1998 Annual Report
Contents || Corporate ListingsNotes to Consolidated financial Statements
Nature of Operations
The financial statements include the accounts of Frontier Oil Corporation (formerly known as Wainoco Oil Corporation), a Wyoming corporation, and its wholly-owned subsidiaries, including Frontier Holdings Inc. (the "Refinery"), collectively referred to as Frontier or the Company. At the Annual Meeting held on April 27, 1998, the shareholders of the Company approved the change in the Company's corporate name from "Wainoco Oil Corporation" to "Frontier Oil Corporation." The Company is engaged in the crude oil refining and wholesale marketing of refined petroleum products business (the "refining operations"). The Company conducts its refining operations in the Rocky Mountain region of the United States. The Company's Cheyenne, Wyoming Refinery purchases the crude oil to be refined and markets the refined petroleum products produced, including various grades of gasoline, diesel fuel, asphalt and petroleum coke. Prior to the third quarter of 1997, the Company also explored for and produced oil and gas in Canada and prior to the first quarter of 1996 in the United States (together, the "oil and gas operations"). Operating results for the Company's oil and gas operations segment are presented as discontinued operations in the accompanying statements of operations and all previously reported results are restated to this presentation.Significant Accounting Policies
Property, Plant and Equipment
Property, plant and equipment are depreciated based on the straight-line method over their estimated useful lives. The estimated useful lives are:
Maintenance and repairs are expensed as incurred except for major scheduled repairs and maintenance ("turnaround") of the Refinery operating units. The costs for turnarounds are ratably accrued over the period from the prior turnaround to the next scheduled turnaround. Major improvements are capitalized and the assets replaced are retired.
Inventories
Inventories of crude oil, other unfinished oils and all finished products are recorded at the lower of cost on a first-in, first-out (FIFO) basis or market. Refined product exchange transactions are considered asset exchanges with deliveries offset against receipts. The net exchange balance is included in inventory. Inventories of materials and supplies are recorded at the lower of average cost or market.
Environmental Expenditures
Environmental expenditures are expensed or capitalized based upon their future economic benefit. Costs which improve a property's pre-existing condition and costs which prevent future environmental contamination are capitalized. Costs related to environmental damage resulting from operating activities subsequent to acquisition are expensed. Liabilities for these expenditures are recorded when it is probable that obligations have been incurred and the amounts can be reasonably estimated.
Refined Product Revenues
Revenues are recognized when product ownership is transferred to the customer. Excise and other taxes on products sold are netted against revenues.
Hedging
The Company, at times, engages in futures transactions in its refining operations for the purpose of hedging its inventory position and natural gas prices. Gains and losses on futures contracts designated as hedges are recognized in refining operating costs when the associated hedge transaction is consummated. The Company does not enter into derivative contracts for speculative purposes.
Interest
Interest is reported net of interest capitalized and interest income. Interest income of $1.5 million, $2.0 million and $109,000 was recorded in the years ended December 31, 1998, 1997 and 1996, respectively. During 1998 and 1996, the Company capitalized interest of $101,000 and $24,000, respectively. The Company capitalizes interest on debt incurred to fund the construction or acquisition of a significant asset.
Stock Based Compensation
Compensation cost is measured using the intrinsic value method. Under this method, compensation cost is the excess, if any, of the quoted market value of the Company's common stock at the grant date over the amount the employee must pay to acquire the stock. No compensation cost was recognized for the years ended December 31, 1998, 1997 and 1996.
Currency Translation
The Canadian dollar financial statements of the Canadian oil and gas operations have been translated to United States dollars. Gains and losses on currency transactions were included in the consolidated statements of operations
currently and translation adjustments were included in the consolidated statements of changes in shareholders' equity. See Note 8 for information relating to the recognition of the cumulative translation adjustment in 1997.
Intercompany Transactions
Significant intercompany transactions are eliminated in consolidation.
Use of Estimates
The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures 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.
New Accounting Statement
In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities." The Statement established accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the income statement and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting.
Statement 133 is effective for fiscal years beginning after June 15, 1999. A company may also implement the Statement as of the beginning of any fiscal quarter after issuance (that is fiscal quarters beginning June 16, 1998 and thereafter). Statement 133 cannot be applied retroactively. Statement 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired or substantively modified after December 31, 1997 (and, at the company's election, before January 1, 1998).
The Company has not yet quantified the impacts of adopting Statement 133 on the financial statements. However, the Statement could increase volatility in earnings and other comprehensive income.
