery's river terrace area; and (3) we had failed to comply with certain conditions of the refinery's groundwater discharge permit. 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 prepare a comprehensive action plan for the investigation and remediation of contaminated soil and groundwater at the refinery. Until this plan is completed and approved by the two agencies with regulatory oversight, OCD and NMED, we cannot reasonably estimate the cost of any associated activities. We believe the requirements of this settlement may duplicate some of the requirements of the draft NMED order discussed below under the caption "Bloomfield Refinery - NMED Draft Order". We anticipate further discussions with OCD and NMED concerning their respective requirements for investigation and remediation at the Bloomfield refinery.
BLOOMFIELD REFINERY - EPA COMPLIANCE ORDER
In October 2005, we received an Administrative Compliance Order from EPA in connection with a compliance evaluation inspection at the Bloomfield refinery in 2000 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 alleged that benzene levels in the aeration ponds exceed permissible RCRA levels. EPA also alleged that we failed to make a RCRA hazardous waste determination in connection with wastewater going into the aeration ponds. In May 2006, we reached a settlement with EPA in the form of a consent agreement and paid a civil penalty of $75,000. The settlement requires that we make equipment modifications to reduce benzene levels in the wastewater coming from the refinery's process units. We currently estimate that we will incur capital expenditures of between approximately $3,200,000 and $3,500,000 to comply with the settlement. We spent approximately $100,000 for this project in 2006, with the remainder of the expenditures to be incurred in 2007. Since the settlement does not require us to undertake any cleanup activities, we have not recorded an environmental liability for this matter.
BLOOMFIELD REFINERY - NMED DRAFT ORDER
On June 21, 2006, we received a draft administrative compliance order from NMED alleging that releases of contaminants and hazardous substances that have occurred at the Bloomfield refinery over the course of its operation have resulted in soil and groundwater contamination. Among other things, the draft order requires that we:
- investigate and determine the nature and extent of such releases of contaminants and hazardous substances;
- perform interim remediation measures, or continue interim measures already begun, to mitigate any potential threats to human health or the environment from such releases;
- identify and evaluate alternatives for corrective measures to clean up any contaminants and hazardous substances released at the refinery and prevent or mitigate their migration at or from the site;
- implement any corrective measures that may be approved by NMED; and
- develop and implement work plans and corrective measures over a period of approximately four years.
The draft order recognizes that prior work we have satisfactorily completed may fulfill some of the foregoing requirements. In that regard, we have already put in place some remediation measures with the approval of NMED or OCD.
We submitted written comments on the draft order during the public comment period and have received NMED's written response. We anticipate further communications with NMED prior to issuance of a final order. We currently do not know the nature and extent of any cleanup actions that may be required under the final order and, accordingly, have not recorded a liability for this matter.
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, Pennsylvania, and New Mexico. Due to our historical operations in New Mexico, including retail sites, we potentially have greater risk in connection with the New Mexico litigation than in the litigation in the Eastern states where we have only operated since 2002 and have no retail operations. 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.
CINIZA REFINERY FIRE INCIDENT (DECEMBER 2006)
On December 26, 2006, a fire occurred in a process heater in the distillate hydrotreater ("DHT") unit. The DHT unit is used to manufacture ultra low sulfur diesel fuel. Instrumentation and electrical cabling associated with the DHT unit and other process units also were damaged. All of the process units in the refinery were shutdown for safety reasons. Repairs have been made that have enabled us to restart all of the units at the refinery except for the portion of the DHT unit damaged in the fire. We currently expect that the rest of the DHT unit will be returned to service in early April.
We currently expect that repairs to, and/or replacement of, the units, instrumentation, and cabling damaged by the fire will cost approximately $6,700,000. We do not anticipate receiving any insurance proceeds related to these repairs as the cost of the repairs has not exceeded the associated $10,000,000 deductible of our current property insurance coverage. In addition, we do not anticipate making a claim under our business interruption insurance. As of December 31, 2006, we wrote-off approximately $875,000 of property, plant and equipment to loss on write- down of assets.
CINIZA REFINERY FIRE INCIDENT (OCTOBER 2006)
On October 5, 2006, a pump failure in the alkylation unit at our Ciniza refinery resulted in a fire at the refinery. The fire caused damage
to the alkylation unit and an associated unit. The alkylation unit produces high octane blending stock for gasoline. Repairs to the affected units cost approximately $6,400,000 and the unit was restarted in mid- December of 2006. We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the unit. We do not anticipate making a claim under our business interruption insurance. As of December 31, 2006, we wrote-off approximately $392,000 of property, plant and equipment to accounts receivable in connection with the fire.
YORKTOWN REFINERY INCIDENT (2006)
On September 30, 2006, a fire occurred at our Yorktown refinery in the processing unit required to produce ultra low sulfur diesel fuel. Repairs to the unit cost approximately $12,000,000 and were completed in January 2007. The unit was returned to operation in February 2007. Until the unit became operational, we sold more heating oil than otherwise would be the case, which was a less profitable product than ultra low sulfur diesel.
We have property insurance coverage with a $1,000,000 deductible that should cover a significant portion of the costs of repairing the ultra low sulfur diesel unit. We also have business interruption insurance coverage that should cover a significant portion of the financial impact of the fire after the policy's 45-day waiting period is exceeded. As of December 31, 2006, we wrote-off approximately $5,000,000 of property, plant and equipment to accounts receivable in connection with the fire.
YORKTOWN REFINERY INCIDENT (2005)
On November 25, 2005, a fire occurred at our Yorktown refinery. Damage was primarily done to the gas plant that supports the fluid catalytic converter ("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. Repairs related to this fire were completed in April 2006.
Our property insurance covered a significant portion of the costs of repairing the Yorktown refinery and our business interruption insurance reimbursed us for a portion of the financial impact of the fire. We received $89,000,000 of insurance proceeds consisting of $27,700,000 for property claims and $61,300,000 for business interruption claims. For the year ended December 31, 2006, we recorded a gain of $82,003,000 as a result of insurance recoveries related to the fire. No more proceeds will be received as all of our claims have been resolved with our insurance carriers.
CLASS ACTION COMPLAINT
On November 22, 2006, Timothy Bisset filed a class action complaint in Arizona state court against us, our directors and Western in connection
with our merger. Among other things, Mr. Bisset alleges that we and our directors breached our fiduciary duty in voting to amend the Plan of Merger on November 12, 2006 to provide for, among other things, a lower acquisition price of $77.00 per share. Mr. Bisset also alleges that Western aided and abetted this breach of fiduciary duty. Among other things, Mr. Bisset alleges that he and other public stockholders of our common stock are entitled to enjoin the proposed amended transaction or, alternatively, to recover damages in the event the transaction is completed.
We believe that amending our merger agreement was in the best interest of our stockholders. Since the original merger was announced on August 28, 2006, a number of unanticipated events occurred that resulted in a dispute between us and Western regarding the merger. Western asserted that fires at our refineries, changes in our insurance program, increases in our anticipated capital expenditures, other regulatory issues and related costs of compliance, and other events and changes constituted a "material adverse effect" under the merger agreement and also violated various representations, warranties and covenants in the merger agreement, thereby giving Western the right to terminate the merger transaction in its entirety. After extensive consideration, we concluded that the interests of our stockholders were best served by avoiding litigation over this dispute by amending the merger agreement in a way that reduced the merger consideration but at the same time eliminated virtually all of Western's closing conditions and allowed us a 30-day "go-shop" period to see if we could obtain a better price for our stockholders. Accordingly, we think Mr. Bisset's lawsuit is without merit and intend to vigorously defend it.
NOTE 18 - ACQUISITIONS:
On August 1, 2005, we acquired an idle crude oil pipeline running from Jal, New Mexico to Bisti, New Mexico and related assets from Texas- New Mexico Pipe Line Company. This pipeline is connected to our existing pipeline network that directly supplies crude oil to the Bloomfield and Ciniza refineries. We have begun testing the pipeline and taking other actions related to placing it in service. Unless currently unanticipated obstacles are encountered, we anticipate the pipeline will become operational in the second quarter of 2007 with crude oil arriving at the refineries before the end of the second quarter.
On July 12, 2005, we acquired 100% of the common shares of Dial. We funded this acquisition with cash on hand. Dial is a wholesale distributor of gasoline, diesel and lubricants in the Four Corners area of the Southwest. Dial also owns and operates 12 service stations/convenience stores. Dial's assets include bulk petroleum distribution plants, cardlock fueling locations and a fleet of truck transports. The acquisition has been accounted for using the purchase method of accounting whereby the total purchase price has been allocated to tangible and intangible assets acquired and liabilities assumed based on the fair market values on the date of acquisition, and goodwill of $9,707,000 was recorded as a result of this acquisition. The pro forma effect of the acquisition on Giant's results of operations is immaterial.
In May 2006, we acquired a lubricating business in El Paso, Texas. We funded this acquisition with cash on hand. The assets acquired primarily include lubricants inventory, fixed assets, and miscellaneous receivables. The acquisition has been accounted for using the purchase method of accounting whereby the total purchase price has been preliminarily allocated to tangible and intangible assets acquired based on the fair market values on the date of acquisition. The pro forma effect of the acquisition on Giant's results of operations is immaterial.
In August 2006, we acquired certain assets from Amigo. We funded this acquisition with cash on hand. These acquired assets include 25 convenience stores, two bulk petroleum distribution plants, and a transportation fleet. The acquisition is accounted for using the purchase method of accounting whereby the total purchase price is preliminarily allocated to tangible and intangible assets acquired based on the fair market values on the date of acquisition. The pro forma effect of the acquisition on Giant's results of operations is immaterial.
On January 2, 2007, we acquired 100% of the common shares of Empire Oil Co. ("Empire"). We funded this acquisition with cash on hand. Empire is a wholesale distributor of gasoline, diesel, and lubricants in Southern California. Empire's assets include a bulk petroleum distribution plant, cardlock fueling locations, and a fleet of truck transports. The acquisition has been accounted for using the purchase method of accounting whereby the total purchase price has been allocated to tangible and intangible assets acquired and liabilities assumed based on the fair market values on the date of acquisition. The pro forma effect of the acquisition on Giant's results of operations in immaterial.
