ITEM 1. BUSINESS.
Introduction
United Refining Company is a Pennsylvania Corporation that began business operations in 1902. We are the leading integrated refiner and marketer of petroleum products in our primary market area, which encompasses western New York and northwestern Pennsylvania. We own and operate a medium complexity 70,000 barrel per day (“bpd”) petroleum refinery in Warren, Pennsylvania where we produce a variety of products, including various grades of gasoline, ultra low sulfur diesel fuel, kerosene, No. 2 heating oil and asphalt. Operations are organized into two business segments: wholesale and retail. The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers.
The retail segment sells petroleum products under the Kwik Fill®, Citgo®, Keystone® and Country Fair® brand names at a network of Company-operated retail units and convenience and grocery items through convenience stores under the Red Apple Food Mart® and Country Fair® brand names. As of August 31, 2011, (sometimes referred to as “fiscal 2011”), we operated 366 units, of which 185 units are owned, 119 units are leased, and the remaining stores are operated under a management agreement. Approximately 20% of the gasoline stations within this network are branded Citgo® pursuant to a license agreement granting us the right to use Citgo’s applicable brand names, trademarks and other forms of Citgo’s identification. For fiscal 2011 approximately 68% and 25% of our gasoline and distillate production, respectively, was sold through our retail network.
For fiscal 2011, we had total net sales of $3.2 billion, of which approximately 56% were derived from gasoline sales, approximately 36% were from sales of other petroleum products and 8% were from sales of merchandise and other revenue.
We believe that the location of our 70,000 bpd refinery in Warren, Pennsylvania provides us with a transportation cost advantage over our competitors, which is significant within an approximately 100 mile radius of our refinery. For example, in Buffalo, New York over our last five fiscal years, and including fiscal 2011, we have experienced approximately 2.3 cents per gallon transportation cost advantage over those competitors who are required to ship gasoline by pipeline and truck from New York Harbor sources to Buffalo. We own and operate the Kiantone Pipeline, a 78-mile long crude oil pipeline which connects the refinery to Canadian, U.S. and world crude oil sources through the Enbridge Pipelines Inc. and affiliates (collectively, “Enbridge”) pipeline system. Utilizing the storage capability of the West Seneca terminal, we are able to blend various grades of crude oil from different suppliers, allowing us to efficiently schedule production while managing feedstock mix and product yields in order to optimize profitability.
It is our view that the high construction costs and the stringent regulatory requirements inherent in petroleum refinery operations make it uneconomical for new competing refineries to be constructed in our primary market area. The nearest fuels refinery is over 160 miles from Warren, Pennsylvania and we believe that no significant production from such refinery is currently shipped into our primary market area.
Our primary market area is western New York and northwestern Pennsylvania and our core market area encompasses our Warren County base and the eight contiguous counties in New York and Pennsylvania. Our retail gasoline and merchandise sales are split approximately 60% / 40% between rural and urban markets. Margins on gasoline sales are traditionally higher in rural markets, while gasoline sales volume is greater in urban markets. Our urban markets include Buffalo, Rochester and Syracuse, New York and Erie, Pennsylvania.
As of August 31, 2011, 168 of our retail units were located in New York, 185 in Pennsylvania and 13 in Ohio. In fiscal year 2011, approximately 68% of the refinery’s gasoline production was sold through our retail network. In addition to gasoline, all units sell convenience merchandise, 106 are Quick Serve Restaurants (“QSRs”) including franchise operations and eight of the units are full-service truck stops. Customers may pay
for purchases with credit cards including our own Kwik Fill® credit card. In addition to this credit card, we maintain a fleet credit card catering to regional truck and automobile fleets. Sales of convenience products, which tend to have constant margins throughout the year, have served to reduce the effects of the seasonality inherent in gasoline retail margins.
Recent Developments
The Company continues to be impacted by the volatility in petroleum markets in fiscal year 2012. The lagged 3-2-1 crackspread as measured by the difference between the price of crude oil contracts traded on the NYMEX for the proceeding month to the prices of NYMEX gasoline and heating oil contracts in the current trading month, have been positively affected through October. The Company uses a lagged crackspread as a margin indicator as it reflects the time period between the purchase of crude oil and its delivery to the refinery for processing. The lagged crackspread in September, the first month of fiscal 2012 averaged $31.04 as compared to an average of $24.31, for August, 2011, an increase of $6.73 or 28%. The lagged crackspread in October weakened slightly as compared to an average of $30.89, for September, a decrease of $.015 or .5%. As it continued to weaken, the lagged crackspread for the month of November, calculated on November 28, 2011 was $25.50.
Through November 28th, the indicated lagged crackspread for the first quarter of fiscal 2012 was $29.14, a $2.20 or 8% increase over the average for the fourth quarter of fiscal 2011. The indicated lagged crackspread for our second quarter ending February 29, 2012, calculated as of November 28 was $14.81 a 42% decrease from the projection for the first quarter of fiscal 2012. The impact of any decrease in crackspreads for the second quarter of 2012 will be mitigated by the Company’s crackspread derivative program. However, there can be no assurance that the indicated average crackspreads for the second quarter of fiscal 2012 will result in the actual crackspreads for that quarter.
As of November 17, 2011, the mark to market valuation over the remaining term of the crackspread swap contracts changed $52,606,541 from an unrealized loss position of $51,414,000 as of August 31, 2011 to an unrealized gain position of $1,192,541. See also Note 1 to the “Company’s Consolidated Financial Statements”.
The Company has reached an early settlement agreement with its refinery employees represented by the International Union of Operating Engineers, Local 95. The contract is effective February 1, 2012 and expires February 1, 2017. The agreement generally provides for improvement in wages, as well as changes to active and retiree healthcare, pension benefits and the defined contribution plan for the bargaining unit. These changes to the healthcare and pension plans are the same as the healthcare and pension plans provided to salaried employees effective September, 2010.
Industry Overview
We are a regional refiner and marketer located primarily in Petroleum Administration for Defense Districts I (“PADD I”). As of January 1, 2011, there were 14 operable refineries operating in PADD I with a combined crude processing capacity of 1.6 million bpd, representing approximately 9% of U.S. refining capacity. Petroleum product consumption during calendar year 2010 in PADD I averaged 5.61 million bpd, representing approximately 29% of U.S. demand based on industry statistics reported by the Energy Information Administration (“EIA”). According to the EIA, prime supplier sales volume of gasoline in the region decreased by approximately 2.8% during the twelve month period ended August 31, 2011 compared to the twelve month period ended August 31, 2010. Refined petroleum production in PADD I is insufficient to satisfy demand for such products in the region, making PADD I a net importer of such products. Domestic refinery capacity utilization increased marginally from 82% crude capacity utilization in 2009 to 83% in 2010 due to continuing nationwide and global uncertainty.
Refining Operations
The Company’s refinery is located on a 107-acre site in Warren, Pennsylvania. The refinery has a nominal capacity of 70,000 bpd of crude oil processing and averaged saleable production of approximately 52,400 bpd during fiscal 2011. Crude run rates were affected by the rupture to Enbridge Line 6B, as well as two major turnarounds all of which are discussed in this section.
On July 26, 2010, a rupture occurred in Line 6B pipeline on Enbridge’s Lakehead system in Michigan. The Company’s heavy crude oil purchases are shipped on Line 6B from western Canada. As a result, on August 5, 2010, the Company was forced to reduce production in its crude processing unit until such time as the Enbridge Line 6B could be repaired. As a result, during the month of August, crude run rates were reduced by approximately 41% from scheduled crude runs of 69,500 bbl per day to 40,900 bbl per day and further reduced in September to an average of 38,000 bbl per day. For the month of October, actual crude runs were reduced an additional 8,740 bbl per day due to the Enbridge pipeline disruption. The interruption of heavy crude deliveries via Line 6B also negatively affected asphalt production by 65% from the planned production of 656,000 bbl to actual production of 240,000 bbl at the peak of the asphalt selling season. The Company’s supply group maintained crude sourcing at a reduced rate for the refinery during the disruption to Line 6B through other Enbridge pipelines.
On September 28, 2010, Enbridge began a phased restart and return to service of Line 6B. Line 6B is currently operating at approximately 80% of the total capacity and meeting 100% of shipping demand.
The Company’s property insurance covering the refinery operation contains a provision for contingent business interruption, which limits of coverage are separate from the general limits applying to direct damage to the refinery. The Company has placed the insurers on notice of the Enbridge loss and is conducting discussions to settle their claim.
Crude oil processing was reduced during October and November 2010 when the Company completed a scheduled 31 day maintenance and enhancement turnaround of the fluid catalytic cracking (FCC) unit and related operations. The major activities in addition to normal turnaround maintenance was upgrading of the regenerator, flue gas line and electrostatic precipitator at the FCC unit.
The entire refinery was shutdown during March and April 2011 when the Company completed a scheduled 24 day maintenance turnaround of the crude unit. The major activity in addition to normal crude unit shutdown maintenance was the shutdown of the sulfur recovery unit (SRU) for catalyst replacement. The SRU has been on-stream for six and one-half years. The 2011 turnaround included the scheduled shutdown of the refinery’s sulfur recovery unit, and this requires a complete plant shutdown.
Ethanol blending into gasoline began in August, 2010 and by September 2010, the new ethanol storage and injection system was commissioned to blend ten percent ethanol into all gasoline production.
We believe our geographic location in the product short PADD I is a significant marketing advantage. Our refinery is located in northwestern Pennsylvania and is geographically distant from the majority of PADD I refining capacity. The nearest fuels refinery is over 160 miles from Warren, Pennsylvania and we believe that no significant production from such refinery is currently shipped into our primary market area.
Products
We produce three primary petroleum products: gasoline, middle distillates, and asphalt. We presently produce two grades of unleaded gasoline, 87-octane regular and 93-octane premium. We also blend our 87 and 93 octane gasoline to produce a mid-grade 89-octane. In fiscal year 2011, approximately 68% of our gasoline production was sold through our retail network and the remaining 32% of such production was sold to wholesale customers.
Middle distillates include kerosene, ultra low sulfur diesel fuel, and No. 2 heating oil. For fiscal 2011, approximately 75% of our distillate production was sold to wholesale customers and the remaining 25% through our retail network.
We optimize our bottom of the barrel processing by producing asphalt, a higher value alternative to residual fuel oil. Asphalt production as a percentage of all refinery production has exceeded 28% over the last five fiscal years due to our ability and decision to process a larger amount of less costly heavy higher sulfur content crude oil in order to realize higher overall refining margins.
Asphalt is a residual product of the crude oil refining process, which is used primarily for construction and maintenance of roads and highways and as a component of roofing shingles. Distribution of asphalt is localized, usually within a distance of 150 miles from a refinery or terminal, and demand is influenced by levels of federal, state, and local government funding for highway construction and maintenance and by levels of roofing construction activities. We believe that an ongoing need for highway maintenance and domestic economic growth will sustain asphalt demand.
Refining Process
Our production of petroleum products from crude oil involves many complex steps, which are briefly summarized below.
We seek to maximize refinery profitability by selecting crude oil and other feedstocks taking into account factors including product demand and pricing in our market areas as well as price, quality and availability of various grades of crude oil. We also consider product inventory levels and any planned turnarounds of refinery units for maintenance. The combination of these factors is optimized by a sophisticated proprietary linear programming computer model, which selects the most profitable feedstock and product mix. The linear programming model is continuously updated and improved to reflect changes in the product market place and in the refinery’s processing capability.
Blended crude is stored in a tank farm near the refinery, which has a capacity of approximately 200,000 barrels. The blended crude is then brought into the refinery where it is first distilled at low pressure into its component streams in the crude and preflash unit. This yields the following intermediate products: light products consisting of fuel gas components (methane and ethane) and LPG (propane and butane), naphtha or gasoline, kerosene, diesel or heating oil, heavy atmospheric distillate, and crude tower bottoms which are further distilled under vacuum conditions to yield light and heavy vacuum distillates and asphalt. The present capacity of the crude unit is 70,000 bpd.
The intermediate products are then processed in downstream units and blended to produce finished products. A naphtha hydrotreater treats naphtha and FCC light catalytic naptha with hydrogen across a fixed bed catalyst to remove sulfur before further treatment. The treated naphtha is then distilled into light and heavy naphtha at a prefractionator. Light naphtha is then sent to an isomerization unit and heavy naphtha is sent to a reformer, in each case for octane enhancement. The isomerization unit converts the light naphtha catalytically into a gasoline component with 83 octane. The reformer unit converts the heavy naphtha into another gasoline component with up to 94 octane depending upon the desired octane requirement for the grade of gasoline to be produced. The reformer also produces as a co-product hydrogen needed to operate hydrotreating units in the refinery.
Raw kerosene is treated with hydrogen at a distillate hydrotreater to remove sulfur to make finished kerosene. A distillate hydrotreater built in 1993 and modified in 2006 also treats raw distillates to produce ultra low sulfur diesel fuel.
The long molecular chains of the heavy atmospheric and vacuum distillates are broken or “cracked” in the FCC unit and separated and recovered in the gas concentration unit to produce fuel gas, propylene, butylene, LPG, light and heavy catalytic naptha gasoline, light cycle oil and clarified oil. Fuel gas is burned within the refinery, propylene is fed to a polymerization unit which polymerizes its molecules into a larger chain to produce an 87 octane gasoline component, butylene is fed into an alkylation unit to produce a gasoline component and LPG is treated to remove trace quantities of water and then sold. Clarified oil is burned in the refinery or sold.
Various refinery gasoline components are blended together in refinery tankage to produce 87 octane and 93 octane finished gasoline. Likewise, light cycle oil is blended with other distillates to produce No. 2 heating oil. FCC light and heavy catalytic naptha is hydrotreated in order to meet new more stringent legally mandated limits on gasoline sulfur content which took effect January 1, 2008, and a portion of the light cycle oil is hydrotreated in order to meet new more stringent legally mandated limits on diesel fuel sulfur content which took effect June 1, 2006.
Our refining configuration allows the processing of a wide variety of crude oil inputs. During the past five years our inputs have been of Canadian origin and range from light low sulfur (38 degrees API, 0.5% sulfur) to high sulfur heavy asphaltic (21 degrees API, 3.5% sulfur). Our ability to market asphalt on a year round basis enables us to purchase selected heavier crude oils at higher differentials and thus at a lower cost.
Supply of Crude Oil
Substantially all of our crude supply is sourced from Canada and the northern plain states through the Enbridge pipeline. We are however, not dependent on this source alone. While not utilized during the closure of the Enbridge 6B pipeline because of the anticipated length of the disruption, we could within 90 days shift up to 70% of our crude oil requirements to some combination of domestic and offshore crude. With additional time, 100% of our crude requirements could be obtained from non-Canadian sources. This change in crude supply could result in a different crude slate and alter product yields and product mix and could affect refinery profitability. Sixty eight percent of our term contracts with our crude suppliers are on a month-to-month evergreen basis, with 60-to-90 day cancellation provisions; 32% of our term crude contracts are on an annual basis (with month to month pricing provisions). As of August 31, 2011, we had supply contracts with 13 major suppliers for an aggregate of 56,600 bpd of crude oil. We have contracts with four suppliers amounting to approximately 60% of daily crude oil supply (none more than 12,000 barrels per day). None of the remaining suppliers accounted for more than 10% of our crude oil supply.
We access crude through the Kiantone Pipeline, which connects with the Enbridge pipeline system in West Seneca, New York, which is near Buffalo. The Enbridge pipeline system provides access to most North American and foreign crude oils through three primary routes: (i) Canadian crude oils are transported eastward from Alberta and other points in Canada, (ii) foreign crude oils unloaded at the Louisiana Offshore Oil Port are transported north via the Capline and Chicap pipelines which connect to the Enbridge pipeline system at Mokena, Illinois, and (iii) foreign crude unloaded at Portland, Maine shipped to Montreal then shipped on Enbridge’s line 9 to Sarnia, Ontario. Enbridge has announced the Phase I (partial) reversal of Line 9. This reversal includes the segment from Westover to Sarnia. It does not interfere with crude deliveries from Montreal to Westover and deliveries into West Seneca.
The Kiantone Pipeline, a 78-mile Company-owned and operated pipeline, connects our West Seneca, New York terminal at the pipeline’s northern terminus to the refinery’s tank farm at its southern terminus. We completed construction of the Kiantone Pipeline in 1971 and have operated it continuously since then. We are the sole shipper on the Kiantone Pipeline, and can currently transport up to 70,000 bpd along the pipeline. Our right to maintain the pipeline is derived from approximately 265 separate easements, right-of-way agreements, licenses, permits, leases and similar agreements.
