Commission file number 001-33492

 

 

Registrant’s telephone number, including area code:

(281) 207-3200

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes  þ      No  o .

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

(Do not check if a smaller reporting company)

 

Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act).  Yes  o      No  þ .

 

There were 86,141,291 shares of the registrant’s common stock outstanding at August 13, 2008.

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

For The Quarter Ended June 30, 2008

 

 

 

See accompanying notes to the condensed consolidated financial statements.

 

See accompanying notes to the condensed consolidated financial statements.

CVR ENERGY, INC. AND SUBSIDIARIES

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

award will vest on October 24, 2008, one-third will vest on October 24, 2009, and the final one-third will vest on October 24, 2010.

 

Options to purchase 10,300 shares of common stock at an exercise price of $19.00 per share were granted to outside directors on October 22, 2007. These awards will vest over a three year service period. Fair value was measured using an option-pricing model at the date of grant.

 

Nitrogen Fertilizer Limited Partnership

 

In conjunction with the consummation of CVR’s initial public offering, CVR transferred Coffeyville Resources Nitrogen Fertilizer, LLC (CRNF), its nitrogen fertilizer business, to CVR Partners, LP (the Partnership), a newly created limited partnership, in exchange for a managing general partner interest (managing GP interest), a special general partner interest (special GP interest, represented by special GP units) and a de minimis limited partner interest (LP interest, represented by special LP units). This transfer was not considered a business combination as it was a transfer of assets among entities under common control and, accordingly, balances were transferred at their historical cost. CVR concurrently sold the managing GP interest to Coffeyville Acquisition LLC III (CALLC III), an entity owned by CVR’s controlling stockholders and senior management at fair market value. The board of directors of CVR determined, after consultation with management, that the fair market value of the managing general partner interest was $10.6 million. This interest has been reflected as minority interest in the Consolidated Balance Sheet.

 

CVR owns all of the interests in the Partnership (other than the managing general partner interest and the associated incentive distribution rights (IDRs)) and is entitled to all cash distributed by the Partnership. The managing general partner is not entitled to participate in Partnership distributions except with respect to its IDRs, which entitle the managing general partner to receive increasing percentages (up to 48%) of the cash the Partnership distributes in excess of $0.4313 per unit in a quarter. However, the Partnership is not permitted to make any distributions with respect to the IDRs until the aggregate Adjusted Operating Surplus, as defined in the amended and restated partnership agreement, generated by the Partnership through December 31, 2009 has been distributed in respect of the units held by CVR and any common units issued by the Partnership if it elects to pursue an initial public offering. In addition, the Partnership and its subsidiaries are currently guarantors under the credit facility of Coffeyville Resources, LLC (CRLLC), a wholly-owned subsidiary of CVR. There will be no distributions paid with respect to the IDR’s for so long as the Partnership or its subsidiaries are guarantors under the credit facility.

 

The Partnership is operated by CVR’s senior management pursuant to a services agreement among CVR, the managing general partner, and the Partnership. The Partnership is managed by the managing general partner and, to the extent described below, CVR, as special general partner. As special general partner of the Partnership, CVR has joint management rights regarding the appointment, termination, and compensation of the chief executive officer and chief financial officer of the managing general partner, has the right to designate two members of the board of directors of the managing general partner, and has joint management rights regarding specified major business decisions relating to the Partnership. CVR, the Partnership, the managing general partner and various of their subsidiaries also entered into a number of agreements to regulate certain business relations between the parties.

 

At June 30, 2008, the Partnership had 30,333 special LP units outstanding, representing 0.1% of the total Partnership units outstanding, and 30,303,000 special GP interests outstanding, representing 99.9% of the total Partnership units outstanding. In addition, the managing general partner owned the managing general partner interest and the IDRs. The managing general partner contributed assets into the Partnership in exchange for its managing general partner interest and the IDRs.

 

As of June 30, 2008, the Partnership had distributed $50.0 million to CVR from its Adjusted Operating Surplus.

 

On February 28, 2008, the Partnership filed a registration statement with the Securities and Exchange Commission (SEC) to effect an initial public offering of its common units representing limited partner interests. On

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

June 13, 2008, the Company announced that the managing general partner of the Partnership had decided to postpone, indefinitely, the Partnership’s initial public offering due to then-existing market conditions for master limited partnerships. The Partnership, subsequently, withdrew the registration statement.

 

Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements were prepared in accordance with U.S. generally accepted accounting principles (GAAP) and in accordance with the rules and regulations of the SEC. The consolidated financial statements include the accounts of CVR Energy, Inc. and its majority-owned direct and indirect subsidiaries. The ownership interests of minority investors in its subsidiaries are recorded as minority interest. All intercompany accounts and transactions have been eliminated in consolidation. Certain information and footnotes required for the complete financial statements under GAAP have been condensed or omitted pursuant to such rules and regulations. These unaudited condensed consolidated financial statements should be read in conjunction with the December 31, 2007 audited consolidated financial statements and notes thereto included in CVR’s Annual Report on Form 10-K/A for the year ended December 31, 2007.

 

In the opinion of the Company’s management, the accompanying unaudited condensed consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are necessary to fairly present the financial position of the Company as of June 30, 2008 and December 31, 2007, the results of operations for the three and six months ended June 30, 2008 and 2007, and the cash flows for the six months ended June 30, 2008 and 2007.

 

Results of operations and cash flows for the interim periods presented are not necessarily indicative of the results that will be realized for the year ending December 31, 2008 or any other interim period. The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. Actual results could differ from those estimates.