Cash Flow Reporting
Highly liquid investments with a maturity, when purchased, of three months or less are considered to be cash equivalents. Cash payments for interest during 1998, 1997 and 1996 were $6.3 million, $18.4 million and $16.3 million, respectively. Cash payments for income taxes during 1998, 1997 and 1996 were $582,000, $930,000 and $187,000, respectively.
Debt
Senior Notes
On February 9, 1998, the Company issued $70 million of 9 1/8% Senior Notes due 2006. The Notes are redeemable, at the option of the Company, at a premium of 104.563% after February 15, 2002, declining to 100% in 2005. Prior to February 15, 2002, the Company at its option may redeem the Notes at a defined make-whole amount. Interest is paid semiannually. The net proceeds were utilized to fund redemptions of the Company's 12% Senior Notes and 73/4% Convertible Subordinated Debentures.
Early Retirement of Debt
On February 10, 1998, the Company called for redemption the remaining $24.8
million of its 12% Senior Notes and the $46 million 7 3/4%
Convertible Subordinated Debentures. The redemptions were completed on March
12, 1998. Holders of $731,000 of 7 3/4% Convertible
Subordinated Debentures elected to convert into 83,535 shares of the Company's
common stock. Based on the redemptions, the Company has recognized a 1998
extraordinary loss of approximately $3.0 million, net of taxes, due to the
redemption premiums on the Senior Notes and Convertible Debentures and the
write-off of the related remaining debt issuance costs. The redemptions and
retirement of these debt obligations were funded with proceeds from the issuance
of the 9 1/8% Senior Notes.
Based on early debt redemptions during 1997, the Company recognized an extraordinary loss of approximately $3.9 million, net of taxes, due to the redemption premium on the 12% Senior notes and reduction of debt issuance costs. The debt redemptions were funded with proceeds from the sale of the Canadian oil and gas operations.
Revolving Credit Facility
The refining operations has a working capital credit facility with a group of three banks which expires on June 30, 2000. The facility is a collateral-based facility with total capacity of up to $50 million, of which maximum cash borrowings are $20 million. Any unutilized capacity after cash borrowings is available for letters-
of-credit. Short-term debt outstanding was $3.8 million at December 31, 1998. Standby letters of credit outstanding were $7.7 million and $4.5 million at December 31, 1998 and 1997, respectively.
The facility provides working capital financing for operations, generally the financing of crude and product supply. It is generally secured by the Refinery's current assets. The agreement provides for a quarterly commitment fee of .375 of 1% per annum. Interest rates are based, at the Company's option, on the agent bank's prime rate plus 1/2%, the prevailing Federal Funds Rate plus 2 1/4% or the reserve-adjusted LIBOR plus 1 3/4%. Standby letters-of-credit issued bear a fee of 1 1/4% annually, plus standard issuance and renewal fees. The agreement includes certain financial covenant requirements relating to the Refinery's working capital, cash earnings, tangible net worth and fixed charge coverage.
Restrictions on Loans, Transfer of Funds and Payment of Dividends
The Refinery credit facility restricts the Refinery as to the distribution of capital assets and the transfer of cash in the form of dividends, loans or advances when there are any outstanding borrowings under the facility or when a default exists or would occur.
Five-year Maturities
The 9 1/8% Senior Notes are due 2006; until then there
are no maturities of long-term debt.
Income Taxes
The following is the provision (benefit) for income taxes for the three years ended December 31, 1998, 1997 and 1996.
The following is a reconciliation of the provision (benefit) for income taxes computed at the statutory United States income tax rates on pretax income (loss) and the provision (benefit) for income taxes as reported for the three years ended December 31, 1998, 1997 and 1996.
The following are the significant components, by type of temporary differences or carryforwards, of deferred tax liabilities and tax assets, computed at the federal statutory rate, as of December 31, 1998 and 1997.
Realization of deferred tax assets is dependent on the Company's ability to generate taxable income within the life of the tax loss carryforwards. As a result of the Company's history of operating losses, a valuation allowance has been provided for deferred tax assets that are not offset by scheduled future reversals of deferred tax liabilities.
At December 31, 1998, the Company had regular net operating loss ("NOL") carryforwards for United States tax reporting purposes of $125.2 million available to reduce future federal taxable income. The regular NOL carryforwards will expire as follows: $11.8 million in 2002, $7.7 million in 2003, $11.3 million in 2004, $29.5 million in 2005, $17.2 million in 2006, $13.7 million in 2007, $11.3 million in 2008, $2.2 million in 2009, $16.1 million in 2010 and $4.4 million in 2011.