The pipeline operation is monitored by operators using a recently upgraded SCADA system at the refinery. Shipments of crude arriving at the West Seneca terminal are separated and stored in one of the terminal’s three storage tanks, which have an aggregate storage capacity of 485,000 barrels. The refinery tank farm has two additional crude storage tanks with a total capacity of 200,000 barrels. An additional 35,000 barrels of crude can be stored at the refinery.
Refinery Turnarounds
Turnaround cycles vary for different refinery units. A planned turnaround of each of the two major refinery units (the crude unit and the FCC) is conducted approximately every three to five years, during which time such units are shutdown for internal inspection and repair. The recent turnarounds occurred in October and November 2010 at our FCC unit and its related processing equipment, and in March and April 2011 at our crude unit and its related processing equipment. A major turnaround, which generally takes three to four weeks to complete in the case of the two major refinery units, consists of a series of moderate to extensive maintenance exercises. Turnarounds are typically planned and accomplished in a manner that allows for reduced production during maintenance instead of a complete plant shutdown. The 2011 turnaround included the scheduled shutdown of the refinery’s sulfur recovery unit, and this requires a complete plant shutdown. We defer the cost of turnarounds when incurred and amortized on a straight-line basis over the period of benefit, which ranges from 3 to 10 years (for tank turnarounds). Thus, we charge costs to production over the period most clearly benefited by the turnarounds.
The next scheduled turnarounds are planned to begin October 2013 at the FCC unit and March 2015 at the crude unit.
The scheduled maintenance turnarounds result in an inventory build of petroleum products to meet minimum sales demand during the maintenance shutdown period.
Marketing and Distribution
General
We have a long history of service within our market area. Our first retail service station was established in 1927 near the Warren, Pennsylvania refinery, and we have steadily expanded our distribution network over the years.
We maintain an approximate 60% / 40% split between sales at our rural and urban units. We believe this to be advantageous, balancing the higher gross margins and lower volumes often achievable due to decreased competition in rural areas with higher volumes and lower gross margins in urban areas. We believe that our network of rural convenience store units provide an important alternative to traditional grocery store formats. In fiscal year 2011, approximately 68% and 25% of our gasoline and distillate production, respectively, was sold through this retail network.
We deliver asphalt from the refinery to end user contractors by truck or railcar in addition to re-supplying our asphalt terminal in Pittsburgh, Pennsylvania.
Retail Operations
As of August 31, 2011, we operated a retail-marketing network (including those stores operated under a management agreement) that includes 366 retail units, of which 168 are located in western New York, 185 in northwestern Pennsylvania and 13 in eastern Ohio. We own 185 of these units. The retail segment sells petroleum products under the Kwik Fill®, Citgo® and Keystone® brand names and grocery items under the Red Apple Food Mart® and Country Fair® brand names. We believe that Red Apple Food Mart®, Kwik Fill®, Country Fair®, Keystone® and Citgo® are well-recognized names in our marketing areas. Approximately 20% of the gasoline stations within this network are branded Citgo® pursuant to a license agreement granting us the right to use Citgo’s applicable brand names, trademarks and other forms of Citgo’s identification. We believe that the Company operation of our retail units provides us with a significant advantage over competitors that operate wholly or partly through dealer arrangements because we have greater control over pricing and operating expenses.
We classify our retail stores into four categories: convenience stores, limited gasoline stations, truck stop facilities, and other stores. Convenience stores sell a wide variety of foods, snacks, cigarettes and beverages and also provide self-service gasoline. One hundred and six of our 366 retail outlets include QSRs where food is prepared on the premises for retail sales and also distribution to our other nearby units that do not have in-store delicatessens. Limited gasoline stations sell gasoline, cigarettes, oil and related car care products and provide full service for gasoline customers. Truckstop facilities sell gasoline and diesel fuel on a self-service and full-service basis. All truckstops include either a full or mini convenience store.
Total merchandise sales for fiscal year 2011 were $263.7 million, with a gross profit of approximately $66.7 million. Gross margins on the sale of convenience merchandise averaged 25.3% for fiscal 2011 and have been relatively constant at 25.4% for the last three years. Merchandise sales have shown continued positive growth.
Merchandise Supply
Tripifoods, Buffalo, New York is our primary wholesale grocery supplier for our entire chain. During fiscal year 2011, we purchased approximately 78.5% of our convenience merchandise from this vendor. Tripifoods supplies us with products including tobacco, candy, deli, grocery, health and beauty products, and sundry items. We also purchase coffee, dairy products, beer, soda, snacks, and novelty goods from direct store vendors for resale. We annually review our suppliers’ costs and services versus those of alternate suppliers. We believe that alternative sources of merchandise supply at competitive prices are readily available.
Location Performance Tracking
We maintain a store tracking mechanism to collect operating data including sales and inventory levels for our retail network. Data transmissions are made using personal computers, which are available at each location. Once verified, the data interfaces with a variety of retail accounting systems, which support daily, weekly, and monthly performance reports. These different reports are then provided to both the field management and administrative personnel. Upon completion of a capital project, management tracks “before and after” performance, to evaluate the return on investment which has resulted from the improvements.
Wholesale Marketing and Distribution
In fiscal 2011, we sold on a wholesale basis approximately 35,800 bpd of gasoline, distillate and asphalt products to distributor, commercial, and government accounts. In addition, we sell approximately 1,000 bpd of propane to liquefied petroleum gas marketers. In fiscal year 2011, our production of gasoline, distillate, and asphalt sold at wholesale was 32%, 75%, and 100%, respectively. We sell approximately 98% of our wholesale gasoline and distillate products from our refinery in Warren, Pennsylvania, and our Company-owned and operated product terminals. The remaining 2% are sold through third-party exchange terminals.
Our wholesale gasoline customer base includes 47 branded dealer/distributor units operating under our proprietary “Keystone®” and “Kwik Fill®” brand names. Long-term dealer/distributor contracts accounted for approximately 18% of our wholesale gasoline sales in fiscal 2011. Supply contracts generally range from three to five years in length, with branded prices based on our prevailing wholesale rack price in Warren.
We believe that the location of our refinery provides us with a transportation cost advantage over our competitors, which is significant within an approximately 100-mile radius of our refinery. For example, in Buffalo, New York over our last five fiscal years, including fiscal 2011, we have experienced an approximately 2.3 cents per gallon transportation cost advantage over those competitors who are required to ship gasoline by pipeline and truck from New York Harbor sources to Buffalo.
Our ability to market asphalt is critical to the performance of our refinery. Crude oil scheduling and a consistent marketing effort enables the refinery to process lower cost higher sulfur content crude oils, which in
turn affords us higher refining margins. Sales of paving asphalt generally occur during the period May 1 through October 31 based on weather conditions. In order to maximize our in season asphalt sales, we have made substantial investments to increase our asphalt storage capacity through the installation of additional tankage, as well as through the purchase or lease of outside terminals. Partially mitigating the seasonality of the asphalt paving business is our ability to sell asphalt year-round to roofing shingle manufacturers. In fiscal year 2011, we sold 5.5 million barrels of asphalt.
We have a significant share of the asphalt market in southwestern New York and western and central Pennsylvania as well as in the greater metro areas of Pittsburgh, Pennsylvania and Rochester and Buffalo, New York. We distribute asphalt from the refinery by railcar and truck transport to our owned and leased asphalt terminals in such cities or their suburbs. Asphalt can be purchased or exchanged in the Gulf Coast area and delivered by barge to third party or Company-owned terminals near Pittsburgh.
We use a network of six terminals to store and distribute refined products. This network provides distillate, and asphalt storage capacities, of approximately 1,217,000 barrels, as of August 31, 2011.
During fiscal 2011, approximately 89% of our refined products were transported from the refinery via truck transports, with the remaining 11% transported by rail. The majority of our wholesale and retail gasoline distribution is handled by common carrier trucking companies at competitive rates. We also operate a fleet of ten tank trucks that supply approximately 22% of our Kwik Fill® retail stations.
Product distribution costs to both retail and wholesale accounts are minimized through product exchanges. Through these exchanges, we have access to product supplies at approximately 18 sources located throughout our retail marketing area. We seek to minimize retail distribution costs through the use of a system wide distribution model.
Environmental Considerations
General
We are subject to extensive federal, state and local laws and regulations relating to fuel quality, pollution control and protection of the environment, such as those governing releases of certain materials to the air and water and the storage, treatment, transportation, disposal and clean-up of wastes located on land. As with the industry in general, compliance with existing and anticipated environmental laws and regulations increases the overall cost of business, including capital costs to construct, maintain and upgrade equipment and facilities.
Gasoline, Diesel Fuel, and Heating Oil Manufacturing Standards
Mandatory fuel regulations will continue to affect our operations including renewable fuel obligations, benzene reduction in gasoline, and future sulfur reductions in home heating oil.
Under the Renewable Fuel Standard (RFS) program small refineries were exempt from compliance through December 31, 2010. Section 211 (o)(9)(A)(ii) of the Clean Air Act authorized a study to determine whether compliance with the standards would impose a disproportionate economic hardship on small refineries. On April 22, 2011 the Company was identified as one of thirteen small refineries that received a two year extension to the RFS exemption until January 1, 2013.
Because of the uncertainty surrounding a potential extension of the compliance deadline, the Company proceeded with RFS program development in anticipation of a January 1, 2011 implementation date. The aggregate cost for the projects (ethanol and biodiesel) associated with the renewable fuels legislation was $19 million. Additional expenditures will be needed in the future for railcar and truck loading/unloading modifications to comply with the annual increases in renewable fuel obligations.
We continue to blend 2% biodiesel into all our diesel fuel sold in the state of Pennsylvania to comply with the PA Biofuels Development and In-State Production Incentive Act 78 of 2008. This Act requires all on-road diesel fuel sold in Pennsylvania to contain a minimum of 2% biodiesel starting May 1, 2010.
The United States Environmental Protection Agency (“USEPA”) finalized another rule on February 26, 2007 under the Clean Air Act (“CAA”) known as the Mobile Source Air Toxics Rule No. 2 (“MSAT II”) intended to reduce emissions of benzene by, among other things, regulating gasoline quality. The rule requires us to reduce the amount of benzene in gasoline from a 2010 yearly average level of about 2.5% down to 0.62% starting January 2011. The cost of the project to reduce the benzene content was $5 million and was completed in December of 2010. Our average year to date benzene level is currently at 0.49% benzene.
On July 20, 2010 the State of New York mandated that all heating oil sold in the state contain no more than 15 parts per million (ppm) sulfur beginning July 1, 2012. Pennsylvania is also discussing lowering the sulfur content which currently has a maximum of 5,000 ppm. The Company will be able to comply with this mandate and compliance activities are estimated at $4 million and are presently slated for completion by the third quarter of fiscal 2012.
The USEPA is preparing to propose a new Tier 3 gasoline regulation which would call for a further reduction in the average sulfur content below the existing Tier 2 sulfur standard. They are considering a reduction in the refinery annual average maximum sulfur content from 30 ppm to 10 ppm. The Company is monitoring this proposal.
We are also monitoring closely all climate change and Greenhouse Gas (“GHG”) legislation, better known as Cap and Trade as well as fuels mandates requiring the increased use of renewable resources in motor fuel. We believe, however, that implementation of reasonable, incremental changes over time will not have a material adverse effect on the Company’s consolidated financial position or operations. The ultimate cost of GHG reduction mandates and their effect on our business are, however, unknown until implementing regulations are available. Similarly, the costs of compliance with renewable fuels mandates in the future remains unknown until a final regulatory structure has been adopted.
Retail Gasoline Stations
We currently operate gasoline stations in three states with underground petroleum product storage tanks and in the past have operated gasoline stations that are now closed. Federal and state statutes and regulations govern the installation, operation and removal from service of these underground storage tanks and associated piping and product dispensing systems. The operation of underground storage tanks and systems carries the risk of contamination to soil and groundwater with petroleum products. We manage this risk by promptly responding to actual and suspected leaks and spills and implementing remedial action plans meeting regulatory requirements. In addition to prompt response and remediation, we receive reimbursement for response costs associated with leaks and spills in the Commonwealth of Pennsylvania through the Underground Storage Tank Indemnification Fund.
Competition
Petroleum refining and marketing is highly competitive. Our major retail gasoline c-store competitors include British Petroleum, Amerada Hess, Exxon-Mobil, Sunoco, Sheetz, Delta Sonic, Valero and Giant Eagle/GetGo. With respect to wholesale gasoline and distillate sales, we compete with Sunoco, Inc., Exxon-Mobil, and other refiners via their pipeline system. We primarily compete with Marathon Petroleum in the asphalt market, both in New York and Pennsylvania. Many of our principal competitors are integrated multinational oil companies that are substantially larger and better known than us. Because of their diversity, integration of operations, larger capitalization and greater resources, these major oil companies may be better able to withstand volatile market conditions, compete on the basis of price and more readily obtain crude oil in times of shortages.
The principal competitive factors affecting our refining operations are crude oil and other feedstock costs, refinery efficiency, refinery product mix and product distribution and transportation costs. Certain of our larger competitors have refineries, which are larger and more complex and, as a result, could have lower per barrel costs or higher margins per barrel of throughput. We have no crude oil reserves and are not engaged in exploration. We believe that we will continue to be able to obtain adequate crude oil and other feedstocks at generally competitive prices for the foreseeable future.
It is our view that the high construction costs and the stringent regulatory requirements inherent in petroleum refinery operations make it uneconomical for new competing refineries to be constructed in our primary market area. The nearest fuels refinery is over 160 miles from Warren, Pennsylvania and we believe that no significant production from such refinery is currently shipped into our primary market area. In addition, a number of refineries in PADD I were forced to shut down during the recent economic downturn. We believe this capacity rationalization should improve overall utilization by remaining refineries in PADD I, including us, and result in improved margins as demand improves.
Our primary market area is western New York and northwestern Pennsylvania and our core market area encompasses our Warren County base and the eight contiguous counties in New York and Pennsylvania. Our retail gasoline and merchandise sales are split approximately 60% / 40% between rural and urban markets. Margins on gasoline sales are traditionally higher in rural markets, while gasoline sales volume is greater in urban markets. Our urban markets include Buffalo, Rochester and Syracuse, New York and Erie, Pennsylvania. By virtue of our long standing history in the market, significant retail outlet density and recognizable brand names, we believe we have been able to achieve a significant share of this market.
The principal competitive factors affecting our retail marketing network are location, product price, overall appearance and cleanliness of stores and brand identification. Competition from large, integrated oil companies, supermarkets, and “big box” convenience store chains such as Wal-Mart and Sam’s Club, is expected to be ongoing. The principal competitive factors affecting our wholesale marketing business are the price and quality of our products, as well as the reliability and availability of supply and the location of multiple distribution points.
Employees
As of August 31, 2011, we had approximately 4,414 employees; 1,932 full-time and 2,482 part-time employees. Approximately 3,887 persons were employed at our retail units, 363 persons at our refinery, Kiantone Pipeline and at terminals operated by us, with the remainder at our office in Warren, Pennsylvania. We have entered into collective bargaining agreements with International Union of Operating Engineers Local No. 95, United Steel Workers of America Local No. 2122-A and General Teamsters Local Union No. 397 covering 233, 6, and 22 employees, respectively. The agreements expire on February 1, 2012, January 31, 2012 and July 31, 2014, respectively. We believe that our relationship with our employees is good.
Intellectual Property
We own various federal and state service and trademarks used by us, including Kwik Fill®, United®, Country Fair®, SuperKwik®, Keystone®, SubFare® and PizzaFare®. Our subsidiary, Country Fair, and we have licensing agreements with Citgo Petroleum Corporation (“Citgo”) for the right to use Citgo’s applicable brand names, trademarks and other forms of Citgo’s identification for petroleum products purchased under a distributor franchise agreement.
We have obtained the right to use the Red Apple Food Mart® service mark to identify our retail units under a royalty-free, nonexclusive, nontransferable license from Red Apple Supermarkets, Inc., a corporation which is indirectly wholly owned by John A. Catsimatidis, the indirect sole stockholder, Chairman of the Board and Chief Executive Officer of the Company. The license is for an indefinite term. The licensor has the right to terminate
this license in the event that we fail to maintain quality acceptable to the licensor. We license the right to use the Keystone® trademark to approximately 44 independent distributors on a non-exclusive royalty-free basis.
We currently do not own any material patents. Management believes that the Company does not infringe upon the patent rights of others, nor does our lack of patent ownership impact our business in any material manner.
Governmental Approvals
We believe we have obtained all necessary governmental approvals, licenses, and permits to operate the refinery and convenience stores.