 

In connection with CVR’s initial public offering, $3.1 million of deferred offering costs for the six months ended June 30, 2007 were previously presented in operating activities in the interim financial statements. Such amounts have now been reflected as financing activities for the six months ended June 30, 2007 in the accompanying Consolidated Statements of Cash Flows. The impact on the prior financial statements of this revision is not considered material.

 

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement on Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements , which establishes a framework for measuring fair value in GAAP and expands disclosures about fair value measurements. SFAS 157 states that fair value is “the price that would be received to sell the asset or paid to transfer the liability (an exit price), not the price that would be paid to acquire the asset or received to assume the liability (an entry price).” The standard’s provisions for financial assets and financial liabilities, which became effective January 1, 2008, had no material impact on the Company’s financial position or results of operations. At June 30, 2008, the only financial assets and financial liabilities that are measured at fair value on a recurring basis are the Company’s derivative instruments. See Note 14, “Fair Value Measurements.”

 

In February 2008, the FASB issued FASB Staff Position 157-2 which defers the effective date of SFAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in an entity’s financial statements on a recurring basis (at least annually). The Company will be required to adopt SFAS 157 for these nonfinancial assets and nonfinancial liabilities as of January 1, 2009. Management believes the adoption of SFAS 157 deferral provisions will not have a material impact on the Company’s financial position or earnings.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

In March 2008, the FASB issued SFAS No. 161, Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133 . This statement will change the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about how and why an entity uses derivative instruments, how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and how derivative instruments and related hedged items affect an entity’s financial position, net earnings, and cash flows. The Company will be required to adopt this statement as of January 1, 2009. The adoption of SFAS 161 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In May 2008, the FASB issued final FASB Staff Position (“FSP”) No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversions (Including Partial Cash Settlement). The FSP changes the accounting treatment for convertible debt instruments that by their stated terms may be settled in cash upon conversion, including partial cash settlements, unless the embedded conversion option is required to be separately accounted for as a derivative under SFAS 133, Accounting for Derivative Instruments and Hedging Activities. Under the FSP, cash settled convertible securities will be separated into their debt and equity components. The FSP specifies that issuers of such instruments should separately account for the liability of equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. The FSP is effective for financial statements issued for fiscal years beginning after December 15, 2008, and the interim periods within those fiscal years, and will require issuers of convertible debt that can be settled in cash to record the additional expense incurred. The Company is currently evaluating the FSP in conjunction with its proposed convertible debt offering.

 

 

Prior to CVR’s initial public offering, CVR’s subsidiaries were held and operated by CALLC, a limited liability company. Management of CVR holds an equity interest in CALLC. CALLC issued non-voting override units to certain management members who held common units of CALLC. There were no required capital contributions for the override operating units. In connection with CVR’s initial public offering in October 2007, CALLC was split into two entities: CALLC and CALLC II. In connection with this split, management’s equity interest in CALLC, including both their common units and non-voting override units, was split so that half of management’s equity interest was in CALLC and half was in CALLC II. CALLC was historically the primary reporting company and CVR’s predecessor. In connection with the transfer of the managing general partner of the Partnership to CALLC III, CALLC III issued non-voting override units to certain management members of CALLC III.

 

CVR, CALLC, CALLC II and CALLC III account for share-based compensation in accordance with SFAS No. 123(R), Share-Based Payments and EITF 00-12, Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee . CVR has recorded non-cash share-based compensation expense from CALLC, CALLC II and CALLC III.

 

In accordance with SFAS 123(R), CVR, CALLC, CALLC II and CALLC III apply a fair value based measurement method in accounting for share-based compensation. In accordance with EITF 00-12, CVR recognizes the costs of the share-based compensation incurred by CALLC, CALLC II and CALLC III on its behalf, primarily in selling, general, and administrative expenses (exclusive of depreciation and amortization), and a corresponding capital contribution, as the costs are incurred on its behalf, following the guidance in EITF 96-18, Accounting for Equity Investments That Are Issued to Other Than Employees for Acquiring, or in Conjunction with Selling Goods or Services , which requires remeasurement at each reporting period. At June 30, 2008, CVR’s common stock closing price was utilized to determine the fair value of the override units of CALLC and CALLC II. The estimated fair value per unit reflects a ratio of override units to shares of common stock. The estimated fair value of the override units of CALLC III has been determined using a binomial and probability-weighted expected

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

On the tenth anniversary of the issuance of override operating units, such units convert into an equivalent number of override value units. Override operating units are forfeited upon termination of employment for cause. In the event of all other terminations of employment, the override operating units are initially subject to forfeiture as follows:

 

 

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

 

Unless the compensation committee of the board of directors of CVR takes an action to prevent forfeiture, override value units are forfeited upon termination of employment for any reason except that in the event of termination of employment by reason of death or disability, all override value units are initially subject to forfeiture as follows:

 

 

 

 

 

 

 

Phantom Unit Appreciation Plan

 

The Company, through a wholly-owned subsidiary, has a Phantom Unit Appreciation Plan whereby directors, employees, and service providers may be awarded phantom points at the discretion of the board of directors or the compensation committee. Holders of service phantom points have rights to receive distributions when holders of override operating units receive distributions. Holders of performance phantom points have rights to receive distributions when holders of override value units receive distributions. There are no other rights or guarantees, and the plan expires on July 25, 2015 or at the discretion of the compensation committee of the board of directors. As of June 30, 2008, the issued Profits Interest (combined phantom points and override units) represented 15% of combined common unit interest and Profits Interest of CALLC and CALLC II. The Profits Interest was comprised of 11.1% and 3.9% of override interest and phantom interest, respectively. In accordance with SFAS 123(R), using the June 30, 2008 CVR closing stock price to determine the Company’s equity value, through an independent valuation process, the service phantom interest and performance phantom interest were both valued at $40.05 per point. CVR has recorded approximately $25,961,000 and $29,217,000 in personnel accruals as of June 30, 2008 and December 31, 2007, respectively. Compensation expense for the three and six month periods ending June 30, 2008 related to the Phantom Unit Appreciation Plan was reversed by $(2,709,000) and $(3,256,000), respectively. Compensation expense for the three and six month periods ending June 30, 2007 was $2,444,000 and $5,580,000, respectively.