Also, at December 31, 1998, the Company had alternative minimum tax net operating loss ("AMT NOL") carryforwards for United States tax reporting of $79.6 million to reduce future taxable income. The AMT NOL carryforwards will expire as follows: $25.4 million in 2005, $13.1 million in 2006, $11.6 million in 2007, $8.6 million in 2008, $1.4 million in 2009, $16.8 million in 2010 and $2.7 million in 2011.
The Company has alternative minimum tax carryforwards of $1.3 million and tax depletion carryforwards of $8.7 million which are indefinitely available to reduce future United States income taxes payable.
Common Stock
Earnings per Share
The following is a reconciliation of the numerators and denominators used in the calculation of basic and diluted earnings per share ("EPS") for income (loss) from continuing operations for the years ended December 31, 1998, 1997 and 1996.
Certain of the Company's stock options that could potentially dilute basic EPS in the future were not included in the computation of diluted EPS because to do so would have been antidilutive for the periods presented.
Non-employee Directors Stock Grant Plan
During 1995, the Company established a stock grant plan for non-employee directors. The purpose of the plan is to provide a part of non-employee directors compensation in Company stock. The plan will be beneficial to the Company and its stockholders by allowing non-employee directors to have a personal financial stake in the Company through an ownership interest in the Company's common stock. The plan may grant an aggregate of 60,000 shares of the Company's common stock held in treasury. The Company made grants to directors under this plan of 2,500 shares in 1997 and 1996.
Stock Option Plans
The Company has three stock option plans which authorize the granting of restricted stock and options to purchase shares. The plans through December 31, 1998 have reserved for issuance a total of 3,959,355 shares of common stock of which 2,555,435 shares were granted and exercised, 1,318,250 shares were granted and were outstanding and 85,670 shares were available to be granted. Options under the plans are granted at not less than fair market value on the date of grant. No entries are made in the accounts until the options are exercised, at which time the proceeds are credited to common stock and paid-in capital. Generally, the options vest ratably throughout their one- to five-year terms.
A summary of the status of the Company's plans as of December 31, 1998, 1997 and 1996, and changes during the years ended on those dates is presented below:
The following table summarizes information about stock options outstanding at December 31, 1998:
Had compensation costs been determined based on the fair value at the grant dates for awards made in 1997 and 1996 (no awards were made in 1998), the Company's net income (loss) and EPS would have been the pro forma amounts indicated below for the years ended December 31, 1998, 1997 and 1996:
The fair value of grants was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted- average assumptions used: risk-free interest rates of 5.91% and 5.33%, expected volatilities of 41.07% and 32.95%, expected lives of 2.32 and 1.59 years and no dividend yield in 1997 and 1996, respectively.
Commitments and Contingencies
Lease and Other Commitments
The Company has noncapitalized building, equipment and vehicle lease agreements which expire from 1999 through 2005 having minimum annual payments as of December 31, 1998 of $4.1 million for 1999, $719,000 for 2000, $591,000 for 2001, $368,000 for 2002, $174,000 for 2003, $132,000 for 2004 and $25,000 for 2005. Operating lease rental expense was $2.6 million, $2.6 million and $1.7 million for the three years ended December 31, 1998, 1997 and 1996, respectively.
The Company contracted for pipeline capacity of approximately 13,800 bpd on the Express Pipeline from Hardisty, Alberta to Guernsey, Wyoming in 1997 for a period of 15 years. The Company's commitment for pipeline capacity is approximately $5.8 million per year. The agreement allows the Company to assign a portion of its capacity in early years for additional capacity in later years. The Company owns a 25,000 bpd interest in a crude oil pipeline from Guernsey, Wyoming to the Refinery. The Company's share of operating costs for the crude oil pipeline are recorded as refining operating costs. The Company also has commitments to purchase crude oil from various suppliers on a one month to one year basis at daily market posted prices to meet its Refinery throughput requirements.
Concentration of Credit Risk
The Company has concentrations of credit risk with respect to sales within the same or related industry and within limited geographic areas. The Refining operation sells its products exclusively at wholesale, principally to independent retailers and major oil companies located primarily in the Denver, western Nebraska and eastern Wyoming regions, with 14% of its customers accounting for approximately 69% of total refined product sales in 1998. The Company extends credit to its customers based on ongoing credit evaluations. An allowance for doubtful accounts is provided based on the current evaluation of each customer's credit risk, past experience and other factors. During 1998, the Company made sales to CITGO Petroleum Products of approximately $56 million, which accounted for 19% of consolidated revenues.
Contribution Plans
The Company sponsors separate defined contribution plans for employees covered
by a collective bargaining agreement and employees not covered by such an
agreement. All employees may participate by contributing a portion of their
annual earnings to the plans. The Company makes basic and/or matching contributions
on behalf of participating employees. The cost of the plans for the three
years ended December 31, 1998, 1997 and 1996 was $1.4 million, $1.3 million
and $1.2 million, respectively.