Financing
On February 22, 2011 the Company announced the launch of a cash tender offer (the “Tender Offer”) for any and all of its outstanding Senior Notes due 2012 issued under an indenture dated as of August 6, 2004 (the “2012 Indenture”) and consent solicitation (the “Solicitation”) for certain proposed amendments to the 2012 Indenture (the “Proposed Amendments”). Each holder who validly tendered its Senior Notes due 2012 and delivered consents to the Proposed Amendments prior to 5:00 pm, New York City time, on March 7, 2011, (the “Consent Date”), received the total consideration of $1,005, which included $975 as the tender offer consideration and $30 as a consent payment. In addition, accrued but unpaid interest up to, but not including, the applicable payment date of the Senior Notes due 2012 was paid in cash on all validly tendered and accepted the Senior Notes due 2012. The Company paid a total of $188,607,726 on March 8, 2011 for $181,764,375 principal amount of the Senior Notes due 2012, $5,592,750 for consent payment (which is included in interest expense, net and financing costs), and $1,250,601 for accrued interest on those Senior Notes due 2012 tendered.
The Tender Offer expired at 12:00 midnight, New York City time, on March 21, 2011. Holders who validly tendered their Senior Notes due 2012 after the Consent Date received only the tender offer consideration and were not entitled to receive a consent payment pursuant to the Tender Offer. The Company paid the total consideration or tender offer consideration, as the case may be, plus accrued but unpaid interest, for the Senior Notes due 2012 accepted for purchase promptly following the date of such acceptance (such date, the “Final Payment Date”). On March 22, 2011, the Company paid a total of $678,225 for $670,800 principal amount of the Senior Notes due 2012 and $7,425 for accrued interest on those Senior Notes due 2012 tendered between the Consent Date (March 7, 2011) and the Final Payment Date (March 21, 2011).
On March 8, 2011, the Company sold $365,000,000 of 10.500% First Priority Senior Secured Notes due 2018 (the “Senior Secured Notes due 2018”) for $352,020,600, resulting in original issue discount of $12,979,400, which will be amortized over the life of the Senior Secured Notes due 2018 using the interest method. The net proceeds of the offering of $344,249,000 were used to fund the cash tender offer for all of its outstanding 10 1/2% Senior Notes due 2012 (the “Senior Notes due 2012”), pay accrued interest of $3,400,000 and a redemption premium related thereto. A loss of $1,245,000 on the early extinguishment of debt was recorded consisting of a redemption premium of $915,000, a write-off of unamortized net debt premium of $1,153,000 and a write-off of deferred financing costs of $1,483,000. The Senior Secured Notes due 2018 are guaranteed on an unsecured basis by all of our domestic subsidiaries existing at March 8, 2011. The Senior Secured Notes due 2018 are secured on a first-priority basis by our assets comprising our refinery located in Warren, Pennsylvania and the capital stock of our pipeline subsidiary, subject to permitted liens. The Senior Secured Notes will rank equally with all of our existing and future senior indebtedness that is not subordinate in right of payment to the Senior Secured Notes due 2018.
On March 9, 2011, the Company issued a Notice of Redemption to all holders of its 10 1/2% Senior Notes due 2012 redeeming these Senior Notes due 2012 at 100% par value plus accrued but unpaid interest on the redemption date of April 8, 2011. On April 8, 2011, $138,962,427 was paid in total, of which $136,847,000 was for principal amount of Senior Notes due 2012 and $2,115,427 was for accrued interest.
In May 2011, we entered into an amended and restated Revolving Credit Facility (“Amended and Restated Revolving Credit Facility”) with PNC Bank, National Association, as Administrator (“the Agent”) increasing the maximum facility commitment from $130,000,000 to $175,000,000 and extending the term to May 18, 2016. This amendment provides the Company greater flexibility relative to its cash flow requirements in light of market fluctuations, particularly involving crude oil prices and seasonal business cycles. The improved liquidity resulting from the expansion of the facility will assist the Company in meeting its working capital, ongoing capital expenditure needs and for general corporate purposes. The amendment to the Revolving Credit Facility affected certain terms and provisions thereof including an increase in the interest rate. Under the new amendment to the Revolving Credit Facility effective May 31, 2011, the applicable margin will continue to be calculated on the average unused availability as follows: (a) for base rate borrowing, at the greater of the Agent Bank’s prime rate plus an applicable margin of 0.5% to 0%; the Federal Funds Open Rate plus 0.5%; or the Daily LIBOR rate plus 1%; plus the applicable margin of 1.25% to 1.75% and (b) for euro-rate based borrowings, at the LIBOR Rate plus an applicable margin of 2.75% to 3.25%. The applicable margin varies with our facility leverage ratio calculation. The Agent Bank’s prime rate at August 31, 2011 was 4.75%.
The Amended and Restated Revolving Credit Facility is secured primarily by certain cash accounts, accounts receivable and inventory. Until maturity, we may borrow on a borrowing base formula as set forth in the facility. We had outstanding letters of credit of $4,433,000 as of August 31, 2011. As of August 31, 2011, we had $24,000,000 of outstanding borrowings under the Revolving Credit Facility resulting in net availability of $146,567,000.
ITEM 1A.
ITEM 1A. RISK FACTORS.
Risks Relating to the Business
Substantial Leverage and Ability to Service and Refinance Debt
Our ability to pay interest and principal on the Senior Secured Notes due 2018 and to satisfy our other debt obligations will depend upon our future operating performance, which will be affected by prevailing economic conditions and financial, business and other factors, most of which are beyond our control. We anticipate that our operating cash flow, together with borrowings under the Revolving Credit Facility, will be sufficient to meet our operating expenses and capital expenditures, to sustain operations and to service our interest requirements as they become due.
The Company’s 10.5% Senior Secured Notes mature in 2018, at which time the Company will either have to pay the principal amount in full or refinance the Notes.
We use our Revolving Credit Facility to finance a portion of our operations. These on-balance sheet financial instruments, to the extent they provide for variable rates, expose us to interest rate risks resulting from changes in the PNC Prime rate, the Federal Funds rate or the LIBOR rate.
If we are unable to generate sufficient cash flow to service our indebtedness and fund our capital expenditures, we will be forced to adopt an alternative strategy that may include reducing or delaying capital expenditures, selling assets, restructuring or refinancing our indebtedness (including the notes) or seeking additional equity capital. There can be no assurance that any of these strategies could be affected on satisfactory terms, if at all. Our ability to meet our debt service obligations will be dependent upon our future performance which, in turn, is subject to future economic conditions and to financial, business and other factors, many of which are beyond our control.
Volatility of Crude Oil Prices and Refining Margins
We are engaged primarily in the business of refining crude oil and selling refined petroleum products. Our earnings and cash flows from operations are dependent upon us realizing refining and marketing margins at least
sufficient to cover our fixed and variable expenses. The cost of crude oil and the prices of refined products depend upon numerous factors beyond our control, such as the supply of and demand for crude oil, gasoline and other refined products, which are affected by, among other things, changes in domestic and foreign economies, political events, and instability or armed conflict in oil producing regions, production levels, weather, the availability of imports, the marketing of gasoline and other refined petroleum products by our competitors, the marketing of competitive fuels, the impact of energy conservation efforts, and the extent of domestic and foreign government regulation and taxation. A large, rapid increase in crude oil prices would adversely affect our operating margins if the increased cost of raw materials could not be passed to our customers on a timely basis, and would adversely affect our sales volumes if consumption of refined products, particularly gasoline, were to decline as a result of such price increases. A sudden drop in crude oil prices would adversely affect our operating margins since wholesale prices typically decline promptly in response thereto, while we will be paying the higher crude oil prices until our crude supply at such higher prices is processed. The prices which we may obtain for our refined products are also affected by regional factors, such as local market conditions and the operations of competing refiners of petroleum products as well as seasonal factors influencing demand for such products. In addition, our refinery throughput and operating costs may vary due to scheduled and unscheduled maintenance shutdowns.
At August 31, 2011, the Company had 4,575,000 barrels of heating oil and gasoline crackspread swaps outstanding as part of its risk management strategy. This represents approximately 26.7% of the Company’s scheduled motor gasoline production through March 2012 and approximately 43.0% of scheduled distillate production through December 2012. The remainder of the crackspread swap contracts expire sequentially beginning September 2011 through December 2012. These derivative instruments are being used by the Company to lock in margins on future sales by the Company of heating oil and gasoline. See also Item 7A “Quantitative and Qualitative Disclosures about Market Risk”.
At August 31, 2011, we were exposed to the risk of market price fluctuations with respect to a substantial portion of our crude oil and refined product inventories.
Competition
Many of our competitors are fully integrated companies engaged on a national and/or international basis in many segments of the petroleum business, including exploration, production, transportation, refining and marketing, on scales much larger than ours. Large oil companies, because of the diversity and integration of their operations, larger capitalization and greater resources, may be better able to withstand volatile market conditions, compete on the basis of price, and more readily obtain crude oil in times of shortages.
We face strong competition in our market for the sale of refined petroleum products, including gasoline. Such competitors have in the past and may in the future engage in marketing practices that result in profit margin deterioration for us for periods of time, causing an adverse impact on us.
Concentration of Refining Operations
All of our refinery activities are conducted at our facility in Warren, Pennsylvania. We currently obtain substantially all of our crude oil supply through pipelines owned and operated by Enbridge Energy Partner (“Enbridge Pipeline”), and our owned and operated Kiantone Pipeline. While the Company does have the ability to shift its sources of supply over a 90 to 120 day period, any prolonged disruption to the operations of our refinery, the Enbridge Pipeline or the Kiantone Pipeline, whether due to labor difficulties, destruction of or damage to such facilities, severe weather conditions, interruption of utilities service or other reasons, would have a material adverse effect on our business, results of operations or financial condition. In order to minimize the effects of any such incident, we maintain a full schedule of insurance coverage which includes, but is not limited to, property and business interruption insurance. The property insurance policy has a combined loss limit for a property loss and business interruption at our refinery of $500 million, with various sub-limit accounts for specialized risks. A deductible of $5 million applies to physical damage claims, with a 45-day wait period and a
$5 million deductible for business interruption. We believe that our coverage limits are adequate. However, there can be no assurance that the proceeds of any such insurance would be paid in a timely manner or be in an amount sufficient to meet our needs if such an event were to occur.
Impact of Environmental Regulation; Government Regulation
Our operations and properties are subject to increasingly more stringent environmental laws and regulations, such as those governing the use, storage, handling, generation, treatment, transportation, emission, release, discharge and disposal of certain materials, substances and wastes, remediation of areas of contamination and the health and safety of employees. These laws may impose strict, and under certain circumstances, joint and several, liability for remediation costs and also can impose responsibility for natural resource damages. Failure to comply, including failure to obtain required permits, can also result in significant fines and penalties, as well as potential claims for personal injury and property damage.
We cannot predict the nature, scope or effect of environmental legislation or regulatory requirements that could be imposed or how existing or future laws or regulations will be administered or interpreted. The nature of our operations and previous operations by others at certain of our facilities exposes us to the risk of claims under those laws and regulations. There can be no assurance that material costs or liabilities will not be incurred in connection with such claims, including potential claims arising from discovery of currently unknown conditions.
Taxes
Our operations and products will be subject to taxes imposed by federal, state and local governments, which taxes have generally increased over time. There can be no certainty of the effect that increases in these taxes, or the imposition of new taxes, could have on us, or whether such taxes could be passed on to our customers.
Nature of Demand for Asphalt
In fiscal 2011, asphalt sales represented 13% of our total revenues. Over the same period, approximately 87% of our asphalt was produced for use in paving or repaving roads and highways. The level of paving activity is, in turn, dependent upon funding available from federal, state and local governments. Funding for paving has been affected in the past, and may be affected in the future, by budget difficulties at the federal, state or local levels. A decrease in demand for asphalt could cause us to sell asphalt at significantly lower prices or to curtail production of asphalt by processing more costly lower sulfur content crude oil which would adversely affect refining margins. In addition, paving activity in our marketing area generally ceases in the winter months. Therefore, much of our asphalt production during the winter must be stored until warmer weather arrives, resulting in delayed revenue recognition and inventory buildups each year.
Controlling Stockholder
John A. Catsimatidis indirectly owns all of our outstanding voting stock. By virtue of such stock ownership, Mr. Catsimatidis has the power to control all matters submitted to our stockholder and to elect all of our directors.
Restrictions Imposed by Terms of Indebtedness
The terms of the Revolving Credit Facility, the Indenture and the other agreements governing our indebtedness impose operating and financing restrictions on us and our subsidiaries. Such restrictions affect, and in many respects limit or prohibit, among other things, our ability and our subsidiaries’ ability to incur additional indebtedness, create liens, sell assets, or engage in mergers or acquisitions. These restrictions could limit our ability to plan for or react to market conditions or meet extraordinary capital needs or otherwise could restrict corporate activities. There can be no assurance that such restrictions will not adversely affect our ability to finance our future operations or capital needs or to engage in other business activities which will be in our interest.
Our Pension Plans are Currently Underfunded
Substantially all of our employees are covered by three noncontributory defined benefit pension plans. As of August 31, 2011, as measured under ASC 715 (which is not the same as the measure used for purposes of calculating required contributions and potential liability to the Pension Benefit Guaranty Corporation, or PBGC), the aggregate accumulated benefit obligation under our pension plans was approximately $94.9 million and the value of the assets of the plans was approximately $66.2 million. In fiscal 2011, we contributed $4.1 million to the three plans, and we have made additional contributions to our pension plans of $2.2 million in fiscal year 2012. If the performance of the assets in our pension plans does not meet our expectations or if other actuarial assumptions are modified, our contributions for future years could be higher than we expect.
In June 2010, the Company announced changes to the healthcare and pension plans provided to salaried employees. Effective September 1, 2010, postretirement medical benefits for new hires and active salaried employees retiring after September 1, 2010 were eliminated. Additionally, effective January 1, 2011, deductibles and co-payments were added to the medical benefits plan for all active and retired employees. For salaried employees meeting certain age and service requirements, the Company will contribute a defined dollar amount towards the cost of retiree healthcare based upon the employee’s length of service. Similarly, effective August 31, 2010, benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide an enhanced contribution under its defined contribution 401(k) plan as well as a transition contribution for older employees.
Our pension plans are subject to the Employee Retirement Income Security Act of 1974, or ERISA. Under ERISA, the PBGC generally has the authority to terminate an underfunded pension plan if the possible long-run loss of the PBGC with respect to the plan may reasonably be expected to increase unreasonably if the plan is not terminated. In the event our pension plans are terminated for any reason while the plans are underfunded, we will incur a liability to the PBGC that may be equal to the entire amount of the underfunding.
Risks Relating to Senior Secured Notes due 2018
The Senior Secured Notes due 2018 are secured by certain assets of the Company and a foreclosure on such liens could adversely affect our business.
The Senior Secured Notes due 2018 are secured by a pledge of the stock of our subsidiary Kiantone Pipeline Corporation and, subject to certain exceptions, by a mortgage lien on and a security interest in the assets comprising the refinery. In case of a continuing event of default by the Company, the collateral agent may exercise all rights of a mortgagee and/or secured party under applicable law, including, without limitation, transferring to itself or a nominee title to such collateral, which could adversely affect our business.
We may issue additional notes and enter into hedging activities that would be secured by the same collateral securing the Senior Secured Notes due 2018.
Subject to the covenants and conditions contained in the indenture, we are permitted to issue additional notes and enter into hedging obligations secured by a lien that ranks equally with the Senior Secured Notes due 2018. In addition, the estimated net book value of the collateral is substantially less than the outstanding aggregate principal amount of the Senior Secured Notes due 2018 and the mortgage on the refinery is limited to a stated maximum principal amount of $450 million. To the extent that the Senior Secured Notes due 2018, any obligations in respect of hedging arrangements and any other obligations secured by the mortgagee exceed $450 million, the principal amount of such obligations in excess of such capped amount is not secured by the mortgage. Moreover, by its nature, some or all of the collateral may be illiquid and may have no readily ascertainable market value. Any additional obligations, and the limited net book value and potential illiquidity of the collateral, may limit the recovery from the realization of the value of such collateral available to satisfy the holders of the Senior Secured Notes due 2018.
Our ability to repurchase the Senior Secured Notes due 2018 upon a change of control may be limited.
Upon the occurrence of specified change of control events, we are required to offer to repurchase all outstanding Senior Secured Notes due 2018 at 101% of the principal amount, plus accrued and unpaid interest to the date of repurchase. The lenders under the Amended and Restated Revolving Credit Facility have the right to accelerate the indebtedness thereunder upon a change of control. Any of our future debt agreements may contain similar provisions. However, we may not have sufficient funds at the time of the change of control to make the required repurchase of Senior Secured Notes due 2018 or repayment of our other indebtedness. The terms of the Amended and Restated Revolving Credit Facility also limit our ability to purchase the Senior Secured Notes due 2018 until all debt under the Amended and Restated Revolving Credit Facility is paid in full. Any of our future debt agreements may contain similar restrictions. If we fail to repurchase any Senior Secured Notes due 2018 submitted in a change of control offer, it would constitute an event of default under the indenture governing the Senior Secured Notes due 2018 which could, in turn, constitute an event of default under our other indebtedness, even if the change of control itself would not cause a default.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not Applicable.