 

At June 30, 2008, assuming no change in the estimated fair value at June 30, 2008, there was approximately $15.4 million of unrecognized compensation expense related to the Phantom Unit Appreciation Plan. This is expected to be recognized over a remaining period of approximately three years.

 

Long Term Incentive Plan

 

CVR has a Long Term Incentive Plan which permits the grant of options, stock appreciation rights, or SARS, non-vested shares, non-vested share units, dividend equivalent rights, share awards and performance awards.

 

During the quarter there were no forfeitures or vesting of stock options or non-vested shares. On June 10, 2008, options to purchase 4,350 shares of common stock at an exercise price of $24.96 per share were granted to an outside director upon his election to the Company’s board of directors.

 

As of June 30, 2008, there was approximately $0.1 million of total unrecognized compensation cost related to non-vested shares to be recognized over a weighted-average period of approximately one year. Compensation expense recorded for the three month periods ending June 30, 2008 and 2007 related to the non-vested common stock and common stock options was $94,000 and $0, respectively. Compensation expense recorded for the six month periods ending June 30, 2008 and 2007 related to the non-vested common stock and common stock options was $185,000 and $0, respectively.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

Inventories consist primarily of crude oil, blending stock and components, work in progress, fertilizer products, and refined fuels and by-products. Inventories are valued at the lower of the first-in, first-out (FIFO) cost, or market, for fertilizer products, refined fuels and by-products for all periods presented. Refinery unfinished and finished products inventory values were determined using the ability-to-bare process, whereby raw materials and production costs are allocated to work-in-process and finished products based on their relative fair values. Other inventories, including other raw materials, spare parts, and supplies, are valued at the lower of moving-average cost, which approximates FIFO, or market. The cost of inventories includes inbound freight costs.

 

Inventories consisted of the following (in thousands):

 

 

 

A summary of costs for property, plant, and equipment is as follows (in thousands):

 

 

Capitalized interest recognized as a reduction in interest expense for the three month periods ended June 30, 2008 and June 30, 2007 totaled approximately $203,000 and $2,328,000, respectively. Capitalized interest for the six month periods ended June 30, 2008 and June 30, 2007 totaled approximately $1,321,000 and $6,407,000, respectively. Land and buildings that are under a capital lease obligation approximate $5,097,000.

 

 

The direct-expense method of accounting is used for planned major maintenance activities. Maintenance costs are recognized as expense when maintenance services are performed. The nitrogen fertilizer plant last completed a major scheduled turnaround in the third quarter of 2006 and is scheduled to complete a turnaround in the fourth quarter of 2008. The refinery started a major scheduled turnaround in February 2007 with completion in April 2007. Costs of $10,795,000 and $76,798,000 associated with the 2007 refinery turnaround were included in

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

direct operating expenses (exclusive of depreciation and amortization) for the three and six months ending June 30, 2007, respectively.

 

 

Cost of product sold (exclusive of depreciation and amortization) includes cost of crude oil, other feedstocks, blendstocks, pet coke expense and freight and distribution expenses. Cost of product sold excludes depreciation and amortization of $611,000 and $577,000 for the three months ended June 30, 2008 and June 30, 2007, respectively. For the six months ended June 30, 2008 and 2007 cost of product sold excludes depreciation and amortization of $1,210,000 and $1,197,000, respectively.

 

Direct operating expenses (exclusive of depreciation and amortization) includes direct costs of labor, maintenance and services, energy and utility costs, environmental compliance costs as well as chemicals and catalysts and other direct operating expenses. Direct operating expenses excludes depreciation and amortization of $20,108,000 and $17,089,000 for the three months ended June 30, 2008 and 2007, respectively. For the six months ended June 30, 2008 and 2007, direct operating expenses excludes depreciation and amortization of $38,811,000 and $30,619,000, respectively.

 

Selling, general and administrative expenses (exclusive of depreciation and amortization) consist primarily of legal expenses, treasury, accounting, marketing, human resources and maintaining the corporate offices in Texas and Kansas. Selling, general and administrative expenses excludes depreciation and amortization of $361,000 and $291,000 for the three months ended June 30, 2008 and June 30, 2007, respectively. For the six months ended June 30, 2008 and 2007, selling, general and administrative expenses excludes depreciation and amortization of $694,000 and $376,000, respectively.

 

 

The Company entered into an insurance premium finance agreement with Cananwill, Inc. in July 2007 to finance the purchase of its property, liability, cargo and terrorism policies. The original balance of the note was $7.6 million and required repayment in nine equal installments with final payment due in April 2008. As of December 31, 2007 the Company owed $3.4 million related to this agreement. The balance due was paid in full in April 2008.