NOTE 19 - QUARTERLY FINANCIAL INFORMATION (UNAUDITED)
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. 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.
(c) Management Report on Internal Control Over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control system was designed to provide reasonable assurance to our management and board of directors regarding the preparation and fair presentation of published financial statements.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Our management assessed the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, we used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO") in Internal Control- Integrated Framework. Based on our assessment, we believe that, as of December 31, 2006, our internal control over financial reporting is effective based on those criteria.
Our registered public accounting firm, Deloitte & Touche LLP has issued a report on our assessment of our internal control over financial reporting.
(d) INDEPENDENT AUDITORS REPORT ON OUR ASSESSMENT OF OUR INTERNAL CONTROL OVER FINANCIAL REPORTING.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Giant Industries, Inc. Scottsdale, Arizona
We have audited management's assessment, included in the accompanying Management Report on Internal Control over Financial Reporting, that Giant Industries, Inc. and subsidiaries (the "Company") maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the company's board of directors, management, and other personnel 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. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.
Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management's assessment that the Company maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2006 of the Company and our reports dated March 1, 2007 expressed an unqualified opinion on those financial statements and financial statement schedule and included an explanatory paragraph regarding the Company's 2005 change in its method of accounting for conditional asset retirement obligations to comply with Financial Accounting Standards Board ("FASB") Interpretation 47, Accounting for Conditional Asset Retirement Obligations, and the Company's 2006 change in its method of accounting for pension and post-retirement obligations to comply with Statement of Financial Accounting Standards No. 158, Employer's Accounting for Defined Benefit Plans and Other Post-retirement Benefits, an Amendment of FASB Statements No. 87, 88, 106, and 132(R).
/s/ Deloitte & Touche LLP
Phoenix, Arizona March 1, 2007
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
Not applicable.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Our directors and executive officers as of March 1, 2007 are listed below:
- ------- (1) Each director's term of office expires in the year set forth opposite his name above. Each officer serves until his or her successor is chosen and qualified or until his or her earlier resignation or removal.
Fred L. Holliger has served as one of our directors since we went public in October 1989 and as our chairman of the board and chief executive officer since March 2002. From October 1989 to March 2002, Mr. Holliger was our executive vice president and chief operating officer. Mr. Holliger joined us as senior vice president, and president of our refining division, in February 1989.
Brooks J. Klimley has served as one of our directors since August 2002. Mr. Klimley also serves as a member of the audit committee and the compensation committee and is chairman of the corporate governance and nominating committee. Since 2005, Mr. Klimley has served as the President of CIT Energy, an energy finance and advisory business. In this role, Mr. Klimley is responsible for refining CIT's strategy to expand client relationships and product offerings to support the global financing needs of companies throughout the energy sector. From 2001 to 2004, Mr. Klimley was a managing director at Citigroup Global Markets Inc. and its predecessor firm Salomon Smith Barney, Inc., and he was the co-head of the diversified industrials group. From 1998 to 2001, Mr. Klimley was senior managing director and co-head of the natural resources group for Bear, Stearns & Co., Inc., where he led origination and execution teams covering a broad range of natural resources companies.
George M. Rapport has served as one of our directors since September 2001. Mr. Rapport also serves as chairman of the audit committee and as a member of the compensation committee and the corporate governance and nominating committee. He currently is a director and the chief financial officer for Knightsbridge Petroleum (UK) Ltd., an international oil and gas exploration and production company, and the finance director for Knightsbridge Chemicals Limited, an international chemicals manufacturing company. Both of these companies are subsidiaries of Knightsbridge Investments Limited ("Knightsbridge"), of which Mr. Rapport is a shareholder. In August 2004, Knightsbridge acquired Nimir Petroleum Limited ("Nimir"), an international oil and gas exploration and production company. From August 2001 to October 2004, Mr. Rapport was the senior vice president and chief financial officer of Nimir. From May 2001 to August 2001, Mr. Rapport was a financial advisor to Nimir. From 1993 to May 2001, he was a managing director - private banking for Chase Manhattan Bank in New York.
Donald M. Wilkinson has served as one of our directors since September 2003. Mr. Wilkinson also serves as a member of the audit committee, the compensation committee, and the corporate governance and nominating committee. Since 1984, Mr. Wilkinson has been the chairman and chief investment officer of Wilkinson O'Grady & Co., Inc., a global asset management firm located in New York City that he co-founded in 1972. Mr. Wilkinson is a member of the Board of Visitors of the Virginia Military Institute and is a former chairman of the Board of Trustees for the Darden School of Business Management at the University of Virginia.
Larry L. DeRoin has served as one of our directors since June 2002. Mr. DeRoin also serves as a member of the audit committee and the corporate governance and nominating committee and is chairman of the compensation committee. Since September 2000, Mr. DeRoin has been the president of DeRoin Management, Inc., which provides investment, management and consulting services. From 1993 to September 2000, Mr. DeRoin was chairman and chief executive officer of Northern Border Partners, L.P., chairman of the management committee for Northern Border Pipeline Co., and president of Northern Plains Natural Gas Co.
Morgan Gust has served as our president since March 2002 and as the president of our refining strategic business unit since May 2006. From February 1999 to March 2002, Mr. Gust served as our executive vice president. Mr. Gust joined the company in August 1990, and over the years served in various senior management positions for us, including vice president, vice president administration, general counsel, and corporate secretary.
Mark B. Cox has served as our vice president, treasurer, financial officer and assistant secretary since December 1998. In March 2002, Mr. Cox was named chief financial officer and in April 2004, Mr. Cox was made executive vice president.
Kim H. Bullerdick has served as our vice president and corporate secretary since December 1998 and our general counsel since May 2000. In April 2004, Mr. Bullerdick was made senior vice president. From December 1998 to May 2000, Mr. Bullerdick was our legal department director.
Jack W. Keller has served as the president of our wholesale strategic business unit since its formation in July 2005 following the acquisition of Dial Oil Co. ("Dial"). The wholesale group combines the operations of Phoenix Fuel and Dial. He also has served as the president of Phoenix Fuel since we acquired it in June 1997 and as chief operating officer of Phoenix Fuel since May 1998. Mr. Keller also has served as president and chief operating officer of Dial since its acquisition.
Robert C. Sprouse has served as executive vice president of our retail strategic business unit since April 2003. From January 2000 to April 2003, Mr. Sprouse served as our director of retail operations. From 1996 to January 2000, Mr. Sprouse held several management positions with Strasburger Enterprises, Inc., a retail management consulting company.
S. Leland Gould has served as our executive vice president, governmental affairs and real estate since June 2002. From March 2002 to June 2002, Mr. Gould served as our executive vice president of retail operations. Mr. Gould joined us in August 2000 as vice president, strategic business development. Prior to August 2000, Mr. Gould was vice president and national sales manager for Wolf Camera, a photo retail store chain with 800 stores nationwide. Mr. Gould also is a director and the treasurer for the New Mexico Oil and Gas Association and is a director for the New Mexico Petroleum Marketers Association.
Natalie R. Dopp has served as our vice president, human resources since September 2002. Prior to that, Ms. Dopp was responsible for our recruiting and compensation functions. Ms. Dopp joined us in April 2000 and prior to that she was employed by Scottsdale Insurance Company, a subsidiary of Nationwide Insurance.
Jeff D. Perry joined us in August 2005 and initially was responsible for all of our information technology products and services. He was named our chief information officer in April 2006. Prior to joining us, he was chief information officer for Three-Five Systems, Inc.
ABOUT THE BOARD OF DIRECTORS
We currently have five members on our board of directors. In June 2006, we reduced the size of our board from six to five following the retirement of Anthony J. Bernitsky.
Our board of directors is divided into three classes. As of March 1, 2007, there were two class I directors (George M. Rapport and Donald M. Wilkinson), two class II directors (Fred L. Holliger and Brooks J. Klimley), and one class III director (Larry L. DeRoin). The term of each class of director is three years, with the term of one class expiring at each of our annual meetings of stockholders. The term of office of the class III director expires at the 2007 annual meeting of stockholders.
Our board of directors meets throughout the year on a set schedule. The board also holds special meetings and acts by unanimous written consent from time to time as appropriate. The non-management members of the board and, when different individuals, the independent members of the board periodically meet in executive session without management present. As provided in the corporate governance guidelines adopted by the board, the non-management directors designate the director who will preside at the executive sessions. The non-management directors have designated Mr. Klimley as the presiding director. He will continue to serve in that role until such time as the non-management directors designate someone else to serve in that role. It is anticipated that the non-management directors will consider the designation at least once a year.
Our board held 13 meetings during 2006. The board has established an audit committee, a compensation committee, and a corporate governance and nominating committee. During 2006, all incumbent directors attended 75% or more of the aggregate of: (1) the total number of meetings of the board, and (2) the total number of meetings of all committees on which the director served.
It is our policy that our board of directors should make every effort to attend the annual meeting. Last year, all but one of our members of the board attended the annual meeting.
INDEPENDENT DIRECTORS
Our board has determined that it is comprised of a majority of individuals who are independent under the rules of the New York Stock Exchange and applicable federal law. The board has determined that the following directors are independent: George M. Rapport, Donald M. Wilkinson, Brooks J. Klimley and Larry L. DeRoin.
In reaching that determination, the board affirmatively determined that the individuals it considers independent have no material relationship with us, either directly or as a partner, shareholder or officer of a company that has a relationship with us. In particular, the board determined that these individuals satisfied all of the following standards:
- Neither they, nor any immediate member of their family, have ever been employed by us.
- Neither they, nor any immediate member of their family, has received any direct compensation from us (director and committee fees and pensions or other forms of deferred compensation for prior service were not considered compensation for this purpose; provided such compensation was not contingent in any way on continued service) in any twelve-month period within the last three years.