ITEM 2.
ITEM 2. PROPERTIES.
We own a 107-acre site in Warren, Pennsylvania upon which we operate our refinery. The site also contains an office building housing our principal executive office.
We own various real property in the states of Pennsylvania, New York, Ohio, and Alabama, upon which, as of August 31, 2011, we operated 185 retail units and two crude oil and six refined product storage terminals. We also own the 78-mile long Kiantone Pipeline, a pipeline which connects our crude oil storage terminal to the refinery’s tank farm. Our right to maintain the pipeline is derived from approximately 265 separate easements, right-of-way agreements, leases, permits, and similar agreements. We also have easements, right-of-way agreements, leases, permits, and similar agreements that would enable us to build a second pipeline on property contiguous to the Kiantone Pipeline.
As of August 31, 2011, we also lease an aggregate of 181 sites in Pennsylvania, New York, and Ohio upon which we operate retail units.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS.
The Company and its subsidiaries are from time to time parties to various legal proceedings that arise in the ordinary course of their respective business operations. These proceedings include various administrative actions relating to federal, state and local environmental laws and regulations as well as civil matters before various courts seeking money damages. The Company believes that if the legal proceedings in which it is currently involved were determined against the Company, there would be no material adverse effect on the Company’s operations or its consolidated financial condition. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that an unfavorable disposition would not have a material adverse effect on the consolidated operations or financial position of the Company.
ITEM 4.
ITEM 4. (REMOVED AND RESERVED).
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
None.
ITEM 6.
ITEM 6. SELECTED FINANCIAL DATA.
The following table sets forth certain historical financial and operating data (the “Selected Information”) as of the end of and for each of the years in the five-year period ended August 31, 2011. The selected income statement, balance sheet, financial and ratio data as of and for each of the five-years ended August 31, 2011 has been derived from our audited consolidated financial statements. The operating information for all periods presented has been derived from our accounting and financial records. The Selected Information set forth below should be read in conjunction with, and is qualified by reference to, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Item 7
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
Forward Looking Statements
This Annual Report on Form 10-K contains certain statements that constitute “forward looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward looking statements may include, among other things, United Refining Company and its subsidiaries current expectations with respect to future operating results, future performance of its refinery and retail operations, capital expenditures and other financial items. Words such as “expects”, “intends”, “plans”, “projects”, “believes”, “estimates”, “may”, “will”, “should”, “shall”, “anticipates”, “predicts”, and similar expressions typically identify such forward looking statements in this Annual Report on Form 10-K.
By their nature, all forward looking statements involve risk and uncertainties. All phases of the Company’s operations involve risks and uncertainties, many of which are outside of the Company’s control, and any one of which, or a combination of which, could materially affect the Company’s results of operations and whether the forward looking statements ultimately prove to be correct. Actual results may differ materially from those contemplated by the forward looking statements for a number of reasons.
Although we believe our expectations are based on reasonable assumptions within the bounds of its knowledge, investors and prospective investors are cautioned that such statements are only projections and that actual events or results may differ materially depending on a variety of factors described in greater detail in the Company’s filings with the SEC, including quarterly reports on Form 10-Q, annual reports on Form 10-K, current reports on Form 8-K, etc. In addition to the factors discussed elsewhere in this Annual Report 10-K, the Company’s actual consolidated quarterly or annual operating results have been affected in the past, or could be affected in the future, by additional factors, including, without limitation:
•
the effect of the current banking and credit crisis on the Company and our customers and suppliers;
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repayment of debt;
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general economic, business and market conditions;
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risks and uncertainties with respect to the actions of actual or potential competitive suppliers of refined petroleum products in our markets;
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the demand for and supply of crude oil and refined products;
•
the spread between market prices for refined products and market prices for crude oil;
•
the possibility of inefficiencies or shutdowns in refinery operations or pipelines;
•
the availability and cost of financing to us;
•
environmental, tax and tobacco legislation or regulation;
•
volatility of gasoline prices, margins and supplies;
•
merchandising margins;
•
labor costs;
•
level of capital expenditures;
•
customer traffic;
•
weather conditions;
•
acts of terrorism and war;
•
business strategies;
•
expansion and growth of operations;
•
future projects and investments;
•
expected outcomes of legal and administrative proceedings and their expected effects on our financial position, results of operations and cash flows;
•
future operating results and financial condition; and
•
the effectiveness of our disclosure controls and procedures and internal control over financial reporting.
All subsequent written and oral forward looking statements attributable to the Company or persons acting on its behalf are expressly qualified in their entirety by the foregoing. We undertake no obligation to update any information contained herein or to publicly release the results of any revisions to any such forward looking statements that may be made to reflect events or circumstances that occur, or which we become aware of, after the date of this Annual Report on Form 10-K.
Business Strategy and Overview
Our strategy is to strengthen our position as a leading producer and marketer of high quality refined petroleum products within our market area. We plan to accomplish this strategy through continued attention to optimizing our operations, resulting in the lowest possible crude and overhead costs, and continuing to improve and enhance our retail and wholesale positions. More specifically, we intend to:
•
Maximize the favorable economic impact of our transportation cost advantage by increasing our retail and wholesale market shares within our market area.
•
Optimize profitability by managing feedstock costs, product yields, and inventories through our refinery feedstock management program and our system-wide distribution model.
•
Continue to investigate additional strategic acquisitions and capital improvements to our existing facilities.
Company Background
Critical Accounting Policies
The accompanying consolidated financial statements and supplementary information were prepared in accordance with accounting principles generally accepted in the United States of America. Significant accounting policies are discussed in Note 1 to the Consolidated Financial Statements, Item 8. Inherent in the application of many of these accounting policies is the need for management to make estimates and judgments in the determination of certain revenues, expenses, assets and liabilities. As such, materially different financial results can occur as circumstances change and additional information becomes known. The policies with the greatest potential effect on our results of operation and financial position include:
Revenue Recognition
Revenues for products sold by the wholesale segment are recorded upon delivery of the products to our customers, at which time title to those products is transferred and when payment has either been received or collection is reasonably assured. At no point do we recognize revenue from the sale of product prior to transfer of its title. Title to product is transferred to the customer at the shipping point, under predetermined contracts for sale at agreement upon or posted prices to customers of which collectibility is reasonably assured.
Revenues for products sold by the retail segment are recognized immediately upon sale to the customer. Revenue derived from other sources including freight charges are recognized when the related product revenue is recognized.
Collectibility of Accounts Receivable
For accounts receivable we estimate the net collectibility considering both historical and anticipated trends relating to our customers and the possibility of non-collection due to their financial position. While such non-collections have been historically within our expectations and the allowances the Company has established, the Company cannot guarantee that it will continue to experience non-collection rates that it has experienced in the past. A significant change in the financial position of our customers could have a material impact on the quality of our accounts receivable and our future operating results.
Goodwill and Other Non-Amortizable Assets
In accordance with ACS 350, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests. We assess the impairment of goodwill and other indefinite-lived intangible assets annually.
The Company performed separate impairment tests on June 1, 2011 for its tradename and other intangible assets using discounted and undiscounted cash flow methods, respectively. The fair value of the tradename and other intangible assets exceeded their respective carrying values. The Company has noted no subsequent indication that would require testing the tradename and intangible assets for impairment.
There were no material changes in the gross carrying amounts of goodwill, tradename, or other intangible assets for fiscal 2011.
Long-Lived Assets
Whenever events or changes in circumstances indicate that the carrying value of any of these assets may not be recoverable, the Company will assess the recoverability of such assets based upon estimated undiscounted cash flow forecasts. When any such impairment exists, the related assets will be written down to fair value.
Value of Pension Assets
The Company maintains three noncontributory defined benefit retirement plans for substantially all its employees. The assets of the plans are invested with a financial institution that follows an investment policy drafted by the Company. The investment guidelines provide a percentage range for each class of assets to be managed by the financial institution. The historic performance of these asset classes supports the Company’s expected return on the assets. The asset classes are rebalanced periodically should they fall outside the range allocations.
The percentage of total asset allocation range is as follows:
The discount rate utilized in valuing the benefit obligations of the plans was derived from the rate of return on high quality bonds as of August 31, 2011. Similarly, the rate of compensation utilizes historic increases granted by the Company and the industry as well as future compensation policies. See Note 10 to “Consolidated Financial Statements, Item 8”.
Environmental Remediation and Litigation Reserve Estimations
Management also makes judgments and estimates in recording liabilities for environmental cleanup and litigation. Liabilities for environmental remediation are subject to change because of matters such as changes in laws, regulations and their interpretation; the effect of additional information on the extent and nature of site contamination; and improvements in technology. Likewise, actual litigation costs can vary from estimates based on the facts and circumstance and application of laws in individual cases.
The above assessment of critical accounting policies is not meant to be an all-inclusive discussion of the uncertainties to financial results that occur from the application of the full range of the Company’s accounting policies. Materially different financial results could occur in the application of other accounting policies as well. Likewise, materially different results can occur upon the adoption of new accounting standards promulgated by the various rule-making bodies.
General
The Company is engaged in the refining and marketing of petroleum products. In fiscal 2011, approximately 68% and 25% of the Company’s gasoline and distillate production, respectively, was sold through the Company’s network of service stations and truck stops. The balances of the Company’s refined products were sold to wholesale customers. In addition to transportation and heating fuels, primarily gasoline and distillate, the Company is a major regional wholesale marketer of asphalt. The Company also sells convenience merchandise at convenience stores located at most of its service stations. The Company’s profitability is influenced by fluctuations in the market prices of crude oils and refined products. Although the Company’s product sales mix helps to reduce the impact of large short-term variations in crude oil price, net sales and costs of goods sold can fluctuate widely based upon fluctuations in crude oil prices. Specifically, the margins on wholesale gasoline and distillate tend to decline in periods of rapidly declining crude oil prices, while margins on asphalt, retail gasoline and distillate tend to improve. During periods of rapidly rising crude oil prices, margins on wholesale gasoline and distillate tend to improve, while margins on asphalt and retail gasoline and distillate tend to decline. Gross margins on the sale of convenience merchandise averaged 25.3% for fiscal 2011 and have been between 25.2% and 27.1% for the last five years and are essentially unaffected by variations in crude oil and petroleum products prices.
The Company includes in costs of goods sold operating expenses incurred in the refining process. Therefore, operating expenses reflect only selling, general and administrative expenses, including all expenses of the retail network, and depreciation and amortization.
Recent Developments
The Company continues to be impacted by the volatility in petroleum markets in fiscal year 2012. The lagged 3-2-1 crackspread as measured by the difference between the price of crude oil contracts traded on the NYMEX for the proceeding month to the prices of NYMEX gasoline and heating oil contracts in the current trading month, have been positively affected through October. The Company uses a lagged crackspread as a margin indicator as it reflects the time period between the purchase of crude oil and its delivery to the refinery for processing. The lagged crackspread in September, the first month of fiscal 2012 averaged $31.04 as compared to an average of $24.31, for August, 2011, an increase of $6.73 or 28%. The lagged crackspread in October weakened slightly as compared to an average of $30.89, for September, a decrease of $.015 or .5%. As it continued to weaken, the lagged crackspread for the month of November, calculated on November 28, 2011 was $25.50.
Through November 28th, the indicated lagged crackspread for the first quarter of fiscal 2012 was $29.14, a $2.20 or 8% increase over the average for the fourth quarter of fiscal 2011. The indicated lagged crackspread for our second quarter ending February 29, 2012, calculated as of November 28 was $14.81 a 42% decrease from the projection for the first quarter of fiscal 2012. The impact of any decrease in crackspreads for the second quarter of 2012 will be mitigated by the Company’s crackspread derivative program. However, there can be no assurance that the indicated average crackspreads for the second quarter of fiscal 2012 will result in the actual crackspreads for that quarter.
As of November 17, 2011, the mark to market valuation over the remaining term of the crackspread swap contracts changed $52,606,541 from an unrealized loss position of $51,414,000 as of August 31, 2011 to an unrealized gain position of $1,192,541. See also Note 1 to the “Company’s Consolidated Financial Statements”.
The Company has reached an early settlement agreement with its refinery employees represented by the International Union of Operating Engineers, Local 95. The contract is effective February 1, 2010 and expires February 1, 2017. The agreement generally provides for improvement in wages, as well as changes to active and retiree healthcare, pension benefits and the defined contribution plan for the bargaining unit. These changes to the healthcare and pension plans are the same as the healthcare and pension plans provided to salaried employees effective September, 2010.
Results of Operations
The Company is a petroleum refiner and marketer in its primary market area of Western New York and Northwestern Pennsylvania. Operations are organized into two business segments: wholesale and retail.
The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers. The retail segment sells petroleum products under the Kwik Fill®, Citgo® and Keystone® brand names at a network of Company-operated retail units and convenience and grocery items through Company-owned gasoline stations and convenience stores under the Red Apple Food Mart® and Country Fair® brand names.
A discussion and analysis of the factors contributing to the Company’s results of operations are presented below. The accompanying Consolidated Financial Statements and related Notes (See Item 8), together with the following information, are intended to supply investors with a reasonable basis for evaluating the Company’s operations, but should not serve as the only criteria for predicting the Company’s future performance.
Retail Operations:
(a) Includes the effect of intersegment purchases from our wholesale segment at prices which approximate market.
(b) Company management calculates petroleum margin per gallon by dividing petroleum gross profit by petroleum sales volumes. Management uses fuel margin per gallon calculations to compare profitability to other companies in the industry. Petroleum margin per gallon may not be comparable to similarly titled measures used by other companies in the industry.
Net Sales
2011 vs. 2010
Retail sales increased during fiscal 2011 by $264.7 million or 19.5% for the comparable period in fiscal 2010 from $1,359.1 million to $1,623.8 million. The increase was primarily due to $259.7 million in petroleum sales and $5.0 million in merchandise sales. The petroleum sales increase resulted from a 22.8% increase in retail selling prices per gallon, and a 2.4 million gallon or .6% increase in retail petroleum volume. The merchandise
sales increase is primarily due to increased prepared food and beverages due to promotional campaigns and increased selling prices.
2010 vs. 2009
Retail sales increased during fiscal 2010 by $145.5 million or 12.0% for the comparable period in fiscal 2009 from $1,213.6 million to $1,359.1 million. The increase was primarily due to $126.0 million in petroleum sales and $19.5 million in merchandise sales. The petroleum sales increase resulted from a 12.1% increase in retail selling prices per gallon, and a 3.0 million gallon or .8% increase in retail petroleum volume. The merchandise sales increase is primarily due to increased prepared food, beverages and cigarette sales due to promotional campaigns and increased selling prices.
Costs of Goods Sold
2011 vs. 2010
Retail costs of goods sold increased during fiscal 2011 by $264.2 million or 21.6% for the comparable period in fiscal 2010 from $1,221.0 million to $1,485.2 million. The increase was primarily due to $248.2 million in petroleum purchase prices, merchandise cost of $3.7 million, inventory costs of $4.9, fuel tax of $5.7 million, and freight cost of $1.7 million.
2010 vs. 2009
Retail costs of goods sold increased during fiscal 2010 by $167.9 million or 15.9% for the comparable period in fiscal 2009 from $1,053.1 million to $1,221.0 million. The increase was primarily due to $143.4 million in petroleum purchase prices, merchandise cost of $15.9 million, inventory costs of $4.8, fuel tax of $3.1 million, and freight cost of $.7 million
Selling, General and Administrative Expenses
2011 vs. 2010
Retail Selling, General and Administrative (“SG&A”) expenses increased during fiscal 2011 by $4.5 million or 3.5% for the comparable period in fiscal 2010 from $128.0 million to $132.5 million. The increase was primarily due to credit/customer service costs of $2.6 million, maintenance costs of $1.4 million, payroll costs of $1.3 million, environmental costs of $.6 million and insurance/utilities/taxes of $.5 million offset by a decrease in pension/post retirement costs of $1.9 million. The decrease was primarily due to changes made in pension/post retirement benefits. Effective September 1, 2010, postretirement medical benefits for new hires and active salaried employees retiring after September 1, 2010 were eliminated. Additionally, effective January 1, 2011, deductibles and co-payments were added to the medical benefits plan for all plan participants. For salaried employees meeting certain age and service requirements, the Company will contribute a defined dollar amount towards the cost of retiree healthcare based upon the employee’s length of service. Similarly, effective September 1, 2010, benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide an enhanced contribution under its defined contribution 401(k) plan for all eligible employees as well as a transition contribution for older employees.