 

The Company entered into two capital leases in 2007 to lease platinum required in the manufacturing of new catalyst. The recorded lease obligations fluctuate with the platinum market price. The leases terminate on the date an equal amount of platinum is returned to each lessor, with the difference to be paid in cash. One lease was settled and terminated in January 2008. At June 30, 2008 and December 31, 2007 the lease obligations were recorded at approximately $10.5 million and $8.2 million on the Consolidated Balance Sheets, respectively.

 

The Company also entered into a capital lease for real property used for corporate purposes on May 29, 2008. The lease has an initial lease term of one year with an option to renew for three additional one-year periods. The Company has the option to purchase the property during the initial lease term or during the renewal periods if the lease is renewed. In connection with the capital lease the Company recorded a capital asset and capital lease obligation of $5.1 million. The capital lease obligation was reduced by $0.9 million payment made during the quarter resulting in a capital lease obligation of $4.2 million as of June 30, 2008.

 

(9)  Flood, Crude Oil Discharge and Insurance Related Matters

 

On June 30, 2007, torrential rains in southeast Kansas caused the Verdigris River to overflow its banks and flood the town of Coffeyville, Kansas. As a result, the Company’s refinery and nitrogen fertilizer plant were severely flooded, resulting in significant damage to the refinery assets. The nitrogen fertilizer facility also sustained damage, but to a much lesser degree. The Company maintained property damage insurance which included damage

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

caused by a flood, up to $300 million per occurrence, subject to deductibles and other limitations. The deductible associated with the property damage was $2.5 million.

 

Additionally, crude oil was discharged from the Company’s refinery on July 1, 2007 due to the short amount of time to shut down and save the refinery in preparation of the flood that occurred on June 30, 2007. The Company maintained insurance policies related to environmental cleanup costs and potential liability to third parties for bodily injury or property damage. The policies were subject to a $1.0 million self-insured retention.

 

The Company has submitted voluminous claims information to, and continues to respond to information requests from and negotiate with, the insurers with respect to costs and damages related to the 2007 flood and crude oil discharge. See Note 12, “Commitments and Contingent Liabilities” for additional information regarding environmental and other contingencies relating to the crude oil discharge that occurred on July 1, 2007.

 

As of June 30, 2008, the Company has recorded total gross costs associated with the repair of, and other matters relating to the damage to the Company’s facilities and with third party and property damage remediation incurred due to the crude oil discharge of approximately $153.6 million. Total anticipated insurance recoveries of approximately $102.4 million have been recorded as of June 30, 2008 (of which $21.5 million had already been received as of June 30, 2008 by the Company from insurance carriers). At June 30, 2008, total accounts receivable from insurance were $80.9 million. The receivable balance is segregated between current and long-term in the Company’s Consolidated Balance Sheet in relation to the nature and classification of the items to be settled. As of June 30, 2008, $58.7 million of the amounts receivable from insurers were not anticipated to be collected in the next twelve months, and therefore has been classified as a non-current asset.

 

Management believes the recovery of the receivable from the insurance carriers is probable. While management believes that the Company’s property insurance should cover substantially all of the estimated total costs associated with the physical damage to the property, the Company’s insurance carriers have cited potential coverage limitations and defenses, which while unlikely to preclude recovery, are anticipated to delay collection for more than twelve months.

 

The Company’s property insurers have raised a question as to whether the Company’s facilities are principally located in “Zone A,” which was, at the time of the flood, subject to a $10 million insurance limit for flood or “Zone B” which was, at the time of the flood, subject to a $300 million insurance limit for flood. The Company has reached an agreement with certain of its property insurers representing approximately 32.5% of its total property coverage for the flood that the facilities are principally located in “Zone B” and therefore subject to the $300 million limit for the flood. The remaining property insurers have not, at this time, agreed to this position. The Company’s primary environmental liability insurance carrier has asserted that the pollution liability claims are for “cleanup,” which is subject to a $10 million sub-limit, rather than “property damage,” which is covered to the limits of the policy. The excess carrier has reserved its rights under the primary carrier’s position. While the Company will vigorously contest the primary carrier’s position, the Company contends that if that position were upheld, the Company’s umbrella and excess Comprehensive General Liability policies would continue to provide coverage for these claims. Each insurer, however, has reserved its rights under various policy exclusions and limitations and has cited potential coverage defenses. On July 10, 2008, the Company filed two lawsuits against certain of its insurance carriers. One lawsuit was filed against the nonsettling property damage insurance carriers and the second lawsuit was filed against carriers under the environmental insurance policies. The lawsuits involved the Zone A/Zone B issue and the cleanup, property damage issue described above. The Company intends to pursue the litigation vigorously. Considering the effect of the lawsuits, the Company continues to believe its receivable of $80.9 million is probable of recovery.

 

The Company’s insurance policies also provide coverage for interruption to the business, including lost profits, and reimbursement for other expenses and costs the Company has incurred relating to the damages and losses suffered for business interruption. This coverage, however, only applies to losses incurred after a business interruption of 45 days. Because the fertilizer plant was restored to operation within this 45-day period and the

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

refinery restarted its last operating unit in 48 days, a substantial portion of the lost profits incurred because of the flood cannot be claimed under insurance. The Company continues to assess its policies to determine how much, if any, of its lost profits after the 45-day period are recoverable. No amounts for recovery of lost profits under the Company’s business interruption policy have been recorded in the accompanying consolidated financial statements.