- Neither the director, nor any immediate family member, is employed by another company that makes payments to, or receives payments from, us for property or services in an amount which, in any of the last three fiscal years, exceeds $60,000.
- They satisfy each of the bright-line standards of the New York Stock Exchange that must be met if a director is to be considered independent.
Our directors on the audit committee meet the following additional two standards:
- They have not accepted, directly or indirectly, any consulting, advisory or other compensatory fee from us other than (1) compensation for board or committee service, or (2) fixed amounts of compensation under a retirement plan for prior service that is not contingent on continued service.
- They are not affiliated with us. By this we mean that the director does not directly, or indirectly through one or more intermediaries, control us, and is not controlled by, or under common control with, us. The director is not considered to be in control of us if (1) he is not the beneficial owner, directly or indirectly, of more than 10% of any class of our voting equity securities, and (2) he is not one of our executive officers.
ABOUT THE COMMITTEES OF THE BOARD OF DIRECTORS
Our board has an audit committee, a compensation committee, and a corporate governance and nominating committee. Each of the committees has a written charter that may be found on our website at www.giant.com. In addition, copies of the charters are available to all stockholders by calling (480) 585-8888 or by writing to: Kim H. Bullerdick, Corporate Secretary, at our corporate headquarters located at 23733 N. Scottsdale Road, Scottsdale, AZ 85255. All of the members of each of our committees are independent directors as required by the New York Stock Exchange listing standards and applicable federal law. The following table presents information about each committee.
AUDIT COMMITTEE
The members of the committee are George M. Rapport (Chairman), Larry L. DeRoin, Brooks J. Klimley, and Donald M. Wilkinson. The committee met six times, either in person or by telephone, in 2006. Our board has determined that Mr. Rapport qualifies as an "audit committee financial expert" as that term is defined in the rules of the Securities and Exchange Commission. Among other matters, the committee:
- Directly hires and replaces the independent auditors as appropriate.
- Evaluates the performance of, independence of, and pre-approves the services provided by, the independent auditors.
- Discusses the quality of our accounting principles and financial reporting procedures with management and our independent auditors.
- Reviews with management and our independent auditors our annual and quarterly financial statements and recommends to the board whether the annual financial statements should be included in our annual report.
- Oversees the internal auditing functions and controls.
- Established procedures for handling complaints regarding accounting, internal accounting controls and auditing matters, including procedures for the confidential, anonymous submission of concerns by employees regarding accounting and auditing matters.
- Prepares the audit committee report required by the rules of the Securities and Exchange Commission.
COMPENSATION COMMITTEE
The members of the committee are Larry L. DeRoin (Chairman), Brooks J. Klimley, George M. Rapport, and Donald M. Wilkinson. The committee met twice, either in person or by telephone, in 2006. Among other matters, the committee:
- Oversees the administration of our compensation programs.
- Sets the compensation for our chief executive officer and our president.
- Reviews the compensation of our executive officers.
- Prepares the report on executive compensation required by the rules of the Securities and Exchange Commission.
CORPORATE GOVERNANCE AND NOMINATING COMMITTEE
The members of the committee are Brooks J. Klimley (Chairman), Larry L. DeRoin, George M. Rapport, and Donald J. Wilkinson. The committee met once, either in person or by telephone, in 2006. Among other matters, the committee:
- Identifies individuals believed to be qualified to become members of our board and recommends to the board the nominees to stand for election as directors at the annual meeting.
- Makes recommendations to the board as to changes that the committee believes to be desirable to the size of the board and any committee of the board and to the types of committees of the board.
- Makes recommendations to the board regarding the composition of board committees.
- Develops and recommends to the board a set of corporate governance guidelines and reviews those guidelines at least once a year.
In identifying and nominating candidates to the board, the corporate governance and nominating committee considers, among other factors, the following:
- Personal qualities, including background and reputation, reflecting the highest personal and professional integrity. We seek individuals of exceptional talent and judgment. We also seek individuals with the ability to work with other directors and director nominees to build a board that is effective and responsive to the needs of the stockholders.
- Current knowledge of (1) the communities in which we do business, (2) our industry, (3) other industries relevant to our business, or (4) other organizations of similar size.
- Ability and willingness to commit adequate time to board and committee matters.
- Diversity of viewpoints, background, experience and other demographics.
- The individual's agreement with our corporate governance guidelines.
DIRECTOR CANDIDATES PROPOSED BY YOU
The corporate governance and nominating committee may consider candidates recommended by our stockholders. If a stockholder wishes to propose a nominee for consideration by the committee, he or she may do so by submitting name(s) and supporting information to:
Giant Industries, Inc. 23733 N. Scottsdale Rd. Scottsdale, AZ 85255 Attention: Corporate Secretary
When submitting nominees for consideration, a stockholder should explain why the proposed nominee meets the factors that the corporate governance and nominating committee considers important. All candidates proposed will be evaluated by the same criteria regardless of who proposes the candidate.
CORPORATE GOVERNANCE GUIDELINES
We have adopted a set of corporate governance guidelines. A copy of the corporate governance guidelines may be found on our website at www.giant.com. In addition, copies of the corporate governance guidelines are available to all stockholders by calling (480) 585-8888 or by writing to: Kim H. Bullerdick, Corporate Secretary, at our corporate headquarters located at 23733 N. Scottsdale Road, Scottsdale, AZ 85255. The guidelines set out our thoughts on, among other things, the following:
- The role of our board and management.
- The functions of our board and its committees and the expectations we have for our directors.
- The selection of directors, the chairman of the board, and the chief executive officer.
- Election terms, retirement of directors, and management succession.
- Executive and board compensation.
- Evaluating board performance.
- Communications with the board.
CODE OF ETHICS
We have adopted a code of ethics that applies to all of our directors, executives and employees. We have filed a copy of our code of
ethics as Exhibit 14.1 to our annual report on Form 10-K for the year ended December 31, 2003. The code of ethics also is posted on our website at www.giant.com. In addition, copies of the code of ethics are available to all stockholders by calling (480) 585-8888 or by writing to: Kim H. Bullerdick, Corporate Secretary, at our corporate headquarters located at 23733 N. Scottsdale Road, Scottsdale, AZ 85255. We intend to report on Form 8-K all amendments to or waivers from the code of ethics that are required to be reported by the rules of the Securities and Exchange Commission.
CONTACTING THE BOARD
If you wish to contact the board, you may do so by writing the board at:
Giant Industries, Inc. 23733 N. Scottsdale Rd. Scottsdale, AZ 85255 Attention: Corporate Secretary (Board Matters)
If you wish to contact the presiding director of the non-management directors or the non-management directors as a group, you may do so by sending your correspondence to the attention of the Corporate Secretary (Presiding Director) or to the attention of the Corporate Secretary (Non- Management Directors), as appropriate. Our corporate secretary will forward your correspondence to the appropriate members of the board.
SECTION 16(A) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE
The federal securities laws require our officers and directors, and persons who own more than 10% of our common stock, to file reports of ownership and changes in ownership with the Securities and Exchange Commission and the New York Stock Exchange. These individuals also are required to furnish us with copies of all reports they file. Based solely upon a review of the filings provided to us during 2006, or with respect to 2006, or written representations that no filings were required, we believe that each person who at any time during 2006 was a director, officer, or greater than 10% beneficial owner filed the required reports on a timely basis.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
OVERVIEW
The purpose of this compensation discussion and analysis is to present our overall compensation objectives, policies, and practices and is intended to provide the material information necessary to understand our compensation policies and decisions for our principal executive officer, principal financial officer, and our three other most highly compensated executive officers. We will refer to these five persons as our named executive officers.
PURPOSE OF THE COMPENSATION COMMITTEE
The compensation committee of the board of directors has responsibility for (i) overseeing the administration of our compensation programs (including our stock incentive plans, except as otherwise specified by the board), (ii) setting the compensation for our chief executive officer (the "CEO") and our president, (iii) reviewing and approving the compensation of our executive officers, (iv) preparing any reports on executive compensation required by the rules of the Securities and Exchange Commission, and (v) addressing any further compensation matters requested by the board.
COMPENSATION PHILOSOPHY AND OBJECTIVES
The key principle behind our compensation program is to attract, retain and motivate superior individuals to work for us. To that end, we have designed compensation programs to:
- reward key personnel who, by the nature and scope of their positions, significantly impact our overall results and success,
- reward employees based on an evaluation of the participant's individual performance and accomplishments, and contributions to the achievement of business unit strategies and goals,
- reward commitment to our core values,
- reward contributions to the achievement of annual goals,
- provide incentives and rewards for superior performance linked to our profitability and increases in stockholder value, and
- -	provide mechanisms for retirement savings as well as certain benefits in the event of death, disability, or termination of employment.
In the case of our CEO, president, chief financial officer, and general counsel, we also have entered into employment contracts with those individuals. The terms of those employment contracts are discussed in more detail below under the heading "Potential Payments Upon Termination or Change-In-Control".
Our general compensation philosophy is established by the compensation committee of our board of directors in consultation with senior management.
In particular, we consider the following major elements in establishing compensation for our executive officers:
(1) The level of compensation paid to executive officers in similar positions by other companies. To determine whether pay is competitive, our compensation committee, from time to time, compares our total compensation and benefits packages with those of other companies in the same or similar industries or with other similar attributes such as size or capitalization. Some, but not all, of these companies are included in the S&P Industrials Index and the S&P Energy Composite Index. Many of the companies used in these indexes are engaged in different businesses than us and almost all are larger. The committee recognizes that our asset and business mix is rather unique given our relatively smaller size, making direct comparisons of compensation difficult. The committee also recognizes, however, that total compensation for similar positions must be competitive to attract and retain competent executives.
(2) The individual performance of each executive officer. Individual performance includes any specific accomplishments of the executive officer, demonstration of job knowledge and skills, teamwork and demonstration of our core values.
(3) The responsibility and authority of each position relative to other positions within our organization.