2010 vs. 2009
Retail SG&A expenses increased during fiscal 2010 by $6.4 million or 5.3% for the comparable period in fiscal 2009 from $121.6 million to $128.0 million. The increase was primarily due to payroll costs of $3.7 million, credit/customer service costs of $.8 million, pension/post retirement costs of $1.1 million, maintenance costs of $.3 million, advertising costs of $.3 million and insurance/utilities/taxes of $.2 million.
Wholesale Operations:
Key Wholesale Operating Statistics:
(a) Sources of total product sales include products manufactured at the refinery located in Warren, Pennsylvania and products purchased from third parties.
(b) The Company defines “heavy” crude oil as crude oil with an American Petroleum Institute specific gravity of 26 or less.
Net Sales
2011 vs. 2010
Wholesale sales increased during fiscal 2011 by $247.8 million or 19.1% for the comparable period in fiscal 2010 from $1,295.3 million to $1,543.1 million. The increase was due to a 30.5% increase in wholesale prices offset by a 8.7% decrease in wholesale volume.
2010 vs. 2009
Wholesale sales increased during fiscal 2010 by $121.7 million or 10.4% for the comparable period in fiscal 2009 from $1,173.6 million to $1,295.3 million. The increase was due to a 10.4% increase in wholesale prices offset by a 2.3% decrease in wholesale volume.
Costs of Goods Sold
2011 vs. 2010
Wholesale costs of goods sold increased during fiscal 2011 by $79.2million or 5.9% for the comparable period in fiscal 2010 from $1,338.8 million to $1,418.0 million. The increase in wholesale costs of goods sold during this period was primarily due to an increase in cost of raw materials.
2010 vs. 2009
Wholesale costs of goods sold increased during fiscal 2010 by $264.0 million or 24.6% for the comparable period in fiscal 2009 from $1,074.8 million to $1,338.8 million. The increase in wholesale costs of goods sold during this period was primarily due to an increase in cost of raw materials.
Loss on Derivative Contracts
During fiscal year 2011, the Company recognized a $58.7 million charge to costs and expenses which was attributed to losses resulting from fair value changes of the Company’s derivative instruments. Of the $58.7 million charge, $7.3 million was realized and $51.4 million unrealized (non-cash). See also Item 7A
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We use our Amended and Restated Revolving Credit Facility to finance a portion of our operations. These on-balance sheet financial instruments, to the extent they provide for variable rates, expose us to interest rate risk resulting from changes in the PNC Prime rate, the Federal Funds rate or the LIBOR rate.
We have exposure to price fluctuations of crude oil and refined products. We do not manage the price risk related to all of our inventories of crude oil and refined products with a permanent formal hedging program, but we do manage our risk exposure by managing inventory levels and by selectively applying hedging activities. At August 31, 2011, the Company had no future positions hedging crude or product inventories.
From time to time the Company uses derivatives to reduce its exposure to fluctuations in crude oil purchase costs and refining margins. Derivative products, historically crude oil option contracts (puts) and crack spread option contracts have been used to hedge the volatility of these items. The Company does not enter such contracts for speculative purposes. The Company accounts for changes in the fair value of its contracts by marking them to market and recognizing any resulting gains or losses in its statement of operations. The Company includes the carrying amounts of the contracts in prepaid expenses and other assets or accounts payable in its Consolidated Balance Sheet.
At August 31, 2011, the Company had 4,575,000 barrels of heating oil and gasoline crackspread swaps outstanding as part of its risk management strategy. This represents approximately 26.7% of the Company’s scheduled motor gasoline production through March 2012 and approximately 43.0% of scheduled distillate production through December 2012. The remainder of the crackspread swap contracts expire sequentially beginning September 2011 through December 2012. These derivative instruments are being used by the Company to lock in margins on future sales by the Company of heating oil and gasoline.
During the year ended August 31, 2011, the Company recognized $58,733,000 of losses in its Consolidated Statement of Operations. Of this amount $7,319,000 was realized losses (cash losses) for contracts which expired for the period ending August 31, 2011 and $51,414,000 was unrealized losses (non-cash losses) over the remaining term of the contracts as of August 31, 2011.
As of November 17, 2011, the mark to market valuation over the remaining term of the crackspread swap contracts changed $52,606,541 from an unrealized loss position of $51,414,000 as of August 31, 2011 to an unrealized gain position of $1,192,541. See also Note 1 to the “Company’s Consolidated Financial Statements”.
At August 31, 2011, we were exposed to the risk of market price declines with respect to a substantial portion of our crude oil and refined product inventories.
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholder
United Refining Company
Warren, Pennsylvania
We have audited the accompanying consolidated balance sheets of United Refining Company and subsidiaries as of August 31, 2011 and 2010, and the related consolidated statements of operations, comprehensive (loss) income , stockholder’s equity and cash flows for each of the three years in the period ended August 31, 2011. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated 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 consolidated financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, 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 consolidated financial statements referred to above present fairly, in all material respects, the financial position of United Refining Company and subsidiaries as of August 31, 2011 and 2010, and the results of their operations and their cash flows for each of the three years in the period ended August 31, 2011, in conformity with accounting principles generally accepted in the United States of America.
/s/ BDO USA, LLP
New York, New York
November 29, 2011
UNITED REFINING COMPANY AND SUBSIDIARIES
Consolidated Balance Sheets
(in thousands, except share amounts)
See accompanying notes to consolidated financial statements.
UNITED REFINING COMPANY AND SUBSIDIARIES
Consolidated Statements of Operations
(in thousands)
See accompanying notes to consolidated financial statements.
UNITED REFINING COMPANY AND SUBSIDIARIES
Consolidated Statements of Comprehensive (Loss) Income
(in thousands)
See accompanying notes to consolidated financial statements.
UNITED REFINING COMPANY AND SUBSIDIARIES
Consolidated Statements of Stockholder’s Equity
(in thousands, except share data)
See accompanying notes to consolidated financial statements.
UNITED REFINING COMPANY AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(in thousands)
See accompanying notes to consolidated financial statements.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Description of Business and Summary of Significant Accounting Policies
Description of Business and Basis of Presentation
The consolidated financial statements include the accounts of United Refining Company and its subsidiaries, United Refining Company of Pennsylvania and its subsidiaries, Kiantone Pipeline Corporation (collectively, the “Company”) and United Refining Asphalt, Inc. (“URA”), a variable interest entity that was created in January 2011 for which the Company was the primary beneficiary. The Company ceased to be the primary beneficiary of URA as of August 31, 2011 and URA was deconsolidated as of that date and URA was dissolved. All significant intercompany balances and transactions have been eliminated in consolidation.
A variable interest entity (“VIE”) is defined as an entity that either has investor voting rights that are not proportional to their economic interests or has equity investors that do not provide sufficient financial resources for the entity to support its activities. A VIE is required to be consolidated by a company if that company is the primary beneficiary. The primary beneficiary of the VIE is the company that controls the VIE’s activities and is subject to a majority of the risk of loss from the VIE’s activities or, if no company is subject to a majority of such risk, the company that is entitled to receive a majority of the VIE’s residual returns.
The Company is a petroleum refiner and marketer in its primary market area of Western New York and Northwestern Pennsylvania. Operations are organized into two business segments: wholesale and retail.
The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers. The retail segment sells petroleum products under the Kwik Fill®, Citgo® and Keystone® brand names at a network of Company-operated retail units and convenience and grocery items through Company-owned gasoline stations and convenience stores under the Red Apple Food Mart® and Country Fair® brand names.
The Company is a wholly-owned subsidiary of United Refining, Inc., a wholly-owned subsidiary of United Acquisition Corp., which in turn is a wholly-owned subsidiary of Red Apple Group, Inc. (the “Parent”).
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, the Company considers all highly liquid investment securities with maturities of three months or less at date of acquisition to be cash equivalents.
Derivative Instruments
From time to time the Company uses derivatives to reduce its exposure to fluctuations in crude oil purchase costs and refining margins. Derivative products, historically crude oil option contracts (puts) and crack spread option contracts have been used to hedge the volatility of these items. The Company does not enter such contracts for speculative purposes. The Company accounts for changes in the fair value of its contracts by marking them to market and recognizing any resulting gains or losses in its statement of operations. The Company includes the carrying amounts of the contracts in prepaid expenses and other assets or derivative liability in its Consolidated Balance Sheet.
At August 31, 2011, the Company had 4,575,000 barrels of heating oil and gasoline crackspread swaps outstanding as part of its risk management strategy. This represents approximately 26.7% of the Company’s scheduled motor gasoline production through March 2012 and approximately 43.0% of scheduled distillate production through December 2012. The remainder of the crackspread swap contracts expire sequentially beginning September 2011 through December 2012. These derivative instruments are being used by the Company to lock in margins on future sales by the Company of heating oil and gasoline.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The fair value and balance sheet classification of our derivative instruments at August 31, 2011 are as follows:
During the year ended August 31, 2011 the Company recognized $58,733,000 of losses in costs and expenses in its Consolidated Statement of Operations. As of November 17, 2011, the mark to market valuation over the remaining term of the crackspread swap contracts changed $52,606,541 from an unrealized loss position of $51,414,000 as of August 31, 2011 to an unrealized gain position of $1,192,541.
At August 31, 2010, the Company had no derivative financial instruments outstanding and did not recognize any gains or losses from its risk management strategy for the year then ended.
Inventories and Exchanges
Inventories are stated at the lower of cost or market, with cost being determined under the Last-in, First-out (LIFO) method for crude oil and petroleum product inventories and the First-in, First-out (FIFO) method for merchandise. Supply inventories are stated at either lower of cost or market or replacement cost and include various parts for the refinery operations. If the cost of inventories exceeds their market value, provisions are made currently for the difference between the cost and the market value.
Property, Plant and Equipment
Property, plant and equipment is stated at cost and depreciated by the straight-line method over the respective estimated useful lives. Routine current maintenance, repairs and replacement costs are charged against income. Expenditures which materially increase values expand capacities or extend useful lives are capitalized. A summary of the principal useful lives used in computing depreciation expense is as follows:
Leases
The Company leases land, buildings, and equipment under long-term operating and capital leases and accounts for the leases in accordance with ASC 360-10-30-8. Lease expense for operating leases is recognized on a straight-line basis over the expected lease term. The lease term begins on the date the Company has the right to control the use of the leased property pursuant to the terms of the lease.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Deferred Maintenance Turnarounds
The cost of maintenance turnarounds, which consist of complete shutdown and inspection of significant units of the refinery at intervals of two or more years for necessary repairs and replacements, are deferred when incurred and amortized on a straight-line basis over the period of benefit, which ranges from 2 to 10 years. As of August 31, 2011 and 2010, deferred turnaround costs included in Deferred Turnaround Costs and Other Assets, amounted to $17,789,000 and $3,228,000, net of accumulated amortization of $20,642,000 and $17,588,000, respectively. Amortization expense included in costs of goods sold for the fiscal years ended August 31, 2011, 2010 and 2009 amounted to $4,350,000, $5,056,000, and $6,539,000, respectively.
Amortizable Intangible Assets
The Company amortizes identifiable intangible assets such as brand names, non-compete agreements, leasehold covenants and deed restrictions on a straight line basis over their estimated useful lives which range from 5 to 25 years.
Revenue Recognition
Revenues for products sold by the wholesale segment are recorded upon delivery of the products to our customers, at which time title to those products is transferred and when payment has either been received or collection is reasonably assured. At no point do we recognize revenue from the sale of products prior to the transfer of its title. Title to product is transferred to the customer at the shipping point, under pre-determined contracts for sale at agreed upon or posted prices to customers of which collectibility is reasonably assured. Revenues for products sold by the retail segment are recognized immediately upon sale to the customer. Included in Net Sales and Costs of Goods Sold are consumer excise taxes of $224,551,000, $218,811,000, and $215,670,000 for the years ended August 31, 2011, 2010 and 2009, respectively.
Cost Classifications
Our Cost of goods sold (which excludes depreciation and amortization on property, plant and equipment and losses on derivative contracts) includes Refining Cost of Products Sold and related Refining Operating expenses.
Refining Cost of Products Sold includes cost of crude oil, other feedstocks, blendstocks, the cost of purchased finished products, amortization of turnaround costs, transportation costs and distribution costs. Retail cost of products sold includes cost for motor fuels and for merchandise. Motor fuel cost of products sold represents net cost for purchased fuel. Merchandise cost of products sold includes merchandise purchases, net of merchandise rebates and inventory shrinkage. Wholesale cost of products sold includes the cost of fuel and lubricants, transportation and distribution costs and labor.
Income Taxes
The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.
The Company’s results of operations are included in the consolidated Federal Income tax return of the Parent and separately in various state jurisdictions. Income taxes are calculated on a separate return basis with
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
consideration of the Tax Sharing Agreement between the Parent and its subsidiaries. The Company is open to examination for tax years 2002 through 2010 and there is a federal tax audit in process for the tax years 2007 through 2010. There are currently no state tax audits in process and there are no unsettled income tax assessments outstanding. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax positions as a component of interest expense, net and other, net, respectively. No amounts of such expenses are currently accrued.
Post-Retirement Healthcare and Pension Benefits
The Company provides post-retirement healthcare benefits to salaried and certain hourly employees that retired prior to September 1, 2010. The benefits provided are hospitalization and medical coverage for the employee and spouse until age 65. Benefits continue until the death of the retiree, which results in the termination of benefits for all dependent coverage. If an employee leaves the Company as a terminated vested member of a pension plan prior to normal retirement age, the person is not entitled to any post-retirement healthcare benefits. Benefits payable under this program are secondary to any benefits provided by Medicare or any other governmental programs.
In June 2010, the Company announced changes to the healthcare and pension plans provided to salaried employees. Effective September 1, 2010, postretirement medical benefits for new hires and active salaried employees retiring after September 1, 2010 were eliminated. Additionally, effective January 1, 2011, deductibles and co-payments were added to the medical benefits plan for all active and retired employees. For salaried employees meeting certain age and service requirements, the Company contributes a defined dollar amount towards the cost of retiree healthcare based upon the employee’s length of service. Similarly, effective August 31, 2010, benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide an enhanced contribution under its defined contribution 401(k) plan as well as a transition contribution for older employees.
The Company accrues post-retirement benefits other than pensions, during the years that the employee renders the necessary service, of the expected cost of providing those benefits to an employee and the employee’s beneficiaries and covered dependents.
Use of Estimates
The preparation of 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 disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Allowance for Doubtful Accounts
The Company records an allowance for doubtful accounts based on specifically identified amounts that we believe to be uncollectible. The Company also recorded additional allowances based on historical collection experience and its assessment of the general financial conditions affecting the customer base. Senior management reviews accounts receivable on a weekly basis to determine if any receivables will potentially be uncollectible. After all attempts to collect a receivable have failed, the receivable is written off against the allowance.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Concentration Risks
Financial instruments which potentially subject the Company to concentrations of credit risk consist principally of temporary cash investments.
The Company places its temporary cash investments with quality financial institutions. At times, such investments were in excess of FDIC insurance limits. The Company has not experienced any losses in such accounts.
The Company purchased approximately 10% of its cost of goods sold from one vendor during the year ended August 31, 2011 and approximately 32% from one vendor during the year ended August 31, 2010. The Company is not obligated to purchase from this vendor, and, if necessary, there are other vendors from which the Company can purchase crude oil and other petroleum based products. The Company had approximately $4,507,000 and $0 in accounts payable for the years ended August 31, 2011 and 2010 to this respective vendor.
Environmental Matters
The Company expenses environmental expenditures related to existing conditions resulting from past or current operations and from which no current or future benefit is discernible. Expenditures, which extend the life of the related property or mitigate or prevent future environmental contamination are capitalized. The Company determines its liability on a site by site basis and records a liability at the time when it is probable and can be reasonably estimated. The Company’s estimated liability is reduced to reflect the anticipated participation of other potentially responsible parties in those instances where it is probable that such parties are legally responsible and financially capable of paying their respective shares of the relevant costs. The estimated liability of the Company is not reduced for possible recoveries from insurance carriers and is recorded in accrued liabilities.
Goodwill and Other Non-Amortizable Assets
In accordance with ASC 350, goodwill and intangible assets deemed to have indefinite lives are no longer amortized but are subject to annual impairment tests in accordance with ASC 350. Other intangible assets continue to be amortized over their estimated useful lives.
The Company performed separate impairment tests for its goodwill and tradename using the discounted cash flow method. The fair value of the goodwill and tradename exceeded their respective carrying values. The Company has noted no subsequent indication that would require testing its goodwill and tradename for impairment.