 

The Company has recorded net pretax costs in total since the occurrence of the flood of approximately $51.2 million associated with both the flood and related crude oil discharge as discussed in Note 12, “Commitments and Contingent Liabilities.” This amount is net of anticipated insurance recoveries of $102.4 million.

 

Below is a summary of the gross cost associated with the flood and crude oil discharge and reconciliation of the insurance receivable (in millions):

 

 

Although the Company believes that it will recover substantial sums under its insurance policies, the Company is not sure of the ultimate amount or timing of such recovery because of the difficulty inherent in projecting the ultimate resolution of the Company’s claims. The difference between what the Company ultimately receives under its insurance policies compared to what has been recorded and described above could be material to the consolidated financial statements.

 

In 2007, the Company received insurance proceeds of $10.0 million under its property insurance policy and $10.0 million under its environmental policies related to recovery of certain costs associated with the crude oil discharge. In the first quarter of 2008, the Company received $1.5 million under its Builder’s Risk Insurance Policy. In July 2008, the Company received $13.0 million under its property insurance policy. See Note 12, “Commitments and Contingent Liabilities” for additional information regarding environmental and other contingencies relating to the crude oil discharge that occurred on July 1, 2007.

 

 

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertain Tax Positions — an interpretation of FASB No. 109 (FIN 48) on January 1, 2007. The adoption of FIN 48 did not affect the Company’s financial position or results of operations. The Company does not have any unrecognized tax benefits as of June 30, 2008.

 

As of June 30, 2008, the Company did not have an accrual for any amounts for interest or penalties related to uncertain tax positions. The Company’s accounting policy with respect to interest and penalties related to tax uncertainties is to classify these amounts as income taxes.

 

CVR and its subsidiaries file U.S. federal and various state income and franchise tax returns. The Company’s U.S. federal income tax return for its 2005 tax year is currently under examination. The Company has not been subject to any other U.S. federal, state or local income and franchise tax examinations by taxing authorities with

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

respect to other tax returns. The Texas taxing authority has recently contacted the Company to inform them that they will be examining the fertilizer businesses’ Texas franchise tax return for the 2004 to 2007 franchise periods. The Company’s U.S. federal and state tax years subject to examination are 2004 to 2007. As of June 30, 2008, no taxing authority has proposed any adjustments to the Company’s tax positions.

 

The Company’s effective tax rate for the six months ended June 30, 2008 and 2007 was 17.0% and 72.1%, respectively, as compared to the federal statutory tax rate of 35%. The effective tax rate is lower than the statutory rate for the six months ended June 30, 2008 due to federal income tax credits available to small business refiners related to the production of ultra low sulfur diesel fuel and Kansas state incentives generated under the High Performance Incentive Program (HPIP). The annualized effective tax rate in 2008 is lower than 2007 due to the correlation between the amount of credits projected to be generated in 2007 in comparison with the projected pre-tax loss levels in 2007.

 

 

On October 26, 2007, the Company completed the initial public offering of 23,000,000 shares of its common stock. Also, in connection with the initial public offering, a reorganization of entities under common control was consummated whereby the Company became the indirect owner of the subsidiaries of CALLC and CALLC II and all of their refinery and fertilizer assets. This reorganization was accomplished by the Company issuing 62,866,720 shares of its common stock to CALLC and CALLC II, its majority stockholders, in conjunction with a 628,667.20 for 1 stock split and the merger of two newly formed direct subsidiaries of CVR. Immediately following the completion of the offering, there were 86,141,291 shares of common stock outstanding, excluding non-vested shares issued. See Note 1, “Organization and History of Company and Basis of Presentation”.

 

 

Outstanding stock options totaling 23,250 common shares were excluded from the diluted earnings per share calculation for the three and six months ended June 30, 2008 as they were antidilutive.

 

2007 Earnings (Loss) Per Share

 

The computation of basic and diluted loss per share for the three and six months ended June 30, 2007 is calculated on a pro forma basis assuming the capital structure in place after the completion of the initial public offering was in place for the entire period.

 

 

 

The minimum required payments for the Company’s lease agreements and unconditional purchase obligations are as follows (in thousands):

 

 

The Company leases various equipment, including rail cars, and real properties under long-term operating leases, expiring at various dates. In the normal course of business, the Company also has long-term commitments to purchase services such as natural gas, electricity, water and transportation services. For the three months ended June 30, 2008 and 2007, lease expense totaled $1,003,000 and $955,000, respectively. For the six months ended June 30, 2008 and 2007, lease expense totaled $2,074,000 and $1,962,000, respectively. The lease agreements have various remaining terms. Some agreements are renewable, at the Company’s option, for additional periods. It is expected, in the ordinary course of business, that leases will be renewed or replaced as they expire.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

From time to time, the Company is involved in various lawsuits arising in the normal course of business, including matters such as those described below under “Environmental, Health, and Safety Matters”. Liabilities related to such lawsuits are recognized when the related outcome and costs are probable and can be reasonably estimated. It is possible that management’s estimates of the outcomes will change within the next year due to uncertainties inherent in litigation and settlement negotiations. In the opinion of management, the ultimate resolution of the Company’s litigation matters is not expected to have a material adverse effect on the accompanying consolidated financial statements. There can be no assurance that management’s beliefs or opinions with respect to liability for potential litigation matters are accurate.

 

Crude oil was discharged from the Company’s refinery on July 1, 2007 due to the short amount of time available to shut down and secure the refinery in preparation for the flood that occurred on June 30, 2007. As a result of the crude oil discharge, two putative class action lawsuits (one federal and one state) were filed seeking unspecified damages with class certification under applicable law for all residents, domiciliaries and property owners of Coffeyville, Kansas who were impacted by the oil release.