(4) Corporate performance. Corporate performance is evaluated both subjectively and objectively. Subjectively, the committee discusses and makes its own determination of how we performed relative to the opportunities and difficulties we encountered during the year and relative to the performance of our competitors and business conditions. Objectively, corporate performance is measured by earnings, cash flow, and other financial results compared to budgeted results.
(5) Incentives for executive officers to make decisions and take actions that will increase the market value of our stock over the long- term and that encourage our executives to remain with us as long-term employees.
We do not have a pre-established policy or target for the allocation between either cash and non-cash or short-term and long-term incentive compensation. In the case of base salary and awards granted under our stock plan to executive officers, the application and weight given each of these factors is not done mechanically or quantitatively, but rather the committee uses its discretion, best judgment and the experience of its members to examine the totality of all of the relevant factors. In exercising this discretion, the committee believes that it generally tends to give greater weight to factors (1), (2), and (3) above in fixing base salary and any merit/cost of living increase and to factor (5) in making awards under our stock plan. The committee believes that it considers factor (4) equally in making all awards. In applying factor (1), the committee believes that total compensation is similar to amounts paid to equally competent employees in similar positions at other companies after giving effect to the belief that we have historically granted fewer stock- based awards than appears to be the historical practice at other companies.
ROLE OF EXECUTIVE OFFICERS IN COMPENSATION DECISIONS
The compensation committee makes all compensation decisions for our CEO and our president. The committee also reviews and approves the compensation of our executive officers other than our CEO and president, including the individual elements of the total compensation for such executive officers. Specific decisions regarding the compensation for executive officers other than the CEO and president are made by the CEO and president.
2006 EXECUTIVE COMPENSATION COMPONENTS
For the fiscal year ended December 31, 2006, the principal components of compensation for our named executive officers were:
- Base salary, - Bonus, - Long-term equity compensation, - Retirement and other benefits, and - Perquisites and other personal benefits.
Detailed information regarding the specific amounts of compensation paid or earned by the named executive officers in 2006 is set forth in the tables following this compensation discussion and analysis.
BASE SALARY
We provide our named executive officers and other employees with base salary to compensate them for services rendered during the fiscal year. Increases in base salary are considered annually as part of our performance review process as well as upon a promotion or other change in job responsibility. In approving salary increases in 2006, the compensation committee considered the elements and criteria discussed above, information on executive compensation paid by other companies, the terms of the employment agreements noted above, and various other information relating to compensation.
BONUS
For our executive officers, as well as for certain other key management employees, we adopted the 2006 Management Discretionary Bonus Plan. As to our CEO and president, the plan is administered by the compensation committee. As to all other employees, the plan is administered by an administrative committee consisting of our CEO and president.
The plan provided for the accrual during 2006 of a pool of money from which bonuses could be paid. We generally had to meet a minimum pre-tax level of earnings for 2006 before any bonuses could be paid. As our performance exceeded this level during the year, the accrual was increased. The accrual did not, however, reach the full amount budgeted for management bonuses in the 2006 budget.
Under the plan, executives were rewarded based on an evaluation of the participant's individual performance and accomplishments, and contributions to the achievement of business unit strategies and goals. They also were rewarded based on an evaluation of the executive's commitment to our core values and contributions to the achievement of our 2006 goals for: (i) pre-tax earnings, cash flow and capital expenditures; (ii) renovating and placing into service the crude oil pipeline we acquired in 2005; (iii) refinery utilization; (iv) compliance with low sulfur diesel standards; (v) maximizing the synergies associated with the Dial Oil acquisition; (vi) maintenance of our Sarbanes-Oxley 404 compliance status; and (vii) strategic growth.
The compensation committee determined the bonus for our CEO and president. The CEO and the president made recommendations to the committee of the amount of bonuses to be paid to our other executive officers. Subject to the review and approval of the compensation committee, the amount of bonuses actually paid to these executive officers is within the sole discretion of the administrative committee. To receive a bonus, the participant had to be employed by us at the time the funds were awarded.
In reviewing the administrative committee's proposed bonuses for our executive officers, and determining the bonuses to be paid to our CEO and president, the compensation committee reviewed and discussed information on executive compensation paid by other companies as well as various other materials and matters regarding the payment of bonuses to the Corporation's executive officers. These included: (1) the elements and criteria considered by the compensation committee in setting executive compensation discussed above; (2) the application of the provisions of the plan regarding the award of bonuses, including how our results of operations for 2006 compared to our goals and objectives; (3) the performance and contribution of the executive officers; (4) Section 162(m) of the Internal Revenue Code; and (5) the terms of the employment agreements with the individuals noted above. In looking at our performance, the committee considered both our financial performance and our operating performance. In particular, while year-end financial performance was good, the committee also considered the fact that there were unscheduled outages at the refineries during the year, delays in completing certain projects, and cost overruns on several refinery projects.
In connection with the compensation committee's discussion of the 2006 performance and contribution of both our CEO and president, the compensation committee took note of the leadership role that they had played in the following: (1) year-end financial performance; (2) the pending Western transaction; (3) the acquisition of the assets of Amigo Petroleum in August 2006; and (4) the acquisition of Empire Oil Co. effective January 1, 2007. The Committee also took into account the fact that while not all of our identified goals for 2006 were completely met, we made significant progress towards many of them as well as in other areas.
LONG-TERM EQUITY COMPENSATION
Although we occasionally make stock-based awards to employees, we do not have any regular schedule for making such awards. Further, we currently do not have any stock ownership guidelines for our executive officers. If the pending transaction with Western does not close, we expect to develop a regular schedule for making stock-based awards and guidelines for stock ownership in the near-term.
We last made a stock-based award on December 6, 2005, when certain of our officers and key employees, including the CEO and the president, were awarded restricted stock. In deciding to award restricted stock rather than stock options as we had in the past, we took into account the accounting rule for stock options requiring expensing. The restricted shares vest in five equal annual installments beginning on December 6, 2006. If the Western transaction closes, the vesting of the shares will be accelerated to the closing date of the transaction. The holders are entitled to receive dividends on the restricted shares to the same extent dividends are paid to all stockholders. We currently do not pay dividends.
In making stock-based awards, including the 2005 award of restricted stock, the compensation committee considers, among other things: (1) the contributions of each of the recipients to our success, and (2) the motivation that the awards may create for the recipients to make decisions that will increase the market value of our stock over the long term and encourage these individuals to remain with us as long-term employees.
RETIREMENT AND OTHER BENEFITS
We have a 401(k) retirement savings plan for all employees, including the named executive officers. The objective of the plan is to provide a mechanism for employees to save for retirement as well as certain benefits in the event of death, disability or termination of employment.
Employees may make pre-tax and after-tax contributions to the plan. Participants older than 50 also may make catch-up contributions to the plan. We currently make matching contributions on the pre-tax and after- tax contributions, but not for catch-up contributions. All of these contributions are subject to limits set periodically by the Internal Revenue Service ("IRS"). We currently also make a separate supplemental contribution annually to certain of our employees, including the named executive officers. Employees have a variety of mutual funds in which to invest their accounts. The employees generally are fully vested in their own contributions and our supplemental contributions when the contributions are made. Our matching contributions are subject to a three year cliff vesting schedule.
During 2005, we adopted a Deferred Compensation Plan. Participation in the Plan is limited to certain highly compensated members of our management team, including the named executive officers, and the members of our board of directors. The plan was adopted to provide our highly
compensated executives with a mechanism to defer compensation to future years for tax and other financial planning purposes and to keep such executives whole in view of the IRS limitations applicable to the 401(k) plan.
Under the plan, the participants may defer a portion of their annual salary and/or bonus to future years. They effectively may invest the deferred compensation in a variety of investment fund choices. At our discretion, we also will match a portion of the amounts deferred on a basis similar to matches in our 401(k) plan, but without regard to the annual caps applicable to the 401(k) plan. The plan is discussed in more detail below under the heading "Nonqualified Deferred Compensation".
We also have various medical, dental and insurance programs available for all employees, including the named executive officers. We bear a portion of the costs of these programs for all employees on the same basis. The objective of these programs is to provide competitive, cost- effective benefits to all employees.
PERQUISITES AND OTHER PERSONAL BENEFITS
We provide the named executive officers with perquisites and other personal benefits that the we and the compensation committee believe are reasonable and consistent with our overall compensation philosophy. We believe this enables us to attract and retain superior employees for key positions. We periodically review the levels and types of perquisites and other personal benefits provided to the named executive officers.
The perquisites and other personal benefits provided to the named executive officers include an automobile allowance, use of the company aircraft, use of company provided golf club memberships, use of company event tickets, tax preparation services, and use of administrative assistant services for personal matters. Although many of these activities have a business component, the individuals also receive personal benefits.
TAX AND ACCOUNTING IMPLICATIONS
Section 162 of the Internal Revenue Code includes a provision limiting tax deductions for certain executive compensation in excess of $1,000,000 for each executive. The committee has analyzed the impact of this tax law on our compensation policies, and has decided for the present to not modify our compensation policies based on this tax law. The committee will periodically reconsider its decision as circumstances dictate.
In 2004, the American Jobs Creation Act of 2004 was enacted. The act changed the tax rules applicable to nonqualified deferred compensation arrangements. Although the final regulations have not become effective yet, we believe we are operating in good faith compliance with the statutory provisions that are currently effective.
Beginning on January 1, 2006, we began accounting for stock-based compensation awarded employees, including the named executive officers, in accordance with the requirements of FASB Statement 123R. For more information regarding this accounting requirement, please see Note 10 to our Consolidated Financial Statements included in Part I of this Annual Report on Form 10-K.
COMPENSATION COMMITTEE REPORT
The following report of the compensation committee of the board on executive compensation shall not be deemed to be "soliciting material" or to be "filed" with the Securities and Exchange Commission nor shall this information be incorporated by reference into any future filing made by us with the Securities and Exchange Commission, except to the extent that we specifically incorporate it by reference into any filing.