Long-Lived Assets
Whenever events or changes in circumstances indicate that the carrying value of any of these assets (other than goodwill and tradename) may not be recoverable, the Company will assess the recoverability of such assets based upon estimated undiscounted cash flow forecasts. When any such impairment exists, the related assets will be written down to fair value.
Other Comprehensive (Loss) Income
The Company reports comprehensive (loss) income in accordance with ASC 220-10. ASC 220-10 establishes guidelines for the reporting and display of comprehensive (loss) income and its components in
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
financial statements. Comprehensive (loss) income includes charges and credits to equity that is not the result of transactions with the shareholder. Included in other comprehensive loss for the Company is a charge for unrecognized post retirement costs, which is net of taxes in accordance with ASC 715.
Recent Accounting Pronouncements
In May 2011, the FASB issued amended guidance on fair value measurement and related disclosures. The new guidance clarifies the concepts applicable for fair value measurement of non-financial assets and requires the disclosure of quantitative information about the unobservable inputs used in a fair value measurement. This guidance will be effective for reporting periods beginning after December 15, 2011, and will be applied prospectively. We do not anticipate that the adoption of this amended guidance will have a material impact on our consolidated financial statements.
In June 2011, the FASB issued amended guidance on the presentation of comprehensive income. The amended guidance eliminates one of the presentation options provided by current U.S. GAAP, that is, to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. In addition, it gives an entity the option to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This guidance will be effective for reporting periods beginning after December 15, 2011 and will be applied retrospectively. The adoption of this guidance will not have a material impact on our consolidated financial statements.
In September 2011, the FASB issued an accounting standard update that amends the accounting guidance on goodwill impairment testing. The amendments are intended to reduce complexity and costs by allowing an entity the option to make a qualitative evaluation about the likelihood of goodwill impairment to determine whether it should calculate the fair value of a reporting unit. The amendments also improve previous guidance by expanding upon the examples of events and circumstances that an entity should consider between annual impairment tests in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. The amendments in this accounting standard update are effective for interim and annual goodwill impairment tests performed for fiscal years beginning after December 15, 2011. We do not anticipate that the adoption of this accounting standard update will have a material impact on our consolidated financial statements.
Reclassification
Certain amounts in the prior year’s consolidated financial statements have been reclassified to conform with the presentation in the current year.
2. Accounts Receivable, Net
As of August 31, 2011 and 2010, accounts receivable were net of allowance for doubtful accounts of $1,800,000 and $2,050,000, respectively.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
3. Inventories
Inventories consist of the following:
Included in petroleum product inventories are exchange balances either held for or due from other petroleum marketers. These balances are not significant.
The Company does not own sources of crude oil and depends on outside vendors for its needs.
As of August 31, 2011 and 2010, the replacement cost of LIFO inventories exceeded their LIFO carrying values by approximately $92,059,000 and $50,265,000, respectively. For the fiscal years ended August 31, 2011 and 2010, the Company recorded a charge to cost of sales from a LIFO layer liquidation of $11,467,000 and $13,748,000, respectively.
4. Property, Plant and Equipment
Property, plant and equipment is summarized as follows:
The Company has temporarily postponed its efforts to construct a Coker Facility for use in the refinery. As of August 31, 2011 and 2010, the Company has spent approximately $29,719,000, relating to, among other things, the design of the facility as well as materials to be used in construction. These costs are currently capitalized in construction-in-progress within Property Plant and Equipment, net. The Company presently believes that the Coker Facility will be constructed and consequently the costs incurred to date will be realizable. The Company continues to monitor the financial markets for an opportunity which will allow the Company to seek favorable financing to fund the remainder of the project.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
5. Goodwill and Intangible Assets
As of August 31, 2011 and 2010, the Company’s intangible assets and goodwill, included in the Company’s retail segment, were as follows:
Amortization expense for the fiscal years ended August 31, 2011, 2010, and 2009 amounted to $106,000, $107,000, and $230,000, respectively.
Amortization expense for intangible assets subject to amortization for each of the years in the five-year period ending August 31, 2016 is estimated to be $106,000 in each year.
6. Accrued Liabilities
Accrued liabilities include the following:
7. Leases
The Company occupies premises, primarily retail gas stations and convenience stores and office facilities under long-term leases which require minimum annual rents plus, in certain instances, the payment of additional rents based upon sales. The leases generally are renewable for one to three five-year periods.
As of August 31, 2011 and 2010, capitalized lease obligations, included in long-term debt, amounted to $918,000 and $1,078,000, respectively, inclusive of current portion of $96,000 and $160,000, respectively. The related assets (retail gas stations and convenience stores) as of August 31, 2011 and 2010 amounted to $630,000 and $769,000, net of accumulated amortization of $1,190,000 and $1,051,000, respectively. Lease amortization amounting to $139,000, $167,000, and $168,000, for the years ended August 31, 2011, 2010, and 2009, respectively, is included in depreciation and amortization expense.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Future minimum lease payments as of August 31, 2011 are summarized as follows:
Net rent expense for operating leases amounted to $12,137,000, $12,107,000 and $11,342,000, for the years ended August 31, 2011, 2010 and 2009, respectively.
8. Credit Facility
On May 18, 2011, the Company, United Refining Company of Pennsylvania, Kiantone Pipeline Corporation, Country Fair, Inc. and Kwik-Fill Corporation (as Guarantor) entered into an amended and restated Revolving Credit Facility (“Amended and Restated Revolving Credit Facility”) with PNC Bank, National Association as Administrator (the “Agent”) increasing the maximum facility commitment from $130,000,000 to $175,000,000 and extending the term to May 18, 2016. Under the Amended and Restated Revolving Credit Facility, interest is calculated as follows: (a) for base rate borrowings, at the greater of the Agent’s prime rate, federal funds open rate plus 0.5% or the daily LIBOR rate plus 1.0% plus the applicable margin of 1.25% to 1.75% and (b) for euro-rate borrowings, at the LIBOR rate plus an applicable margin of 2.75% to 3.25%. The applicable margin will vary depending on a formula calculating the Company’s unused availability under the facility. The Amended and Restated Revolving Credit Facility continues to be secured primarily by certain cash accounts, accounts receivable and inventory which amounted to $275,000,000 as of August 31, 2011. Until maturity, the Company may borrow on a borrowing base formula as set forth in the facility. The participating banks in the Amended and Restated Revolving Credit Facility are PNC Bank, National Association, Bank of America, N.A., Manufacturers and Traders Trust Company, and Bank Leumi USA.
As of August 31, 2011, $14,000,000 of Base-Rate borrowings and $10,000,000 of Euro-Rate borrowings were outstanding under the agreement. As of August 31, 2010, $33,000,000 of Base-Rate borrowing and $50,000,000 of Euro-Rate borrowings were outstanding under the agreement. $4,433,000 of letters of credit were outstanding under the agreement at August 31, 2011 and 2010, respectively. The weighted average interest rate for Base-Rate borrowing for the years ended August 31, 2011 and 2010 was 2.6% and 3.4%, respectively. The weighted average interest rate for Euro-Rate borrowings for the years ended August 31, 2011 and 2010 was 4.0% and 2.3%, respectively. The Company pays a commitment fee of 3/8% per annum on the unused balance of the facility. All bank related charges are included in Other, net in the Consolidated Statements of Operations.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
9. Long-Term Debt
On March 8, 2011, the Company sold $365,000,000 of 10.500% Senior Secured Notes due 2018 for $352,020,600, resulting in original issue discount of $12,979,400, which will be amortized over the life of the Senior Secured Notes due 2018 using the interest method. The net proceeds of the offering of $344,249,000 were used to retire all of its outstanding 10 1/2% Senior Notes due 2012, pay accrued interest of $3,400,000 and a redemption premium related thereto. A loss of $1,245,000 on the early extinguishment of debt was recorded consisting of a redemption premium of $915,000, a write-off of unamortized net debt premium of $1,153,000 and a write-off of deferred financing costs of $1,483,000. The Senior Secured Notes are guaranteed on an unsecured basis by all of our domestic subsidiaries existing at March 8, 2011. The Senior Secured Notes are secured on a first-priority basis by our assets comprising our refinery located in Warren, Pennsylvania and the capital stock of our pipeline subsidiary, subject to permitted liens. The Senior Secured Notes will rank equally with all of our existing and future senior indebtedness that is not subordinate in right of payment to the Senior Secured Notes.
On February 22, 2011 the Company announced the launch of a cash tender offer (the “Tender Offer”) for any and all of its outstanding 10 1/2% Senior Notes due 2012 issued under an indenture dated as of August 6, 2004 (the “2012 Indenture”) and consent solicitation (the “Solicitation”) for certain proposed amendments to the 2012 Indenture (the “Proposed Amendments”). Each holder who validly tendered its Senior Notes due 2012 and delivered consents to the Proposed Amendments prior to 5:00 pm, New York City time, on March 7, 2011, (the “Consent Date”), received the total consideration of $1,005, which included $975 as the tender offer consideration and $30 as a consent payment. In addition, accrued but unpaid interest up to, but not including, the applicable payment date of the Senior Notes due 2012 was paid in cash on all validly tendered and accepted the Senior Notes due 2012. The Company paid a total of $188,607,726 on March 8, 2011 for $181,764,375 principal amount of the Senior Notes due 2012, $5,592,750 for consent payment (which is included in interest expense, net and financing costs), and $1,250,601 for accrued interest on those Senior Notes due 2012 tendered.
The Tender Offer expired at 12:00 midnight, New York City time, on March 21, 2011. Holders who validly tendered their Senior Notes due 2012 after the Consent Date received only the tender offer consideration and were not entitled to receive a consent payment pursuant to the Tender Offer. The Company paid the total consideration or tender offer consideration, as the case may be, plus accrued but unpaid interest, for the Senior Notes due 2012 accepted for purchase promptly following the date of such acceptance (such date, the “Final Payment Date”). On March 22, 2011, the Company paid a total of $678,225 for $670,800 principal amount of the Senior Notes due 2012 and $7,425 for accrued interest on those Senior Notes due 2012 tendered between the Consent Date (March 7, 2011) and the Final Payment Date (March 21, 2011).
On March 9, 2011, the Company issued a Notice of Redemption to all holders of its 10 1/2 % Senior Notes due 2012 redeeming these Senior Notes due 2012 at 100% par value plus accrued but unpaid interest on the redemption date of April 8, 2011. On April 8, 2011, $138,962,427 was paid in total, of which $136,847,000 was for principal amount of Senior Notes due 2012 and $2,115,427 was for accrued interest.
Both the Indenture of the Senior Unsecured Notes and the facility (See Note 8 to “Consolidated Financial Statements”) require that the Company maintain certain financial covenants. The facility requires the Company to meet certain financial covenants, as defined in the facility, a minimum Fixed Charge Coverage Ratio and a minimum Consolidated Net Worth. In addition, the facility limits the amount the Company can distribute for capital and operating leases. Both the facility and the Indenture of the Senior Unsecured Notes restrict the amount of dividends payable and the incurrence of additional Indebtedness. As of August 31, 2011 the Company is in compliance with covenants under the facility and the Indenture.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
During the year ended August 31, 2009, the Company acquired $26,040,000 of its 10 1/2% Senior Unsecured Notes due 2012 at an average price of $59.38, resulting in a gain from extinguishment of debt of $10,096,000, which is net of $346,000 of deferred financing costs and $136,000 of debt discount.
A summary of long-term debt is as follows:
The principal amount of long-term debt matures as follows:
The following financing costs have been deferred and are being amortized to expense over the term of the related debt:
Amortization expense for the fiscal years ended August 31, 2011, 2010 and 2009 amounted to $1,362,000, $1,150,000, and $1,169,000, respectively.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
10. Employee Benefit Plans
The Company sponsors three defined benefit plans and seven defined contribution plans covering substantially all its full time employees. The benefits under the defined benefit plans are based on each employee’s years of service and compensation. Effective August 31, 2010 benefits under the Company’s defined benefit pension plan were frozen for all salaried employees, including the Company’s Chief Executive Officer and Chief Financial Officer. The Company will provide enhanced contributions under its defined contribution 401(k) plan as well as a transition contribution for older employees. The Company’s policy is to contribute the minimum amounts required by the Employee Retirement Income Security Act of 1974 (ERISA), as amended and any additional amounts for strategic financial purposes or to meet other goals relating to plan funded status. The assets of the plans are invested in an investment trust fund and consist of interest-bearing cash, separately managed accounts and bank common/collective trust funds.
In addition to the above, the Company provides certain post-retirement healthcare benefits to salaried and certain hourly employees that retired prior to September 1, 2010. These post-retirement benefit plans are unfunded and the costs are paid by the Company from general assets.
Net periodic pension cost and post-retirement healthcare benefit cost consist of the following components for the years ended August 31, 2011, 2010, and 2009:
The Company adopted ASC 715-30-25 effective August 31, 2007. ASC 715-30-25 requires an employer to recognize the funded status of each of its defined pension and postretirement benefit plans as a net asset or liability in its statement of financial position with an offsetting amount in accumulated other comprehensive income, and to recognize changes in that funded status in the year in which changes occur through comprehensive income.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Other changes in plan assets and benefit obligation recognized in Other Comprehensive Income consist of the following for the fiscal years ending August 31, 2011 and 2010 (in thousands):
The following table summarizes the change in benefit obligations and fair values of plan assets for the years ended August 31, 2011 and 2010:
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Amounts recognized in Accumulated Other Comprehensive Income:
The preceding table presents two measures of benefit obligations for the pension plans. Accumulated benefit obligation (ABO) generally measures the value of benefits earned to date. Projected benefit obligation (PBO) also includes the effect of assumed future compensation increases for plans in which benefits for prior service are affected by compensation changes. Each of the three pension plans, whose information is aggregated above, have asset values less than these measures. Plan funding amounts are calculated pursuant to ERISA and Internal Revenue Code rules. The postretirement benefits are not funded.
Weighted average assumptions used to determine year end benefit obligations:
The discount rate assumptions at August 31, 2011 and 2010 were determined independently for each plan. A yield curve was produced for a universe containing the majority of U.S.-issued Aa-graded corporate bonds, all of which were non-callable (or callable with make-whole provisions). For each plan, the discount rate was developed as the level equivalent rate that would produce the same present value as that using spot rates aligned with the projected benefit payments.
Weighted average assumptions used to determine net periodic costs:
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
For measurement purposes, the assumed annual rate of increase in the per capita cost of covered medical and dental benefits was 7.5% for 2011 and 2010, respectively. The rates were assumed to decrease gradually to 5% for medical benefits until 2017 and remain at that level thereafter. The healthcare cost trend rate assumption has a significant effect on the amounts reported. To illustrate, a 1 percentage point change in the assumed healthcare cost trend rate would have the following effects:
The expected return on plan assets is a long-term assumption established by considering historical and anticipated returns of the asset classes invested in by the pension plans and the allocation strategy currently in place among those classes.
A reconciliation of the above accrued benefit costs to the consolidated amounts reported on the Company’s balance sheets follows:
Fair Value of Plan Assets
Our Defined Benefit plans’ assets fall into any of three fair value classifications as defined in ASC 820-10. Level 1 assets are valued based on observable prices for identical assets in active markets such as national security exchanges. Level 2 assets are valued based on a) quoted prices of similar assets in active markets, b) quoted prices for similar assets in inactive markets, c) other than quoted prices that are observable for the asset, or d) values that are derived principally from or corroborated by observable market data by correlation or other means. There are no Level 3 assets held by the plans as defined by ASC 820-10.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The pension plans weighted-average target allocation for the year ended August 31, 2012 and strategic asset allocation matrix as of August 31, 2011 and 2010 are as follows:
The investment policy for the plans is formulated by the Company’s Pension Plan Committee (the “Committee”). The Committee is responsible for adopting and maintaining the investment policy, managing the investment of plan assets and ensuring that the plans’ investment program is in compliance with all provisions of ERISA, as well as the appointment of any investment manager who is responsible for implementing the plans’ investment process.
In drafting a strategic asset allocation policy, the primary objective is to invest assets in a prudent manner to meet the obligations of the plans to the Company’s employees, their spouses and other beneficiaries, when the obligations come due. The stability and improvement of the plans’ funded status is based on the various reasons for which money is funded. Other factors that are considered include the characteristics of the plans’ liabilities and risk-taking preferences.
The asset classes used by the plan are the United States equity market, the international equity market, the United States fixed income or bond market and cash or cash equivalents. Plan assets are diversified to minimize the risk of large losses. Cash flow requirements are coordinated with the custodian trustees and the investment manager to minimize market timing effects. The asset allocation guidelines call for a maximum and minimum range for each broad asset class as noted above.
The target strategic asset allocation and ranges established under the asset allocation represents a long-term perspective. The Committee will rebalance assets to ensure that divergences outside of the permissible allocation ranges are minimal and brief as possible.