Environmental
The Company accrues for environmental costs as indicated in Note 2. Numerous local, state and federal laws, rules and regulations relating to the environment are applicable to the Company's operations. As a result, the Company falls under the jurisdiction of numerous state and federal agencies and is exposed to the possibility of judicial or administrative actions for remediation and/or penalties brought by those agencies. The Refinery is party to one consent decree requiring the investigation and, in certain instances, mitigation of environmental impacts resulting from past operational activities. The Company has been and will be responsible for costs related to compliance with or remediations resulting from environmental regulations. There are currently no identified environmental remediation projects of which the costs can be reasonably estimated. However, the continuation of the present investigative process, other more extensive investigations over time or changes in regulatory requirements could result in future liabilities.
Litigation
The Company is involved in various lawsuits which are incidental to its business. In management's opinion, the adverse determination of such lawsuits would not have a material adverse effect on the Company's financial position or results of operations.
Collective Bargaining Agreement Expiration
The Company's refining unit hourly employees are represented by seven bargaining units, the largest being the Paper, Allied-Industrial, Chemical and Energy Workers International Union ("PACE"). Six AFL-CIO affiliated unions represent the craft workers. In December 1998, the Company concluded new bargaining agreements, with the three-year PACE agreement due to expire in July 1999 extended to July 2002, while the six-year AFL-CIO contract due to expire in June 2002 extended to June 2005. The union employees represent approximately 57% of the Company's work force at December 31, 1998.
Fair Value of Financial Instruments
The fair value of the Company's Senior Notes and Convertible Subordinated Debentures was estimated based on quotations obtained from broker-dealers who make markets in these and similar securities. The bank revolving credit facility is based on floating interest rates and, as such, the carrying amount is a reasonable estimate of fair value. At December 31, 1998 and 1997, the carrying amounts of long-term debt instruments (including current maturities) were $70.0 million and $70.6 million, respectively, and the estimated fair values were $65.1 million and $72.0 million.
As of December 31, 1998, the Company had entered into futures contracts to hedge a por-tion of its natural gas consumption requirements. The futures contracts are placed with a major financial institution the Company believes is a minimum credit risk. The futures contracts mature each month through April 1999. The estimated fair value of the Company's open natural gas futures contract at December 31, 1998 was $(371,000).
Sale of Oil and Gas Operations
On June 16, 1997, the Company completed the sale of all its Canadian oil and gas properties. The transaction was initiated by the Company through a negotiated bid process in order to maximize shareholder value. The oil and gas assets were located in British Columbia and Alberta and included approximately 94 billion cubic feet of natural gas, 1.7 million barrels of oil, condensate and natural gas liquids, 121,500 net undeveloped leasehold acres and a significant amount of seismic data. Additionally, value was received for certain Canadian income tax pools of the Company.
The contract purchase price of C$133.6 million was adjusted from the January 1, 1997 effective date of the sale to June 16, 1997. Net proceeds after these adjustments, transaction expenses and severance costs were approximately C$126.7 million (US$91.3 million) as of June 16, 1997. A net gain of $23.3 million was realized on the transaction. No Canadian taxes are estimated to be payable due to available oil and gas deductions and net operating loss carryforwards. For U.S. federal income taxes, available net operating loss carryforwards will be utilized to offset the gain; however, alternative minimum taxes of approximately $800,000 have been paid.
The cumulative translation adjustment as of May 5, 1997 (the measurement date of the sale) of $9.9 million was realized against income as a result of the sale. In prior periods, the Company had recognized the currency translation impact of its Canadian operations as a direct reduction to shareholders' equity. Consequently, the recognition of the cumulative translation adjustment in the accompanying statements of operations has no effect on shareholders' equity. A net loss of $54,000 from Canadian operations from the measurement date until June 16, 1997 was included in the gain calculation.
Report of Independent
Public Accountants
To the Shareholders of
Frontier Oil Corporation:
We have audited the accompanying consolidated balance sheets of Frontier Oil
Corporation (formerly known as Wainoco Oil Corporation) (a Wyoming Corporation)
and subsidiaries as of December 31, 1998 and 1997, and the related consolidated
statements of operations, changes in shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1998. 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 generally accepted auditing standards. 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, the financial statements referred to above present fairly, in all material respects, the financial position of Frontier Oil Corporation and subsidiaries as of December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles.
Arthur Andersen LLP
Houston, Texas
February 5, 1999