Our compensation committee has reviewed and discussed with management the Compensation Discussion and Analysis required by Item 402(b) of Regulation S-K and, based on such review and discussion, the compensation committee recommended to the board of directors that the Compensation Discussion and Analysis be included in this Form 10-K.
THE COMPENSATION COMMITTEE
Larry L. DeRoin, Chairman Brooks J. Klimley Donald M. Wilkinson George M. Rapport
SUMMARY COMPENSATION TABLE
The following table sets forth the total compensation paid or earned by our named executive officers for the fiscal year ended December 31, 2006.
- ------- (1) Includes compensation deferred at the election of the named executive officer.
(2) The amounts disclosed in this column represent the earnings realized in 2006 by the named executive officers on compensation deferred in our Deferred Compensation Plan, a nonqualified defined contribution plan.
(3) The amounts disclosed in this column represent the following:
Description Holliger Gust Keller Cox Bullerdick --------------------- -------- ------- ------- ------- ---------- 401(k) match $ 13,200 $13,200 $13,200 $13,200 $13,200
Supplemental 401(k) contribution from us for 2005 made in 2006* $ 6,300 $ 6,300 $ 6,300 $ 6,300 $ 6,300
Deferred compensation plan match $106,366 $65,351 $17,365 $23,971 $12,243
Auto allowance $ 9,400 $ 9,400 $ 9,400 $ 7,000 $ 7,000
Personal use of company aircraft** $ 22,409 $ 0 $ 0 $ 0 $ 0
Personal use of golf club membership $ 4,263 $ 0 $ 0 $ 6,329 $ 0
Tax preparation services $ 5,935 $ 0 $ 0 $ 0 $ 0 -------- ------- ------- ------- ------- $167,873 $94,251 $46,265 $56,800 $38,743
The named executive officers also used company tickets for various events throughout the year and occasionally used their administrative assistants for personal projects. No amounts are included in this column for these benefits as there was no incremental cost to us associated with these benefits.
*The supplemental 401(k) contribution from us was made in the form of shares of our stock. The amount reported in the table above represents the value of the shares on the date of contribution.
**The incremental cost to us of personal use of the corporate aircraft is determined on a per flight basis and includes the cost of actual fuel used, the hourly cost of aircraft maintenance for the applicable number of flight hours, landing fees and related costs, crew expenses, and other variable costs specifically incurred.
GRANTS OF PLAN-BASED AWARDS
The following table summarizes the grants of plan-based awards to our named executive officers in 2006.
Estimated Future Payouts Under Non-Equity Incentive Name Plan Awards - ---------------- -------------------------- Fred L. Holliger (1) Morgan Gust (1) Jack W. Keller (1) Mark B. Cox (1) Kim H. Bullerdick (1)
(1) In 2006, we adopted the 2006 Management Discretionary Bonus Plan. The named executive officers, as well as certain other key employees, participated in the plan. The plan did not provide for threshold, target, or maximum payouts. For a detailed discussion of how the plan was implemented, please see the discussion under the heading "Bonus" in the "Compensation, Discussion and Analysis" section above.
OUTSTANDING EQUITY AWARDS AT FISCAL YEAR-END
The following table provides information on outstanding equity awards held by our named executive officers as of December 31, 2006.
- ------- (1) This column relates to awards of restricted shares made on December 6, 2005. The restricted shares vest in five equal annual installments beginning December 6, 2006.
(2) Based on a price of $74.95 on December 29, 2006, which was the closing price of our stock on the last business day of 2006.
OPTION EXERCISES AND STOCK VESTED
The following table provides information on option exercises during 2006 and the value of restricted stock that vested in 2006 for each of the named executive officers.
Option Awards Stock Awards ---------------------- ---------------------- Number of Value Number of Value Shares Realized Shares Realized Acquired on on Acquired on on Exercise Exercise Exercise Exercise Name (#) ($) (#) ($)(1) - ---------------- ----------- -------- ----------- -------- Fred L. Holliger 0 $0 900 $69,111 Morgan Gust 0 0 600 $46,074 Jack W. Keller 0 0 360 $27,644 Mark B. Cox 0 0 360 $27,644 Kim H. Bullerdick 0 0 360 $27,644
(1) Based on a closing price of $76.79 for our stock on December 6, 2006, the date the restricted shares vested.
PENSION BENEFITS
Our named executive officers do not participate in any pension plans.
NONQUALIFIED DEFERRED COMPENSATION
The following table summarizes 2006 contributions, earnings and balances under our Deferred Compensation Plan for each of our named executive officers.
On October 31, 2005, we established the Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan (the "Plan" or the "DCP"). The plan was adopted to provide our highly compensated executives with a mechanism to defer compensation to future years for tax and other financial planning purposes and to keep such executives whole in view of the IRS limitations applicable to the 401(k) plan.
The Plan is administered by an administrative committee, appointed by our Board, to perform the duties of the plan administrator.
Participation in the Plan is limited to (a) non-employee members of our board of directors, and (b) a select group of our management or highly compensated employees selected by the board, or its designee, to be participants.
Effective October 31, 2005 (January 1, 2006 for non-employee members of the board), employee participants may elect to defer into the Plan a portion of their compensation for the plan year for services after the deferral election. For employees, deferrals may not exceed sixty percent (60%) of their compensation, and non-employee members of the board may defer all of their compensation for services after their deferral election. At our discretion, we also will match a portion of the amounts deferred on a basis similar to matches in our 401(k) plan, but without regard to the annual caps applicable to the 401(k) plan.
The administrative committee for the Plan will open and maintain separate accounts for each participant to which their deferrals and our contributions will be credited. Amounts credited to the accounts will be deemed invested according to investment directions made by the participants in one or more hypothetical investment funds designated by the administrative committee. The performance of the hypothetical investment funds is measured by the performance of actual funds. The amounts in the participants' accounts will be adjusted as if they had actually been invested in the investment funds on which the hypothetical funds were based.
Participants must elect, no later than the time of their initial deferral election, the form in which they will receive the remainder of their vested account after their separation from service on or after normal retirement age. Participants may choose a lump sum or annual installments paid over a period they select up to twenty (20) years. Unless the participant is a key employee (as defined in Internal Revenue Code Section 409A), a lump sum benefit will be paid within sixty (60) days of the date the participant separates from service, and distribution of benefits in the form of installments will begin within sixty (60) days after the close of the plan year in which the participant separates from service. If the participant is a key employee, the distribution on account of separation of service cannot begin until six (6) months after such separation of service.
Participants may make a subsequent election to further defer their distribution date or change the form of benefit (except a change that shortens the installment period), if (1) the election does not take effect for at least twelve (12) months, and (2) the initial distribution date is rescheduled at least five (5) years from the date the distribution would have otherwise been made.
Except in the case of death or disability, if a participant separates from service before normal retirement age, the remainder of their vested account will be paid in a lump sum within sixty (60) days after the separation from service unless the participant is a key employee. If the participant is a key employee, the distribution on account of separation of service cannot begin until six (6) months after such separation of service.
If a participant is determined by the administrative committee to be disabled, they will receive the remainder of their vested account balance in the form of a lump sum within sixty (60) days after the administrative committee determines that the participant has become disabled. If, however, the participant has attained normal retirement age at the time they are determined to be disabled, their vested account will be paid in the same form and at the same time elected with respect to their normal retirement benefit.
If the participant dies before the commencement of distribution of their benefits, the participant's beneficiary will receive a benefit equal to the balance of the participant's vested account.
If the administrative committee determines that our deduction for a payment to a participant from the Plan will be limited or eliminated under Section 162(m) of the Internal Revenue Code, the payment will be delayed until the earliest date that the administrative committee determines that payment would be permitted without the deduction's being limited or eliminated.
No benefit payable under the Plan to any person is subject in any manner to anticipation, alienation, sale, transfer, assignment, pledge, encumbrance or charge, and any attempt to anticipate, alienate, sell, transfer, assign, pledge, encumber, charge or otherwise dispose of the same shall be void. No benefit shall in any manner be subject to the debts, contracts, liabilities, engagements or torts of any person, nor shall it be subject to attachment or legal process for or against any person, except to the extent as may be required by law and except with respect to debts or liabilities of a participant to us.
When a participant makes each annual deferral election, they may elect to receive, before separation from service, the portion of their vested account attributable to such annual deferrals in a plan year that begins at least one full plan year after the close of the plan year of the deferral. The distribution will be paid within sixty (60) days after the beginning of the designated plan year. A participant may make a subsequent
election to further defer that distribution date, if (1) the election does not take effect for at least twelve (12) months, (2) the election is made at least one year before the plan year in which the distribution is scheduled to take place, and (3) the distribution date is rescheduled at least five (5) years from the date the distribution was previously scheduled. Subsequent elections that accelerate the distribution are prohibited. If the participant dies or separates from service, or there is a change in control, before the scheduled payment, the distribution will be made no later than it would under the Plan provisions governing these events.
In accordance with procedures established by the administrative committee, a participant may receive a distribution upon the occurrence of an "unforeseeable emergency" as defined in Section 409A of the Internal Revenue Code and the regulations thereunder. If a distribution under the Plan is made on account of an unforeseeable emergency, or a hardship distribution is made under our 401(k) Plan, the participant's deferral election for the remainder of the plan year is cancelled.
In the event of a change in control as defined in Section 409A of the Internal Revenue Code, a participant will receive the remaining amount in their vested account in a lump sum within sixty (60) days after the change in control, if and only if they made such an election at the time of their initial deferral election.
The portion of the account attributable to a participant's deferrals is fully vested. The portions attributable to additional employer contributions are subject to the same vesting schedules as they are in our 401(k) Plan. If a participant separates from service before becoming fully vested, they will forfeit the unvested portion of their account.
POTENTIAL PAYMENTS UPON TERMINATION OR CHANGE-IN-CONTROL
We have entered into employment agreements with Mr. Holliger, Mr. Gust, Mr. Cox and Mr. Bullerdick. The employment agreements expire on December 11, 2007 but will automatically extend for successive one-year periods unless we or the executive gives notice of termination.