The net of investment manager fee asset return objective is to achieve a return earned by passively managed market index funds, weighted in the proportions identified in the strategic asset allocation matrix. Each investment manager is expected to perform in the top one-third of funds having similar objectives over a full market cycle.
The investment policy is reviewed by the Committee at least annually and confirmed or amended as needed.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Under ASC 715-30-25, the transition obligation, prior service costs, and actuarial (gains)/losses are recognized in Accumulated Other Comprehensive Income each August 31 or any interim measurement date, while amortization of these amounts through net periodic benefit cost will occur in accordance with ASC 715-30 and ASC 715-60. The estimated amounts that will be amortized in 2012 follow:
The following contributions and benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
The pension plan contributions are deposited into a trust, and the pension plan benefit payments are made from trust assets. For the postretirement benefit plan, the contributions and the benefit payments are the same and represent expected benefit amounts, which are paid from general assets.
The Company’s postretirement benefit plan is likely to be affected by The Medicare Prescription Drug, Improvement and Modernization Act of 2003 (the “Act”). Beginning in 2006, the Act provides a Federal subsidy payment to companies providing benefit plans that meet certain criteria regarding their generosity. The Company expects to receive those subsidy payments. The Company has accounted for the Act in accordance with ASC 715-60-05-8, which requires, in the Company’s case, recognition on August 31, 2004. The benefit obligation as of that date reflects the effect of the federal subsidy, and this amount is identified in the table reconciling the change in benefit obligation above. The estimated effect of the subsidy on cash flow is shown in the accompanying table of expected benefit payments above. The expected subsidy reduced net periodic postretirement benefit cost by $2,966,000, as compared with the amount calculated without considering the effects of the subsidy.
The Company also contributes to voluntary employee savings plans through regular monthly contributions equal to various percentages of the amounts invested by the participants. The Company’s contributions to these plans amounted to $1,565,000, $932,000, and $894,000 for the years ended August 31, 2011, 2010 and 2009, respectively.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
11. Income Taxes
Income tax expense (benefit) consists of:
Reconciliation of the differences between income taxes computed at the Federal statutory rate and the provision for income taxes attributable to income before income tax expense (benefit) is as follows:
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
Deferred income tax liabilities (assets) are comprised of the following:
The Company’s results of operations are included in the consolidated Federal tax return of the Parent, See Note 13 to “Consolidated Financial Statements”. The Company has no Federal net operating loss carryforwards for regular tax purposes. For state purposes, two entities have Pennsylvania net operating loss carry forwards of $155,000,000 and $50,000,000, respectively, which will expire between fiscal year 2019 and 2031. Pennsylvania limits the amount of net operating loss carry forwards which can be used to offset Pennsylvania taxable income to the greater of $3,000,000 or 20% of Pennsylvania taxable income prior to the net operating loss deduction. Due to these limitations, the Company has recognized valuation allowances, net of a federal benefit, of $9,224,000 and $8,971,000 at August 31, 2011 and 2010, respectively, for Pennsylvania net operating loss carry forwards not anticipated to be realized before expiration.
12. Disclosures About Fair Value of Financial Instruments
The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value.
The carrying amount of cash and cash equivalents, trade accounts receivable, the revolving credit facility and current liabilities approximate fair value because of the short maturity of these instruments. Derivative financial instruments are recorded at fair value using significant other observable inputs (Level 2).
The fair value of long-term debt (See Note 9 to “Consolidated Financial Statements”) was determined using the fair market value of the individual debt instruments. As of August 31, 2011, the carrying amount and estimated fair value of these debt instruments approximated $357,087,000 and $363,771,000, respectively.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
The following table lists the assets or liabilities measured and recorded at fair value within the fair value hierarchy.
13. Transactions with Affiliated Companies
On December 21, 2001, the Company acquired the operations and working capital assets of Country Fair. The fixed assets of Country Fair were acquired by related entities controlled by John A. Catsimatidis, the indirect sole shareholder of the Company. These assets are being leased to the Company at an annual aggregate rental which management, based on an independent third party valuation believes is fair, over a period ranging from 10 to 20 years. During the fiscal years ended August 31, 2011, 2010 and 2009, $5,102,000, $5,102,000, and $5,102,000 of rent payments were made to these related entities. The Company is not a guarantor on the underlying mortgages on the properties.
Concurrent with the above acquisition of Country Fair, the Company entered into a management agreement with a non-subsidiary affiliate to operate and manage 18 of the retail units owned by the non-subsidiary affiliate on a turn-key basis. For the years ended August 31, 2011, 2010 and 2009, the Company billed the affiliate $1,266,000, $1,243,000, and $1,219,000 for management fees and overhead expenses incurred in the management and operation of the retail units which amount was deducted from expenses. As of August 31, 2011 and 2010, the Company had a receivable (payable) to the affiliate of $175,000 and $(138,000), respectively, under the terms of the agreement, which is included in Amounts Due from Affiliated Companies, Net.
On September 29, 2000, the Company sold 42 retail units to an affiliate for $23,870,000. Concurrent with this asset sale, the Company terminated the leases on 8 additional retail locations which it had previously leased from a non-subsidiary affiliate. The Company has entered into a management agreement with the non-subsidiary affiliate to operate and manage the retail units owned by the non-subsidiary affiliate on a turnkey basis. For the years ended August 31, 2011, 2010 and 2009, the Company billed the affiliate $2,032,000, $2,099,000, and $2,245,000, respectively, for management fees and overhead expenses incurred in the management and operation of the 50 retail units, which amount was deducted from expenses. For the fiscal years ended August 31, 2011, 2010 and 2009, net sales to the affiliate amounted to $184,749,000, $140,277,000 and $112,878,000, respectively. As of August 31, 2011 and 2010, the Company had a receivable (payable) to the affiliate of $342,000 and $(344,000), respectively, under the terms of the agreement.
The Company paid a service fee relating to certain costs incurred by its Parent for the Company’s New York office. During the years ended August 31, 2011, 2010 and 2009, such fees amounted to approximately $2,000,000, $2,000,000, and $2,000,000, respectively, which is included in Selling, General and Administrative Expenses.
The Company joins with the Parent and the Parent’s other subsidiaries in filing a Federal income tax return on a consolidated basis. Income taxes are calculated on a separate return basis with consideration of the Tax Sharing Agreement between the Parent and its subsidiaries. Amounts related to the Tax Sharing Agreement for the utilization by the Company of certain tax attributes of the Parent and other subsidiaries related to the tax years ended August 31, 2011 and 2010 amounted to $2,289,000 and $502,000, respectively and have been
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
recorded as a capital contribution. As of August 31, 2011 and 2010, the Company had a receivable from the Parent of $2,586,326 and $3,455,000, respectively, under the terms of the Tax Sharing Agreement.
During the years ended August 31, 2011, 2010 and 2009, the Company incurred $372,000 in each year as its share of occupancy expenses for our offices in New York that it shares with affiliates of the Company. Such offices are located in a building owned by John Catsimatidis.
14. Environmental Matters and Other Contingencies
The Company is subject to federal, state and local laws and regulations relating to pollution and protection of the environment such as those governing releases of certain materials into the environment and the storage, treatment, transportation, disposal and clean-up of wastes, including, but not limited to, the Federal Clean Water Act, as amended, the Clean Air Act, as amended, the Resource Conservation and Recovery Act of 1976, as amended, the Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, and analogous state and local laws and regulations.
Due to the nature of the Company’s business, the Company is and will continue to be subject to various environmental claims, legal actions and actions by regulatory authorities. In the opinion of management, all current matters are without merit or are of such kind or involve such amounts that an unfavorable disposition would not have a material adverse effect on the consolidated financial condition or operations of the Company.
The management of the Company believes that remediation and related environmental response costs incurred during the normal course of business, including contractual obligations as well as activities required under applicable law and regulation, will not have a material adverse effect on its consolidated financial condition or operations.
In addition to the foregoing proceedings, the Company and its subsidiaries are parties to various legal proceedings that arise in the ordinary course of their respective business operations. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that unfavorable dispositions would not have a material adverse effect on the consolidated financial position or results of operations of the Company.
We are also monitoring closely all climate change and Greenhouse Gas (“GHG”) legislation, better known as Cap and Trade as well as fuels mandates requiring the increased use of renewable resources in motor fuel over time. We believe, however, that implementation of reasonable, incremental changes over time will not have a material adverse effect on the Company’s consolidated financial position or operations. The ultimate cost of GHG reduction mandates and their effect on our business are, however, unknown until implementing regulations are available. Similarly, the costs of compliance with renewable fuels mandates in the future remains unknown until a final regulatory structure has been adopted.
15. Segments of Business
The Company is a petroleum refiner and marketer in its primary market area of Western New York and Northwestern Pennsylvania. Operations are organized into two business segments: wholesale and retail.
The wholesale segment is responsible for the acquisition of crude oil, petroleum refining, supplying petroleum products to the retail segment and the marketing of petroleum products to wholesale and industrial customers. The retail segment sells petroleum products under the Kwik Fill®, Citgo® and Keystone® brand
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
names at a network of Company-operated retail units and convenience and grocery items through Company-owned gasoline stations and convenience stores under the, Red Apple Food Mart® and Country Fair® brand names.
The accounting policies of the reportable segments are the same as those described in Footnote 1 to Consolidated Financial Statements. Intersegment revenues are calculated using market prices and are eliminated upon consolidation. Summarized financial information regarding the Company’s reportable segments is presented in the following table.
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
16. Subsidiary Guarantors
All the Company’s wholly-owned subsidiaries fully and unconditionally guarantee on an unsecured basis, on a joint and several basis, the Company’s Senior Secured Notes due 2018. There are no restrictions within the consolidated group on the ability of the Company or any of its subsidiaries to obtain loans from or pay dividends to other members of the consolidated group. Financial information of the Company’s wholly-owned subsidiary guarantors is as follows:
CONDENSED CONSOLIDATING BALANCE SHEETS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING BALANCE SHEETS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF OPERATIONS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS
(in thousands)
UNITED REFINING COMPANY AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(Continued)
17. Quarterly Financial Data (unaudited)
Operating (Loss) Profit for the third and fourth quarters of 2011 includes derivative gains (losses) of $1,337,000 and ($60,070,000) respectively.
18. Legal Proceedings.
The Company and its subsidiaries are from time to time parties to various legal proceedings that arise in the ordinary course of their respective business operations. These proceedings include various administrative actions relating to federal, state and local environmental laws and regulations as well as civil matters before various courts seeking money damages. The Company believes that if the legal proceedings in which it is currently involved were determined against the Company, there would be no material adverse effect on the Company’s operations or its consolidated financial condition. In the opinion of management, all such matters are adequately covered by insurance, or if not so covered, are without merit or are of such kind, or involve such amounts that an unfavorable disposition would not have a material adverse effect on the consolidated operations or financial position of the Company.
19. Subsequent Event.
The Company has reached an early settlement agreement with its refinery employees represented by the International Union of Operating Engineers, Local 95. The contract is effective February 1, 2012 and expires February 1, 2017. The agreement generally provides for improvement in wages, as well as changes to active and retiree healthcare, pension benefits and the defined contribution plan for the bargaining unit. These changes to the healthcare and pension plans are the same as the healthcare and pension plans provided to salaried employees effective September, 2010.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures
Based on an evaluation of the Company’s disclosure controls and procedures (as defined in Rules 13a - 15(e) and 15d - 15(e) of the Securities Exchange Act of 1934, as amended), as of August 31, 2011, the Company’s Chief Executive Officer and Chief Financial Officer (its principal executive officer and principal financial and accounting officer, respectively) have concluded that the Company’s disclosure controls and procedures were effective at a reasonable assurance level.
Limitations on the Effectiveness of Controls
A control system, no matter how well conceived an operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of the inherent limitations in all controls systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within a company have been detected. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving its objectives. Our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective at that reasonable assurance level.
Management’s Report on Internal Control over Financial Reporting
The Company’s management is responsible for establishing and maintaining adequate internal control over financial reporting as such term is defined in Exchange Act Rule 13a-15(f). Internal control over financial reporting is a process used to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external reporting in accordance with generally accepted accounting principles in the United States of America (“GAAP”). Internal control over financial reporting includes policies and procedure that pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of our assets; provide reasonable assurance that transactions are recorded as necessary to permit preparation of our financial statements in accordance with GAAP; that our receipts and expenditures are being made only in accordance with the authorization of the Company’s board of directors; and 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 Company’s financial statements.
Management evaluates the effectiveness of the Company’s internal control over financial reporting using the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control Integrated Framework. Management, under the supervision and with the participation of the Company’s Chief Executive Officer and Chief Financial Officer, assessed the effectiveness of the Company’s internal control over financial reporting as of August 31, 2011 and concluded that it is effective.
An internal control system over financial reporting has inherent limitations and may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. However, these inherent limitations are known features of the financial reporting process. Therefore, it is possible to design into the process safeguards to reduce, though not eliminate, the risk.
Changes in Internal Control Over Financial Reporting
There have not been any changes in the Company’s internal controls over financial reporting that occurred during the Company’s fiscal quarter ended August 31, 2011 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
Set forth below is certain information as of November 29, 2011 with respect to all directors and executive officers of the Company.
John A. Catsimatidis has been Chairman of the Board and Chief Executive Officer since February 1986, when his wholly-owned company, United Acquisition Corp., purchased our parent. He also served as President from February 1986 until September 1996. He also is Chairman of the Board, Chief Executive Officer, President, and the founder of Red Apple Group, Inc. (a holding company for certain businesses, including the Company and corporations which operate supermarkets in New York). Mr. Catsimatidis’s broad experience as a senior executive and owner of other operating businesses, his experience as a successful investor in real estate, and his twenty five year tenure as Chief Executive Officer of the Company lead us to conclude that he will make significant contributions as a director.
Myron L. Turfitt has been President and Chief Operating Officer since September 1996. From June 1987 to September 1996 he was Chief Financial Officer and Executive Vice President. From August 1983 until June 1987 he was Senior Vice President-Finance and from July 1981 to August 1983, Mr. Turfitt held the position of Vice President, Accounting and Administration. Mr. Turfitt is a CPA with over 30 years of financial and operations experience in all phases of the petroleum business including exploration and production, refining and retail marketing. His experience covers both fully-integrated major oil companies and large independents. Mr. Turfitt’s experience and training as a certified public accountant, his prior experience in other aspects of the petroleum business and his over thirty years of financial and operational experience with the Company lead us to conclude that he will make significant contributions as a director.
Ashton L. Ditka has been Senior Vice President-Marketing since July 1990. From December 1989 to July 1990 he was Vice President-Wholesale & Retail Marketing and from August 1976 until December 1989 he was Vice President-Wholesale Marketing. Mr. Ditka has over 40 years of experience in the petroleum industry, including 11 years in retail marketing with Atlantic Richfield Company.
Thomas E. Skarada has been Vice President-Refining since February 1996. From September 1994 to February 1996 he was Assistant Vice President-Refining and from March 1993, when he joined us, to September 1994 he was Director of Regulatory Compliance. Over his 40 year refining and marketing career, Mr. Skarada has worked in virtually every segment of the downstream business including supply, distribution, refinery operations, economics, planning, research and development. He has 18 years of managerial experience with Sun Refining and Marketing Co. and one year consulting with Muse Stancil and Co. in Dallas, Texas.
Frederick J. Martin, Jr. has been Vice President-Supply and Transportation since February 1993. From 1980 to January 1993 he held other positions with us involving transportation, product supply, crude supply and pipeline and terminal administration.
James E. Murphy has been Chief Financial Officer since January 1997 and in January 2009 also became Treasurer. He was Vice President-Finance from April 1995 to December 1996 and since May 1982 has held other accounting and internal auditing positions with us, including Director of Internal Auditing since April 1986. Mr. Murphy is a CPA and prior to joining us he had over 15 years experience in accounting and auditing with banking, public accounting and manufacturing companies.
John R. Wagner has been Vice President, General Counsel and Secretary since August 1997. Prior to joining us, Mr. Wagner served as Counsel to Dollar Bank, F.S.B. from 1988 to August 1997.
Martin R. Bring has served as a Director since 1988. Since November 2004, he has been a partner at the law firm of Ellenoff, Grossman & Schole LLP. Previously he was a stockholder in Anderson, Kill & Olick, P.C., a New York law firm, from February 2002 to November 2004. Prior thereto Mr. Bring was a partner in the law firm of Wolf, Block, Schorr and Solis-Cohen LLP, a Philadelphia, Pennsylvania law firm and its predecessor law firm for more than 5 years. Mr. Bring’s 44 years of experience as a corporate attorney and 25 years of involvement as a legal advisor to the Company lead us to conclude that he will make significant contributions as a director.