 

The Company filed a motion to dismiss the federal suit for lack of subject matter jurisdiction. On November 6, 2007, the judge in the federal class action lawsuit granted the Company’s motion to dismiss for lack of subject matter jurisdiction and no appeal was taken.

 

With respect to the state suit, the District Court of Montgomery County, Kansas conducted an evidentiary hearing on the issue of class certification on October 24 and October 25, 2007 and ruled against the class certification leaving only the original two plaintiffs. The state suit was later settled with the two original plaintiffs and the case was dismissed.

 

As a result of the crude oil discharge that occurred on July 1, 2007, the Company entered into an administrative order on consent (Consent Order) with the Environmental Protection Agency (EPA) on July 10, 2007. As set forth in the Consent Order, the EPA concluded that the discharge of oil from the Company’s refinery caused and may continue to cause an imminent and substantial threat to the public health and welfare. Pursuant to the Consent Order, the Company agreed to perform specified remedial actions to respond to the discharge of crude oil from the Company’s refinery. The Company substantially completed remediating the damage caused by the crude oil discharge in July 2008 and expects any remaining minor remedial actions to be completed by December 31, 2008. The Company is currently preparing its final report to the EPA to satisfy the final requirement of the Consent Order.

 

As of June 30, 2008, the total gross costs recorded associated with remediation and third party property damage as of the result of the crude oil discharge for obligations approximated $52.3 million. The Company has not estimated or accrued for any potential fines, penalties or claims that may be imposed or brought by regulatory authorities or possible additional damages arising from lawsuits related to the flood as management does not believe any such fines or penalties assessed would be material nor can be estimated.

 

The Company also recently received sixteen notices of claims under the Oil Pollution Act from private claimants in an aggregate amount of approximately $4.4 million. No lawsuits related to these claims have yet been filed.

 

While the remediation efforts were substantially completed in July 2008, the costs and damages that the Company will ultimately pay may be greater than the amounts described and projected above. Such excess costs and damages could be material to the consolidated financial statements.

 

The Company is seeking insurance coverage for this release and for the ultimate costs for remediation, property damage claims, cleanup, resolution of class action lawsuits, and other claims brought by regulatory authorities. Our primary environmental liability insurance carrier has asserted that our pollution liability claims are for “cleanup,” which is subject to a $10 million sub-limit, rather than “property damage,” which is covered to the limits of the policy. The excess carrier has reserved its rights under the primary carrier’s position. While we will vigorously contest the primary carrier’s position, we contend that if that position were upheld, our umbrella and

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

excess Comprehensive General Liability policies would continue to provide coverage for these claims. Each insurer, however, has reserved its rights under various policy exclusions and limitations and has cited potential coverage defenses. Although the Company believes that it is probable substantial sums under the environmental and liability insurance policies will be recovered, the Company can not be certain of the ultimate amount or timing of such recovery because of the difficulty inherent in projecting the ultimate resolution of the Company’s claims. The difference between what the Company receives under its insurance policies compared to what has been recorded and described above could be material to the consolidated financial statements. The Company received $10.0 million of insurance proceeds under its environmental insurance policy in 2007.

 

On July 10, 2008, the Company filed two lawsuits in the United States District Court for the District of Kansas against certain of the Company’s insurance carriers with regard to the Company’s insurance coverage for the flood and crude oil discharge. One of the lawsuits was filed against the insurance carriers under the environmental policies.

 

Environmental, Health, and Safety (EHS) Matters

 

CVR is subject to various stringent federal, state, and local EHS rules and regulations. Liabilities related to EHS matters are recognized when the related costs are probable and can be reasonably estimated. Estimates of these costs are based upon currently available facts, existing technology, site-specific costs, and currently enacted laws and regulations. In reporting EHS liabilities, no offset is made for potential recoveries. Such liabilities include estimates of the Company’s share of costs attributable to potentially responsible parties which are insolvent or otherwise unable to pay. All liabilities are monitored and adjusted regularly as new facts emerge or changes in law or technology occur.

 

CVR owns and/or operates manufacturing and ancillary operations at various locations directly related to petroleum refining and distribution and nitrogen fertilizer manufacturing. Therefore, CVR has exposure to potential EHS liabilities related to past and present EHS conditions at some of these locations.

 

Through Administrative Orders issued under the Resource Conservation and Recovery Act, as amended (RCRA), CVR is a potential party responsible for conducting corrective actions at its Coffeyville, Kansas and Phillipsburg, Kansas facilities. In 2005, CRNF agreed to participate in the State of Kansas Voluntary Cleanup and Property Redevelopment Program (VCPRP) to address a reported release of urea ammonium nitrate (UAN) at the Coffeyville UAN loading rack. As of June 30, 2008 and December 31, 2007, environmental accruals of $7,150,000 and $7,646,000, respectively, were reflected in the consolidated balance sheets for probable and estimated costs for remediation of environmental contamination under the RCRA Administrative Order and the VCPRP, including amounts totaling $2,529,000 and $2,802,000, respectively, included in other current liabilities. The Company’s accruals were determined based on an estimate of payment costs through 2033, which scope of remediation was arranged with the EPA and are discounted at the appropriate risk free rates at June 30, 2008 and December 31, 2007, respectively. The accruals include estimated closure and post-closure costs of $1,512,000 and $1,549,000 for two

 

 

Management periodically reviews and, as appropriate, revises its environmental accruals. Based on current information and regulatory requirements, management believes that the accruals established for environmental expenditures are adequate.