Pursuant to the agreements, Mr. Holliger, Mr. Gust, Mr. Cox, and Mr. Bullerdick receive base salary at an annual rate as follows: Mr. Holliger - - $650,000, Mr. Gust - $450,000, Mr. Cox - $265,000, and Mr. Bullerdick - $225,000. The amounts are subject to increase during the terms of the agreements as the board deems appropriate with respect to Mr. Holliger and Mr. Gust, and as the chief executive deems appropriate and the compensation committee approves with respect to Mr. Cox and Mr. Bullerdick. The base salary for each executive may only be reduced in connection with an across-the-board reduction applicable to all of our senior executives. Each agreement provides that the executive is entitled to participate in any bonus or benefit plans that we make available to our senior executives.
The following is a summary of the amounts or benefits each executive or his estate will receive from us if he is terminated under the circumstance noted. The agreements and applicable amendments have been filed as exhibits to our Annual Report on Form 10-K for the year ended December 31, 2003 and our Quarterly Report on Form 10-Q for the quarter ended June 30, 2006.
(1) Employment of the executive is terminated (1) because of the executive's death or disability, (2) by the executive without good reason, or (3) by us with cause, in each case either prior to a change of control or more than three years following a change in control:
- Any unpaid base salary as of the termination date.
- Reimbursement in accordance with our policies then in effect of any expenses incurred prior to termination.
- Accrued and vested benefits due under our benefit plans.
- Any discretionary bonus for a prior year that has been earned but not paid.
- The right for one year following termination to exercise all vested stock options outstanding on the termination date.
(2) Employment of the executive is terminated (1) within three years of a change of control or by the executive with good reason, or (2) upon the expiration of the term of the agreement within three years of a change of control:
- The amounts and benefits described in paragraph 1 above except the stock option benefit.
- An amount equal to three times the sum of: (1) the base salary in effect at the time of termination, and (2) the average annual bonuses paid to the executive for the last three years, but in no event less than 25% of the executive's base salary.
- Unless expressly prohibited under the terms of the plan(s) pursuant to which the awards were made, all unvested stock options or other stock awards owned by the executive shall vest on the termination date, and the executive shall have the right for one year following termination to exercise all stock options outstanding on the termination date.
- Reimbursement for certain taxes incurred by the executive as a result of receiving the above amounts.
(3) Employment of the executive is terminated (1) by the executive for good reason, (2) by us without cause, or (3) because we gave notice of our intention not to renew the agreement when it expires, in each case either prior to a change of control or more than three years following a change of control:
- The amounts and benefits described in paragraph 1 above.
- A lump sum equal to the executive's base salary in effect at the time of termination.
The agreements also contain restrictive covenants. In general, the executives must maintain the confidentiality of company information and may not compete with us for one year following termination.
The pending transaction with Western will result in payments to our named executive officers if the transaction closes. At the effective time of the merger with Western, our executive officers are required to resign their positions as officers of Giant. Western may, but is not required to, offer employment to some or all of our executive officers on the same basis as our other employees. As noted above, our employment agreements with Fred Holliger, Morgan Gust, Mark Cox and Kim Bullerdick require us to make severance payments to them if their employment is terminated within three years following a change in control. The severance payments are equal to three times the executive's base salary plus the average annual bonus paid to the executive for the three years prior to the fiscal year in which the termination occurs, but not less than 25% of the executive's then base salary. In addition, if the severance payments are deemed to be "excess parachute payments" under applicable income tax laws and therefore subject to excise tax, we will pay the executive the amount of the excise tax and any tax on the amount of the payment made. The following table summarizes the severance payments payable to our executive officers under their employment agreements:
Estimated Base Average Severance Excise Total Name Salary Bonus Payment Tax (1) Payments - -------------- -------- ---------- ---------- ---------- ---------- Fred Holliger $650,000 $1,258,333 $5,725,000 $2,300,013 $8,025,013 Morgan Gust $450,000 $ 725,000 $3,525,000 $1,289,912 $4,814,912 Mark Cox $265,000 $ 345,000 $1,830,000 $ 738,933 $2,568,933 Kim Bullerdick $225,000 $ 290,000 $1,545,000 $ 664,735 $2,209,735 - ------- (1) Estimated excise tax includes only the tax on the severance payments and the tax on proceeds from the restricted stock held by the individuals that is vesting on the effective date of the merger, but excludes any additional excise tax payable as a result of bonuses to be paid in connection with the transaction and other compensation or benefits (other than, in the case of Mr. Bullerdick, retiree medical benefits) to be received by the executive.
DIRECTOR COMPENSATION
The following table summarizes the compensation received by our non- employee directors in 2006.
Our non-employee directors receive the following compensation for serving as a director for us:
- $2,500 per month or portion of a month served as a director.
- $1,500 for each in-person meeting of the board attended and $1,000 for each telephonic meeting of the board in which the director participates.
- $1,250 for each in-person committee meeting attended and $1,000 for each telephonic committee meeting in which the director participates.
- $1,000 for each in-person or telephonic meeting of any special committee in which the director participates.
- $750 per month or portion of a month served as chairman of the audit committee and $500 per month or portion of a month served as chairman of the compensation committee or the corporate governance and nominating committee.
Our directors also are eligible to participate in our Deferred Compensation Plan. We also reimburse all directors for reasonable, out-of-pocket expenses that they incur to attend our board and committee meetings.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The following table includes information regarding securities authorized for issuance under our equity compensation plans.
For a description of our equity compensation plans see Note 10 to our Consolidated Financial Statements included in Item 8.
SECURITY OWNERSHIP OF MANAGEMENT
The following table sets forth information concerning the beneficial ownership of our common stock as of March 1, 2007 (unless otherwise noted) by (1) each director and nominee for director, (2) each named executive officer, and (3) all executive officers and directors as a group. Except as otherwise indicated, to our knowledge, all persons listed below have sole voting and investment power with respect to their shares, except to the extent that authority is shared by spouses under applicable law. Our only outstanding class of equity securities is our common stock.
- ------- *Less than 1%
(1) Includes holdings of restricted stock, if any.
(2) The amount listed is the approximate number of our shares allocated to the Giant Stock Fund portion of the individual's account in the Giant Industries, Inc. and Affiliated Companies 401(k) Plan (the "401(k)") as of December 31, 2006. The Giant Stock Fund is composed primarily of our common stock and a small amount (approximately 5%) of short-term money market funds. Ownership in the Giant Stock Fund is measured in units rather than shares of common stock. Each 401(k) participant has the right to direct the 401(k) trustee to vote the participant's proportionate share of the common stock underlying the units in the Giant Stock Fund. We determine a participant's proportionate share by multiplying the total number of underlying shares held in the Giant Stock Fund by a fraction, the numerator of which is the number of underlying shares allocated to the participant and the denominator of which is the number of underlying shares allocated to all participants' accounts as of the record date. The 401(k) trustee and the participants have shared dispositive power with respect to the underlying shares allocated to a participant's account.
(3) 5,500 shares are held in a trust in which Mr. Gust and his spouse are settlors, co-trustees and beneficiaries.
(4) Shares are held in a living trust in which Mr. Bullerdick is the settlor, co-trustee and a beneficiary.
(5) To date, non-employee directors have not participated in our stock incentive plans or the 401(k).
SHARES OWNED BY CERTAIN SHAREHOLDERS
The following table sets forth information concerning the beneficial ownership of our common stock as of March 1, 2007 (unless otherwise noted) by each stockholder who is known by us to own beneficially in excess of 5% of our outstanding common stock. Except as set forth below, no other person or entity is known by us to beneficially own more than 5% of our outstanding common stock.
Amount and Nature of Beneficial Percent Name and Address of Beneficial Owners Ownership of Class - ------------------------------------- ------------ -------- Gabelli entities........................... 1,263,800(1) 8.6%
Barclays entities.......................... 1,115,752(2) 7.6% - ------- (1) As reported on a Schedule 13D, dated September 8, 2006. In the 13D, the following entities reported ownership of our shares:
GAMCO Asset Management Inc............................. 954,000 One Corporate Center Rye, New York 10580
Gabelli Funds, LLC..................................... 203,000 One Corporate Center Rye, New York 10580
Gabelli Securities, Inc................................ 79,800 One Corporate Center Rye, New York 10580
MJG Associates, Inc.................................... 12,000 140 Greenwich Avenue Greenwich, Connecticut 06830
Mario J. Gabelli....................................... 12,000 One Corporate Center Rye, New York 10580
Gabelli Foundation, Inc................................ 3,000 165 W. Liberty Street --------- Reno, Nevada 89501 1,263,800 =========
(2) As reported on a Schedule 13G, dated January 31, 2007. In the Schedule 13G, the following entities reported ownership of our shares:
Barclays Global Investors, NA.......................... 880,728 45 Fremont Street San Francisco, California 94105
Barclays Global Fund Advisors.......................... 235,024 45 Fremont Street --------- San Francisco, California 94105
Total.................................................. 1,115,752 =========
Each of the entities has sole voting and dispositive power with respect to the shares noted except that Barclays Global Investors, NA has sole voting power only as to 828,511 shares.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
We did not have any transactions with related persons during 2006, nor do we currently anticipate having any transactions with related persons in 2007.
The information required by this item regarding "Director Independence" is incorporated by reference to the information contained in Item 10 under the caption "About the Board of Directors".
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The following table sets forth fees for services Deloitte & Touche LLP provided to us during 2006 and 2005:
2006 2005 ---------- ---------- Audit fees (1)............................... $1,307,500 $1,432,975 Audit-related fees(2)........................ 61,070 42,450 Tax fees(3).................................. 20,870 13,000 All other fees(4)............................ 22,400 0 ---------- ---------- Total...................................... $1,411,840 $1,488,425 ========== ========== - ------- (1) Represents aggregate fees for services in connection with the audit of our annual financial statements and review of our quarterly financial statements, attestation procedures on internal controls over financial reporting, and services related to Securities and Exchange Commission matters and filings.