Jacob Feinstein has served as a Director since 2006. Since 1999, he has been employed as a Consultant to the electric power industry in disciplines such as management, transmission, generation interconnection and power system operation and control. From 1998 to 1999, he was employed by Cogen Technologies, Inc. as a Vice President. From 1991 to 1998, he was employed by Consolidated Edison Company of New York, Inc. as a Vice President. Mr. Feinsten’s management expertise and long involvement in the energy industry lead us to conclude that he will make significant contributions as a director.
Kishore Lall has served as a Director since 1997. He is currently Managing Director & Global Head/ Diamonds & Jewelry with Standard Chartered Bank, London. He was Global Head, Business Development, International Diamond and Jewelry Group of ABN AMRO Bank in New York from September 2005 to September 2008. He served as Chief Financial Officer of Gristede’s Foods, Inc. an affiliate of the Company from August 2003 to August 2005 and Executive Vice President-Finance and Administration and Secretary of Gristede’s Foods, Inc. from May 2002 to August 2005. From January 1997 to October 1997 he served as a consultant to Red Apple Group, Inc. From June 1994 to December 1996 was a private investor. From January 1991 to May 1994 he was Senior Vice President and Head of Commercial Banking of ABN AMRO Bank (New York branch). Mr. Lall’s experience in commercial and investment banking lead us to conclude that he will make significant contributions as a director.
Douglas Lemmonds has served as a Director since 1997. He has also served as Executive Vice President at SunTrust Bank (Washington D.C.) since 2002. From May 1996 to 2002 he served as Managing Director and the Chief Operating Officer, Private Banking-Americas of the Deutsche Bank Group. Private Banking-Americas operates across four separate legal entities, including a registered investment advisor, a broker-dealer, a trust company and a commercial bank. From June 1991 to May 1996 Mr. Lemmonds was the Regional Director of Private Banking of the Northeast Regional Office of the Bank of America and from August 1973 to June 1991 he
held various other positions with Bank of America. Mr. Lemmond’s experience in senior management positions with various and banking institutions lead us to conclude that he will make significant contributions as a director.
Andrew Maloney has served as a Director since 1997. He has also been counsel to De Feis O’Connell & Rose, a New York law firm since January 2003. From April 1998 to December 2002, Mr. Maloney was counsel to Kramer Levin Naftalis & Frankel LLP, a New York law firm. From December 1992 to April 1998 was a partner at Brown & Wood LLP, a New York law firm. From June 1986 to December 1992 he was the United States Attorney for the Eastern District of New York. Mr. Maloney’s training and experience as an attorney in private practice and his experience with both government and law enforcement as a United States Attorney lead us to conclude that he will make significant contributions as a director.
Board Independence
Although the Company’s securities are not listed on any national securities exchange and we are therefore not required to have a majority of independent directors, we apply the NYSE AMEX standard for independent directors to determine which, if any, of our directors are independent pursuant to such definition. The NYSE AMEX defines an independent director generally as a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company’s board of directors would interfere with the director’s exercise of independent judgment in carrying out the responsibilities of a director.
The Company has determined that Messrs. Feinstein, Lall, Lemmonds and Maloney are independent directors as defined under the NYSE AMEX Rule 803.
Audit Committee
We do not have a class of securities listed on a national securities exchange or national securities association subject to the requirements of Rule 10A-3 of the Securities Exchange Act of 1934, as amended. Consequently, the Company does not have an audit committee at this time, and has not designated an audit committee financial expert. However, the Company is reviewing whether it would be appropriate to appoint an audit committee consisting of independent members of its board of directors.
Nominating Committee
We do not have a nominating committee at this time and believe this is appropriate for our Company as we have one indirect stockholder of the Company, our Chairman and Chief Executive Officer, John A. Catsimatidis. The Board of Directors, as a whole, participates in the consideration of director nominees. The Board of Directors does not have a policy with regard to the consideration of any director candidates recommended by security holders and the Board believes this is appropriate as the Company has one indirect stockholder. There are no specific minimum qualifications that the Board believes must be met by a board nominee.
Code Of Ethics
We have adopted a Code of Ethics pursuant to Section 406 of the Sarbanes-Oxley Act of 2002 which is filed as Exhibit 14.1 in the Company’s Annual Report on Form 10-K for the fiscal year ended August 31, 2003. A copy of the Code of Ethics is available for review on the Company’s website at www.urc.com. In the event we determine to amend or waive certain provisions of this code of ethics, we will disclose such amendments or waivers on our website at http://www.urc.com under the heading “Code of Ethics”. Any person may request, and the Company will provide without charge, a copy of such code of ethics by writing to John R. Wagner, General Counsel, 15 Bradley Street, Warren, Pennsylvania 16365.
Section 16(a) Beneficial Ownership Reporting Compliance
Not Applicable.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
COMPENSATION DISCUSSION AND ANALYSIS
The Summary Compensation Table and supplementary tables that follow describe the compensation paid to our Chairman of the Board and Chief Executive Officer (“CEO”), Vice President and Chief Financial Officer (“CFO”), President and Chief Operating Officer (“COO”), Senior Vice President Marketing and Vice President Refining for 2011.
Compensation Objectives and Components
The objective of the Company’s compensation program is to motivate, retain and attract management, linking incentives to financial and personal performance and enhanced shareholder value. The compensation program for the named executive officers consists of the following components:
•
Salary;
•
Annual performance-based cash awards; and
•
Other fringe benefits and perquisites.
There is no Compensation Committee of the Board of Directors; however, the CEO and COO review and approve any proposed changes in salary, as well as discretionary bonuses for the other named executive officers.
Salary
Salaries for the named executive officers have been established by the CEO and COO. There is no policy to provide any scheduled increase to these individuals and increases may be awarded at the discretion of the CEO. There is no deferred compensation program for the named individuals or any other executives of the Company. The salaries of the CEO and COO are set by the CEO after reviewing comparable salaries for similar positions within the industry.
Annual Cash Bonus Awards
While there is no formal bonus program for the named executives, bonuses have been paid to them on an annual basis. The amount of the bonus is determined by the CEO and may vary based on the performance of the Company.
Other Fringe Benefits and Perquisites
The Company provides several fringe benefit plans including the United Refining Company Pension Plan for Salaried Employees (the “Pension Plan”) and the United Refining Company Employees’ 401(k) Plan (the “401(k) Plan”) to its named executive officers. Additionally, the Company provides other benefits, including medical and dental plans, life and accidental death insurance, short-term and long-term disability insurance, paid sick leave and vacation and paid holidays.
Potential Payments upon Termination or Change in Control
The Company does not have any change in control agreements with any of the named executive officers.
Estimated Benefits upon Termination Related to Other Than a Change in Control
The Company does not have a severance policy for benefits paid upon termination of employment.
Indemnification of Directors and Officers
The Company’s By-laws provide an open-ended indemnity of all officers and directors to the fullest extent permitted by law.
The following table sets forth the compensation paid by the Company to its principal executive officer and principal financial officer and each of the three other most highly compensated executive officers of the Company whose salary and bonus exceeded $100,000 for the fiscal year ended August 31, 2011.
SUMMARY COMPENSATION TABLE
(1) Amounts in this column reflect the actuarial increase in the present value at August 31, 2011 compared to August 31, 2010 of the named executive officer’s benefits under the Defined Benefit Plan.
(2) Amounts in this column represent the total of all perquisites (non-cash benefits and perquisites such as the use of employer-owned automobiles, membership dues and other personal benefits), employee benefits (employer cost of life insurance), and employer contributions to defined contribution plans (the 401(K) Plan). Amounts are reported separately under the “All Other Compensations” table below.
2011 ALL OTHER COMPENSATION
PENSION BENEFITS
The Pension Plan is a tax-qualified, non-contributory defined benefit plan established to provide pension benefits to employees of the Company, including the named executive officers, meeting Pension Plan eligibility criteria. The criteria states that employees are eligible to participate in, and will be enrolled in, the Pension Plan on the first day of the month coincident with or next following the later of the completion of one Year of Service and attainment of age twenty-one years. Years of service for benefits purposes are measured based on the number of years in which at least 1,000 hours are worked.
A participant’s normal retirement date is the first of the month coinciding with or following the attainment of age 65. Participants who are actively employed may also elect an unreduced option at age 59 1/2. In addition to a single life annuity, benefits can be paid as other actuarially equivalent annuities.
The United Refining Company’s Pension Plan for Salaried Employees was frozen effective August 31, 2011 and participants will no longer accrue a benefit under the Plan. The Plan has been replaced by a new 3% 401(k) contribution.
The benefit formula is based on the average earnings of the participant for the three years in which such participant’s earnings were the highest. Earnings include salary and bonus up to a maximum of the IRC 401(a)(17) limit, which for 2011 is $245,000. Benefits are calculated by multiplying the sum of (a) 1.1% of average earnings up to the Social Security compensation base, plus (b) 1.25% of average earnings in excess of the Social Security compensation base, by (c) the number of years of service. Payments of retirement benefits are not reduced by any Social Security benefits received by the participant. Effective May 2001, for purposes of calculating retirement benefits, the Company has fixed the earnings subject to tax under the Federal Insurance Contribution Act at $76,200.00 for years after 2001 for purposes of calculating Social Security compensation base.
In connection with a transaction in 1984, a portion of the benefits from the plan are provided through an annuity contract with an insurance company. The benefits shown in the table are gross amounts before offsetting the insured benefit and thereby represent the total benefit earned with the Company.
Vested benefits are those amounts to which participants are entitled regardless of future services to the Company. A participant is credited with a year of service for vesting purposes for each Pension Plan year during which at least 1,000 hours of service are completed, commencing with year of hire. Each executive is currently vested in his accumulated benefit.
In addition to vested benefits, the Pension Plan provides certain death benefits. Upon death of a participant, the beneficiary is entitled to receive a portion of the vested interest of the participant’s accrued benefit in the form of a monthly annuity amount, subject to eligibility requirements stipulated in the Pension Plan.
The present value of accumulated benefits in the table above has been determined by an independent actuary. These assumptions for August 31, 2011 include a 5.05% discount rate and the RP 2000 mortality table projected to 2015 with a 15-year phase-in and no collar adjustment, each of which is consistent with the assumptions used for FYE 2010 financial reporting. Further, it was assumed that benefits will commence at the earliest age in which an unreduced benefit is available (age 59.5 or current age if later) and there will be no turnover or death prior to retirement.
DIRECTOR COMPENSATION
The Company pays its non-officer Directors an annual retainer of $15,000 per year and $1,000 for meetings attended. Directors are reimbursed for reasonable travel, meals, lodging and other expenses incidental to attendance at meetings.
2011 Director Compensation
Fees and expenses paid to Directors are recorded as expense in the period in which the meetings are held, and deducted for income tax purposes in the year incurred.
(1) Martin R. Bring is a partner in the firm of Ellenoff, Grossman and Schole LLP. Mr. Bring was paid $204,000 on a retainer basis for legal and consulting services during fiscal 2011.
(2) Chairman of the Board and Chief Executive Officer of the Company.
(3) President and Chief Operating Officer of the Company.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The following table sets forth certain information regarding ownership of Common Stock on November 29, 2011 by: (i) each stockholder known to the Company to own beneficially, directly or indirectly, more than 5% of the outstanding shares of Common Stock; (ii) each of the Company’s directors; and (iii) all officers and directors of the Company as a group. The Company believes that ownership of the shares by the persons named below is both of record and beneficial and such persons have sole voting and investing power with respect to the shares indicated.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, DIRECTOR INDEPENDENCE.
On December 21, 2001, the Company acquired the operations and working capital assets of Country Fair. The fixed assets of Country Fair were acquired by related entities controlled by John A. Catsimatidis, the indirect sole shareholder of the Company. These assets are being leased to the Company at an annual aggregate rental which management, based on an independent third party valuation believes is fair, over a period ranging from 10 to 20 years. During the fiscal years ended August 31, 2011, 2010 and 2009, $5,102,000, $5,102,000, and $5,102,000 of rent payments were made to these related entities. The Company is not a guarantor on the underlying mortgages on the properties.
Concurrent with the above acquisition of Country Fair, the Company entered into a management agreement with a non-subsidiary affiliate to operate and manage 18 of the retail units owned by the non-subsidiary affiliate on a turn-key basis. For the years ended August 31, 2011, 2010 and 2009, the Company billed the affiliate $1,266,000, $1,243,000, and $1,219,000 for management fees and overhead expenses incurred in the management and operation of the retail units which amount was deducted from expenses. As of August 31, 2011 and 2010, the Company had a receivable (payable) to the affiliate of $175,000 and $(138,000), respectively, under the terms of the agreement, which is included in Amounts Due from Affiliated Companies, Net.
On September 29, 2000, the Company sold 42 retail units to an affiliate for $23,870,000. Concurrent with this asset sale, the Company terminated the leases on 8 additional retail locations which it had previously leased from a non-subsidiary affiliate. The Company has entered into a management agreement with the non-subsidiary affiliate to operate and manage the retail units owned by the non-subsidiary affiliate on a turnkey basis. For the years ended August 31, 2011, 2010 and 2009, the Company billed the affiliate $2,032,000, $2,099,000, and $2,245,000, respectively, for management fees and overhead expenses incurred in the management and operation of the 50 retail units, which amount was deducted from expenses. For the fiscal years ended August 31, 2011, 2010 and 2009, net sales to the affiliate amounted to $184,749,000, $140,277,000 and $112,878,000, respectively. As of August 31, 2011 and 2010, the Company had a receivable (payable) to the affiliate of $342,000 and $(344,000), respectively, under the terms of the agreement.
The Company paid a service fee relating to certain costs incurred by its Parent for the Company’s New York office. During the years ended August 31, 2011, 2010 and 2009, such fees amounted to approximately $2,000,000, $2,000,000, and $2,000,000, respectively, which is included in Selling, General and Administrative Expenses.
The Company joins with the Parent and the Parent’s other subsidiaries in filing a Federal income tax return on a consolidated basis. Income taxes are calculated on a separate return basis with consideration of the Tax Sharing Agreement between the Parent and its subsidiaries. Amounts related to the Tax Sharing Agreement for the utilization by the Company of certain tax attributes of the Parent and other subsidiaries related to the tax years ended August 31, 2011 and 2010 amounted to $2,289,000 and $502,000, respectively and have been recorded as a capital contribution. As of August 31, 2011 and 2010, the Company had a receivable from the Parent of $2,586,326 and $3,455,000, respectively, under the terms of the Tax Sharing Agreement.
During the years ended August 31, 2011, 2010 and 2009, the Company incurred $372,000 in each year as its share of occupancy expenses for our offices in New York that it shares with affiliates of the Company. Such offices are located in a building owned by John Catsimatidis.
United Refining, Inc. of which the Company is a wholly-owned subsidiary, purchased $8,500,000 of the Senior Secured Notes due 2018 sold by the Company in March 2011.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES.
The following represents amounts billed and amounts expected to be billed to the Company for the professional services of BDO USA, LLP rendered during fiscal years 2011 and 2010:
ITEM 15.
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES.
(a)(1) Financial Statements
A list of all financial statements filed as part of this report is contained in the index to Item 8, which index is incorporated herein by reference.
(2) Financial Statement Schedules
Report of Independent Registered Public Accounting Firm
Schedule II-Valuation and Qualifying Accounts
(3) Exhibits
* Filed herewith.
Report of Independent Registered Public Accounting Firm
To the Board of Directors and
Stockholder of United Refining Company
Warren, Pennsylvania
The audits referred to in our report dated November 29, 2011 relating to the consolidated financial statements of United Refining Company, which is contained in Item 8 of this Form 10-K also included the audit of the financial statement schedule listed in the accompanying index. This financial statement schedule is the responsibility of the Company’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion such financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ BDO USA, LLP
New York, New York
November 29, 2011
UNITED REFINING COMPANY AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
(in thousands)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
UNITED REFINING COMPANY OF PENNSYLVANIA
Dated: November 29, 2011
By:
/s/ Myron L. Turfitt
Myron L. Turfitt
President and Chief Operating Officer
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INDEPENDENT GASOLINE & OIL COMPANY OF ROCHESTER, INC.
Dated: November 29, 2011
By:
/s/ Myron L. Turfitt
Myron L. Turfitt
Executive Vice President
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of Section 13 or 15(d) 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 dates indicated:
SUPPLEMENTAL INFORMATION TO BE FURNISHED WITH REPORTS FILED PURSUANT TO SECTION 15(d) OF THE ACT BY REGISTRANTS WHICH HAVE NOT REGISTERED SECURITIES PURSUANT TO SECTION 12 OF THE ACT
No annual report or proxy material was sent to security holders by the Corporation during the fiscal year ended August 31, 2011.