 

The EPA has issued regulations intending to limit the amount of sulfur in diesel and gasoline. The EPA has granted the Company a petition for a technical hardship waiver with respect to the date for compliance in meeting the sulfur-lowering standards. CVR spent approximately $16.8 million in 2007, $79.0 million in 2006 and $27.0 million in 2005 to comply with the low-sulfur rules. CVR spent $8.2 million in the first six months of 2008 and, based on information currently available, anticipates spending approximately $9.7 million in the last six months of 2008 and $27.3 million in 2009 to comply with the low-sulfur rules. The entire amounts are expected to be capitalized.

 

Environmental expenditures are capitalized when such expenditures are expected to result in future economic benefits. For the three month periods ended June 30, 2008 and 2007, capital expenditures were $13,888,000 and $35,894,000, respectively. For the six month periods ended June 30, 2008 and 2007, capital expenditures were $29,361,000 and $86,581,000, respectively. These expenditures were incurred to improve the environmental compliance and efficiency of the operations.

 

CVR believes it is in substantial compliance with existing EHS rules and regulations. There can be no assurance that the EHS matters described above or other EHS matters which may develop in the future will not have a material adverse effect on the Company’s business, financial condition, or results of operations.

 

 

CVR is subject to crude oil and finished goods price fluctuations caused by supply and demand conditions, weather, economic conditions, and other factors. To manage this price risk on crude oil and other inventories and to fix margins on certain future production, CVR may enter into various derivative transactions. In addition, CALLC, as further described below, entered into certain commodity derivate contracts. CVR is also subject to interest rate fluctuations. To manage interest rate risk and to meet the requirements of the credit agreements CALLC entered into an interest rate swap, as further described below as required by the long-term debt agreements.

 

CVR has adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities . SFAS 133 imposes extensive record-keeping requirements in order to designate a derivative financial instrument as a hedge. CVR holds derivative instruments, such as exchange-traded crude oil futures, certain over-the-counter forward swap agreements and interest rate swap agreements, which it believes provide an economic hedge on future transactions, but such instruments are not designated as hedges. Gains or losses related to the change in fair value and periodic settlements of these derivative instruments are classified as loss on derivatives, net in the Consolidated Statements of Operations. For the purposes of segment reporting, realized and unrealized gains or losses related to the commodity derivative contracts are reported in the Petroleum Segment.

 

Cash Flow Swap

 

At June 30, 2008, CVR’s Petroleum Segment held commodity derivative contracts (swap agreements) for the period from July 1, 2005 to June 30, 2010 with a related party (see Note 15, “Related Party Transactions”). The swap agreements were originally executed by CALLC on June 16, 2005 and were required under the terms of the Company’s long-term debt agreement. The notional quantities on the date of execution were 100,911,000 barrels of crude oil, 1,889,459,250 gallons of heating oil and 2,348,802,750 gallons of unleaded gasoline. The swap agreements were executed at the prevailing market rate at the time of execution. At June 30, 2008 the notional open amounts under the swap agreements were 30,070,250 barrels of crude oil, 631,475,250 gallons of heating oil and 631,475,250 gallons of unleaded gasoline.

 

Interest Rate Swap

 

At June 30, 2008, CRLLC held derivative contracts known as interest rate swap agreements that converted CRLLC’s floating-rate bank debt into 4.195% fixed-rate debt on a notional amount of $250,000,000. Half of the agreements are held with a related party (as described in Note 15, “Related Party Transactions”), and the other half

 

 

CVR pays the fixed rates listed above and receives a floating rate based on three-month LIBOR rates, with payments calculated on the notional amounts listed above. The notional amounts do not represent actual amounts exchanged by the parties but instead represent the amounts on which the contracts are based. The swap is settled quarterly and marked-to-market at each reporting date, and all unrealized gains and losses are currently recognized in income. Transactions related to the interest rate swap agreements were not allocated to the Petroleum or Nitrogen Fertilizer segments.

 

 

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements . This statement established a single authoritative definition of fair value when accounting rules require the use of fair value, set out a framework for measuring fair value, and required additional disclosures about fair value measurements. SFAS 157 clarifies that fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

 

The Company adopted SFAS 157 on January 1, 2008 with the exception of nonfinancial assets and nonfinancial liabilities that were deferred by FASB Staff Position 157-2 as discussed in Note 2 to the Condensed Consolidated Financial Statements. As of June 30, 2008, the Company has not applied SFAS 157 to goodwill and intangible assets in accordance with FASB Staff Position 157-2.

 

SFAS 157 discusses valuation techniques, such as the market approach (prices and other relevant information generated by market conditions involving identical or comparable assets or liabilities), the income approach (techniques to convert future amounts to single present amounts based on market expectations including present value techniques and option-pricing), and the cost approach (amount that would be required to replace the service capacity of an asset which is often referred to as replacement cost). SFAS 157 utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

 

The following table sets forth the assets and liabilities measured at fair value on a recurring basis, by input level, as of June 30, 2008 (in thousands):

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The Company’s derivative contracts giving rise to assets or liabilities under Level 2 are valued using pricing models based on other significant observable inputs.

 

 

Management Services Agreements

 

GS Capital Partners V Fund, L.P. and related entities (GS) and Kelso Investment Associates VII, L.P. and related entity (Kelso) through their majority ownership of CALLC and CALLC II are majority owners of CVR.