(2) Represents aggregate fees for services in connection with employee benefit plan audits.
(3) Represents fees for services provided in connection with our tax returns and tax compliance and consulting.
(4) Represents fees for services related to our pending transaction with Western Refining, Inc.
The audit committee has determined that the provision of certain non- audit services by Deloitte & Touche LLP is compatible with maintaining their independence. Except as noted below, the audit committee approves in advance all audit and non-audit services provided by Deloitte & Touche LLP. The chairman, or in his absence, any other member of the audit committee also has delegated authority from the committee to pre-approve services provided by Deloitte & Touche LLP. In this case, the member pre- approving the services must report the pre-approval to the audit committee at its next meeting. In addition, as permitted by SEC rules, our chief financial officer, chief accounting officer, or controller may approve permitted non-audit services having a value of less than $5,000 in certain limited circumstances. During 2006, all services provided by Deloitte & Touche LLP were pre-approved in accordance with this policy.
PART IV
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are included in Item 8:
(i) Report of Independent Registered Public Accounting Firm
(ii) Consolidated Balance Sheets - December 31, 2006 and 2005
(iii) Consolidated Statements of Operations - Years ended December 31, 2006, 2005, and 2004
(iv) Consolidated Statements of Comprehensive Income - Years ended December 31, 2006, 2005 and 2004
(v) Consolidated Statements of Stockholders' Equity - Years ended December 31, 2006, 2005, and 2004
(vi) Consolidated Statements of Cash Flows - Years ended December 31, 2006, 2005, and 2004
(vii) Notes to Consolidated Financial Statements
(2) Financial Statement Schedule. The following financial statement schedule of Giant Industries, Inc. for the years ended December 31, 2006, 2005, and 2004 is filed as part of this report and should be read in conjunction with the Consolidated Financial Statements of Giant Industries, Inc.
Report of Independent Registered Public Accounting Firm Schedule II - Valuation and Qualifying Accounts
Schedules not listed above have been omitted because they are not applicable or are not required or because the information required to be set forth therein is included in the Consolidated Financial Statements or Notes thereto.
(3) Exhibits. The Exhibits listed on the accompanying Index to Exhibits immediately following the financial statement schedule are filed as part of, or incorporated by reference into, this Report.
Except for plans generally available to all employees, contracts with management and any compensatory plans or arrangements relating to management are as follows:
Exhibit No. Description - ------- ---------------------------------------------------------- 10.15 Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, File No. 1-10398.
10.16* First Amendment to the Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan.
10.17 Giant Industries, Inc. 1998 Stock Incentive Plan. Incorporated by reference to Appendix H to the Joint Proxy Statement/Prospectus included in the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed May 4, 1998, File No. 333-51785.
10.18 Amendment No. 1 to 1998 Stock Incentive Plan, dated September 13, 2000. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No 1-10398.
10.19 Amendment No. 2 to 1998 Stock Incentive Plan, dated March 27, 2002. Incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No 1-10398.
10.20 ESOP Substitute Excess Deferred Compensation Benefit Plan. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-10398.
10.21 2006 Management Discretionary Bonus Plan. Incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2005, File No. 1-10398.
10.22* 2007 Management Discretionary Bonus Plan.
10.23 Employment Agreement, dated as of December 12, 2003, between Fred L. Holliger and Giant Industries, Inc. Incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.24 Employment Agreement, dated as of December 12, 2003, between Morgan Gust and Giant Industries, Inc. Incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.25 Employment Agreement, dated as of December 12, 2003, between Mark B. Cox and Giant Industries, Inc. Incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.26 First Amendment to Employment Agreement, dated August 4, 2006, between Giant Industries, Inc. and Mark B. Cox. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 1-10398.
10.27 Employment Agreement, dated as of December 12, 2003, between Kim H. Bullerdick and Giant Industries, Inc. Incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.28 First Amendment to Employment Agreement, dated August 6, 2006, between Giant Industries, Inc. and Kim H. Bullerdick. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 1-10398.
10.29 Consulting and Non-Competition Agreement, dated August 26, 2006, between Fred L. Holliger and Western Refining, Inc. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated August 30, 2006.
10.30 Amendment No. 1 to Consulting Agreement, dated November 12, 2006, between Fred L. Holliger and Western Refining, Inc. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated November 13, 2006. - ------- *Filed herewith.
(b) Reports on Form 8-K. We filed the following reports on Form 8-K during the fourth quarter of 2006 and to date:
(i) On October 12, 2006, we filed a Form 8-K, dated October 12, 2006 containing a press release relating to the Western transaction.
(ii) On November 13, 2006, we filed a Form 8-K, dated November 13, 2006 regarding the amendment to the terms of the Western transaction.
(iii) On November 14, 2006, we filed a Form 8-K, dated November 14, 2006, containing a press release detailing our earnings for the quarter ended September 30, 2006.
(iv) On January 19, 2007, we filed a Form 8-K, dated January 19, 2007, containing a press release relating to the Western transaction.
(v) On February 27, 2007, we filed a Form 8-K, dated February 27, 2007, containing a press release detailing our earnings for the quarter and year ended December 31, 2006.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
GIANT INDUSTRIES, INC.
By: /s/ FRED L. HOLLIGER ---------------------------- Fred L. Holliger Chairman of the Board and Chief Executive Officer
March 1, 2007
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the date indicated.
/s/ FRED L. HOLLIGER Chairman of the Board, Chief March 1, 2007 - ------------------------ Executive Officer and Director Fred L. Holliger
/s/ MARK B. COX Executive Vice President, March 1, 2007 - ------------------------ Treasurer, Chief Financial Mark B. Cox Officer and Assistant Secretary
/s/ LARRY L. DEROIN Director March 1, 2007 - ------------------------ Larry L. DeRoin
/s/ BROOKS J. KLIMLEY Director March 1, 2007 - ------------------------ Brooks J. Klimley
/s/ GEORGE M. RAPPORT Director March 1, 2007 - ------------------------ George M. Rapport
/s/ DONALD M. WILKINSON Director March 1, 2007 - ------------------------ Donald M. Wilkinson
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Stockholders of Giant Industries, Inc. Scottsdale, Arizona
We have audited the consolidated financial statements of Giant Industries Inc. and subsidiaries ("the Company") as of December 31, 2006 and 2005, and for each of the three years in the period ended December 31, 2006, management's assessment of the effectiveness of the Company's internal control over financial reporting as of December 31, 2006, and the effectiveness of the Company's internal control over financial reporting as of December 31, 2006, and have issued our reports thereon dated March 1, 2007 which express unqualified opinions and the financial statement opinion includes an explanatory paragraph relating to a change in accounting method for the adoption of Financial Accounting Standards Board ("FASB") Interpretation 47, Accounting for Conditional Asset Retirement Obligations in 2005, and a change in accounting method for the adoption of Statement of Financial Accounting Standards No. 158, Employer's Accounting for Defined Benefit Plans and Other Post-retirement Benefits, an Amendment of FASB Statements No. 87, 88, 106, and 132(R) in 2006; such financial statements and reports are included elsewhere in this Annual Report on Form 10-K. Our audits also included the consolidated financial statement schedule of the Company listed in Item 15. This consolidated financial statement schedule is the responsibility of the Company's management. Our responsibility is to express an opinion based on our audits. In our opinion, such consolidated financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ Deloitte & Touche LLP
Phoenix, Arizona March 1, 2007
SCHEDULE II
GIANT INDUSTRIES, INC. AND SUBSIDIARIES
Valuation and Qualifying Accounts Three Years Ended December 31, 2006
TRADE RECEIVABLES:
GIANT INDUSTRIES, INC.
ANNUAL REPORT ON FORM 10-K YEAR ENDED DECEMBER 31, 2005
INDEX TO EXHIBITS
DEFINITIONS:
Form S-1 - Refers to the Form S-1 Registration Statement under the Securities Act of 1933 as filed October 16, 1989, File No. 33-31584.
Amendment No. 3 - Refers to the Amendment No. 3 to Form S-1 Registration Statement under the Securities Act of 1933 as filed December 12, 1989, File No. 33-31584.
Form S-3 - Refers to the Form S-3 Registration Statement under the Securities Act of 1933 as filed September 22, 1993, File No. 33-69252.
Exhibit No. Description - ------- ----------------------------------------------------------- 2.1 Asset Purchase Agreement dated February 8, 2002, by and among, BP Corporation North America Inc., BP Products North America Inc., and Giant Industries, Inc. Incorporated by reference to Exhibit 2.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2001, File No. 1-10398.
2.2 Agreement and Plan of Merger, dated August 26, 2006, among Giant Industries, Inc., Western Refining, Inc. and New Acquisition Corporation. Incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated August 30, 2006.
2.3 Amendment No. 1 to Agreement and Plan of Merger, dated November 12, 2006, among Giant Industries, Inc., Western Refining, Inc. and New Acquisition Corporation. Incorporated by reference to Exhibit 2.1 to the Company's Current Report on Form 8-K dated November 13, 2006.
3.1 Restated Certificate of Incorporation of Giant Industries, Inc., a Delaware corporation. Incorporated by reference to Exhibit 3.1 to Amendment No. 3.
3.2 Bylaws of Giant Industries, Inc., a Delaware corporation, as amended September 9, 1999. Incorporated by reference to Exhibit 3.2 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, File No. 1-10398.
3.3 Articles of Incorporation of Giant Industries Arizona, Inc., an Arizona corporation ("Giant Arizona") formerly Giant Acquisition Corp. Incorporated by reference to Exhibit 2.1, Annex V to Form S-1.
3.4 Bylaws of Giant Arizona. Incorporated by reference to Exhibit 2.1, Annex VI to Form S-1.
3.5 Articles of Incorporation of Ciniza Production Company. Incorporated by reference to Exhibit 3.7 to Form S-3.
3.6 Bylaws of Ciniza Production Company. Incorporated by reference to Exhibit 3.8 to Form S-3.
3.7 Articles of Incorporation of Giant Stop-N-Go of New Mexico, Inc. Incorporated by reference to Exhibit 3.9 to Form S-3.
3.8 Bylaws of Giant Stop-N-Go of New Mexico, Inc. Incorporated by reference to Exhibit 3.10 to Form S-3.
3.9 Articles of Incorporation of Giant Four Corners, Inc. Incorporated by reference to Exhibit 3.11 to Form S-3.
3.10 Bylaws of Giant Four Corners, Inc. Incorporated by reference to Exhibit 3.12 to Form S-3.
3.11 Articles of Incorporation of Giant Mid-Continent, Inc. Incorporated by reference to Exhibit 3.13 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-10398.
3.12 Bylaws of Giant Mid-Continent, Inc. Incorporated by reference to Exhibit 3.14 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1994, File No. 1-10398.
3.13 Articles of Incorporation of San Juan Refining Company. Incorporated by reference to Exhibit 3.15 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, File No. 1-10398.
3.14 Bylaws of San Juan Refining Company. Incorporated by reference to Exhibit 3.16 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1995, File No. 1-10398.
3.15 Amended and Restated Articles of Incorporation of Phoenix Fuel Co., Inc. Incorporated by reference to Exhibit 3.15 to the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed July 15, 2002, File No. 333-92386.
3.16 Amended Bylaws of Phoenix Fuel Co., Inc. Incorporated by reference to Exhibit 3.18 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997, File No. 1-10398.
3.17 Articles of Incorporation of Giant Pipeline Company. Incorporated by reference to Exhibit 3.21 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, File No. 1-10398.
3.18 Bylaws of Giant Pipeline Company. Incorporated by reference to Exhibit 3.22 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999, File No. 1-10398.
3.19 Certificate of Incorporation of Giant Yorktown, Inc. Incorporated by reference to Exhibit 3.21 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, File No. 1-10398.
3.20 Bylaws of Giant Yorktown, Inc. Incorporated by reference to Exhibit 3.22 to the Company's Annual Report on Form 10-K for the year ended December 31, 2001, File No. 1-10398.
3.21 Certificate of Incorporation of Giant Yorktown Holding Company. Incorporated by reference to Exhibit 3.23 to the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed July 15, 2002, File No. 333-92386.
3.22 Bylaws of Giant Yorktown Holding Company. Incorporated by reference to Exhibit 3.24 to the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed July 15, 2002, File No. 333-92386.
3.23 Articles of Incorporation of Dial Oil Co. Incorporated by reference to Exhibit 3.23 to the Company's Annual Report on Form 10-K for the year ended December 31, 2005, File No. 1-10398.
3.24 Amended and Restated Bylaws of Dial Oil Co. Incorporated by reference to Exhibit 3.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 20, 2005, File No. 1-10398.
3.25* Articles of Incorporation of Empire Oil Co.
3.26* Amended and Restated Bylaws of Empire Oil co.
4.1 Indenture, dated as of May 14, 2002, among the Company, as Issuer, the Subsidiary Guarantors, as guarantors, and The Bank of New York, as Trustee, relating to $200,000,000 of 11% Senior Subordinated Notes 2012. Incorporated by reference to Exhibit 4.2 to the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed July 15, 2002, File No. 333-92386.
4.2 Indenture, dated as of May 3, 2004, among the Company, as Issuer, the Subsidiary Guarantors, as Guarantors, and The Bank of New York, as Trustee, providing for Issuance of Notes in Series. Incorporated by reference to Exhibit 4.6 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2004, File No. 1-10398.
4.3 Supplemental Indenture, dated as of May 3, 2004, among the Company, as Issuer, the Subsidiary Guarantors, as Guarantors, and The Bank of New York, as Trustee, relating to $150,000,000 of 8% Senior Subordinated Notes due 2014. Incorporated by reference to Exhibit 4.7 to the Company's Quarterly Report on Form 10-Q for the fiscal quarter ended March 31, 2004, File No. 1-10398.
10.1 Giant Industries, Inc. & Affiliated Companies 401(k) Basic Plan Document, effective October 9, 2003. Incorporated by reference to Exhibit 4.3 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.2 Addendum to Giant Industries, Inc. & Affiliated Companies 401(k) Basic Plan Document, effective March 28, 2005. Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, File No. 1-10398.
10.3* Addendum to Giant Industries, Inc. and Affiliated Companies 401(k) Basic Plan Document, effective January 1, 2006.
10.4 Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement, effective June 24, 2003. Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-K for the quarter ended June 30, 2003, File No 1-10398.
10.5 First Amendment to Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement, effective June 24, 2003. Incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-K for the quarter ended June 30, 2003, File No. 1-10398.
10.6 Second Amendment to Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement, effective July 1, 2003. Incorporated by reference to Exhibit 4.3 to the Company's Quarterly Report on Form 10-K for the quarter ended June 30, 2003, File No. 1-10398.
10.7 Third Amendment to Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement, effective January 1, 2004. Incorporated by reference to Exhibit 4.7 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.8 Fourth Amendment to Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement, effective March 1, 2004. Incorporated by reference to Exhibit 4.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.9 Fifth Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement. Incorporated by reference to Exhibit 4.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2005, File No. 1-10398.
10.10 Sixth Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement. Incorporated by reference to Exhibit 4.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, File No. 1-10398.
10.11 Seventh Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, File No. 1-10398.
10.12 Eighth Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement. Incorporated by reference to Exhibit 10.11 to the Company's Annual Report on Form 10-K for the year ended December 31, 2005, File No. 1-10398.
10.13 Ninth Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement. Incorporated by reference to Exhibit 10.12 to the Company's Annual Report on Form 10-K for the year ended December 31, 2005, File No. 1-10398.
10.14* Tenth Amendment to the Giant Industries, Inc. & Affiliated Companies 401(k) Plan Adoption Agreement.
10.15 Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2005, File No. 1-10398.
10.16* First Amendment to the Giant Industries, Inc. and Affiliated Companies Deferred Compensation Plan.
10.17 Giant Industries, Inc. 1998 Stock Incentive Plan. Incorporated by reference to Appendix H to the Joint Proxy Statement/Prospectus included in the Company's Registration Statement on Form S-4 under the Securities Act of 1933 as filed May 4, 1998, File No. 333-51785.
10.18 Amendment No. 1 to 1998 Stock Incentive Plan, dated September 13, 2000. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No 1-10398.
10.19 Amendment No. 2 to 1998 Stock Incentive Plan, dated March 27, 2002. Incorporated by reference to Exhibit 10.9 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2002, File No 1-10398.
10.20 ESOP Substitute Excess Deferred Compensation Benefit Plan. Incorporated by reference to Exhibit 10.8 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1992, File No. 1-10398.
10.21 2006 Management Discretionary Bonus Plan. Incorporated by reference to Exhibit 10.20 to the Company's Annual Report on Form 10-K for the year ended December 31, 2005, File No. 1-10398.
10.22* 2007 Management Discretionary Bonus Plan.
10.23 Employment Agreement, dated as of December 12, 2003, between Fred L. Holliger and Giant Industries, Inc. Incorporated by reference to Exhibit 10.28 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.24 Employment Agreement, dated as of December 12, 2003, between Morgan Gust and Giant Industries, Inc. Incorporated by reference to Exhibit 10.29 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.25 Employment Agreement, dated as of December 12, 2003, between Mark B. Cox and Giant Industries, Inc. Incorporated by reference to Exhibit 10.30 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.26 First Amendment to Employment Agreement, dated August 4, 2006, between Giant Industries, Inc. and Mark B. Cox. Incorporated by reference to Exhibit 10.1 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 1-10398.
10.27 Employment Agreement, dated as of December 12, 2003, between Kim H. Bullerdick and Giant Industries, Inc. Incorporated by reference to Exhibit 10.31 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.28 First Amendment to Employment Agreement, dated August 6, 2006, between Giant Industries, Inc. and Kim H. Bullerdick. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2006, File No. 1-10398.
10.29 Consulting and Non-Competition Agreement, dated August 26, 2006, between Fred L. Holliger and Western Refining, Inc. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated August 30, 2006.
10.30 Amendment No. 1 to Consulting Agreement, dated November 12, 2006, between Fred L. Holliger and Western Refining, Inc. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K dated November 13, 2006.
10.31** Crude Oil Purchase/Sale Agreement 2004-2008, effective as of February 9, 2004, between Giant Yorktown, Inc. and Statoil Marketing & Trading (US) Inc. Incorporated by reference to Exhibit 10.33 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
10.32 Fourth Amended and Restated Credit Agreement, dated as of June 27, 2005, among Giant Industries, Inc., as Borrower, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and as Issuing Bank, and the Lenders parties thereto. Incorporated by reference to Exhibit 10.1 to the Company's Current Report on Form 8-K filed July 1, 2005, File No. 1-10398.
10.33 First Amendment to Fourth Amended and Restated Credit Agreement, dated as of August 4, 2005, among Giant Industries, Inc., as Borrower, Bank of America, N.A., as Administrative Agent, Swing Line Lender, and as Issuing Bank, and the Lenders parties thereto. Incorporated by reference to Exhibit 10.2 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, File No. 1-10398.
10.34 Purchase and Sale Agreement, dated as of June 21, 2005, between Texas-New Mexico Pipe Line Company and Giant Pipeline Company. Incorporated by reference to Exhibit 10.3 to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2005, File No. 1-10398.
14.1 Code of Ethics. Incorporated by reference to Exhibit 14.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2003, File No. 1-10398.
18.1 Letter regarding change in accounting principles. Incorporated by reference to Exhibit 18.1 to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1990, File No. 1-10398.
21.1* Subsidiaries of the Company.
23.1* Consent of Deloitte & Touche LLP to incorporate report in previously filed Registration Statements.
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. ** Portions have been omitted pursuant to a request for confidential treatment filed by the Registrant with the Commission. The omitted portions have been filed separately with the Commission.