 

On June 24, 2005, CALLC entered into management services agreements with each of GS and Kelso pursuant to which GS and Kelso agreed to provide CALLC with managerial and advisory services. In consideration for these services, an annual fee of $1.0 million was paid to each of GS and Kelso, plus reimbursement for any out-of-pocket expenses. The agreements terminated upon consummation of CVR’s initial public offering on October 26, 2007. Relating to the agreements, the Company recorded $544,000 and $1,082,000 in selling, general, and administrative expenses (exclusive of depreciation and amortization) for the three and six months ended June 30, 2007, respectively. As these agreements were terminated on October 26, 2007 there have been no expenses recorded in 2008.

 

Cash Flow Swap

 

CALLC entered into certain crude oil, heating oil and gasoline swap agreements with a subsidiary of GS, J. Aron & Company (J. Aron). Additional swap agreements with J. Aron were entered into on June 16, 2005, with an expiration date of June 30, 2010 (as described in Note 13, “Derivative Financial Instruments”). These agreements were assigned to CRLLC on June 24, 2005. Losses totaling $68,427,000 and $157,468,000 were recognized related to these swap agreements for the three months ended June 30, 2008 and 2007, respectively, and are reflected in loss on derivatives, net in the Consolidated Statements of Operations. For the six months ended June 30, 2008 and 2007 the Company recognized losses of $103,849,000 and $285,705,000, respectively, which are reflected in loss on derivatives, net in the Consolidated Statements of Operations. In addition, the Consolidated Balance Sheet at June 30, 2008 and December 31, 2007 includes liabilities of $371,583,000 and $262,415,000, respectively, included in current payable to swap counterparty, and $46,723,000 and $88,230,000, respectively, included in long-term payable to swap counterparty.

 

J. Aron Deferral

 

As a result of the flood and the temporary cessation of business operations in 2007, the Company entered into three separate deferral agreements for amounts owed to J. Aron. The amount deferred, excluding accrued interest, totaled $123.7 million. These amounts were ultimately deferred to August 31, 2008. As discussed in further detail below, a portion of the deferred amounts may be further deferred until July 31, 2009.

 

These deferred payment amounts are included in the Consolidated Balance Sheet at June 30, 2008 in current payable to swap counterparty. The deferred balance owed to the GS subsidiary, excluding accrued interest payable, totaled $123.7 million at June 30, 2008. Approximately $6,210,000 of accrued interest payable related to the deferred payments is included in other current liabilities at June 30, 2008.

 

On July 29, 2008, CRLLC entered into a revised letter agreement with the J. Aron to defer further $87.5 million of the deferred payment amounts under the 2007 deferral agreements. The unpaid deferred amounts and all accrued and unpaid interest are due and payable in full on December 15, 2008. If the Company receives proceeds, net of fees, under a convertible debt offering, in an aggregate principal amount of at least $125.0 million by December 15, 2008, the maturity date will be automatically extended to July 31, 2009 provided also that there has been no default by the Company in the performance of its obligations under the revised letter agreement. GS and Kelso each agreed to guarantee one half of the deferred payment of $87.5 million. CRLLC has agreed to repay deferred amounts equal to the sum of $36.2 million plus all accrued and unpaid interest by no later than August 31, 2008.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Beginning on August 31, 2008, interest shall accrue and be payable on the unpaid deferred amount of $87.5 million at the rate of LIBOR plus 2.75%. Under the terms of the deferral, the Company will be required to use the substantial majority of any gross proceeds from the pending convertible debt offering (or other debt) in excess of $125.0 million to prepay a portion of the deferred amounts. There is no certainty that the convertible debt offering will be completed. The revised agreement requires CRLLC to prepay the deferred amount each quarter with the greater of 50% of free cash flow or $5.0 million. Failure to make the quarterly prepayments will result in an increase in the interest rate that accrues on the deferred amounts.

 

Interest Rate Swap

 

On June 30, 2005, CALLC entered into three interest-rate swap agreements with J. Aron (as described in Note 13, “Derivative Financial Instruments”). Gains totaling $1,962,000 and $1,523,000 were recognized related to these swap agreements for the three months ended June 30, 2008 and 2007, respectively, and are reflected in loss on derivatives, net in the Consolidated Statements of Operations. For the six months ended June 20, 2008 and 2007, the Company recognized losses totaling $851,000 and gains totaling $1,211,000, respectively related to these swap agreements which are reflected in loss on derivatives, net, in the Consolidated Statements of Operations. In addition, the Consolidated Balance Sheet at June 30, 2008 and December 31, 2007 includes $783,000 and $371,000, respectively, in other current liabilities and $783,000 and $557,000, respectively, in other long-term liabilities related to the same agreements.

 

Crude Oil Supply Agreement

 

Coffeyville Resources Refining & Marketing, LLC (CRRM), a subsidiary of the Company is a counterparty to a crude oil supply agreement with J. Aron. Under the agreement, the parties agreed to negotiate the cost of each barrel of crude oil to be purchased from a third party, and CRRM agreed to pay J. Aron a fixed supply service fee per barrel over the negotiated cost of each barrel of crude purchased. The cost is adjusted further using a spread adjustment calculation based on the time period the crude oil is estimated to be delivered to the refinery, other market conditions, and other factors deemed appropriate. The Company recorded $0 and $360,000 on the Consolidated Balance Sheets at June 30, 2008 and December 31, 2007, respectively, in prepaid expenses and other current assets for the prepayment of crude oil. In addition, $64,960,000 and $43,773,000 were recorded in inventory and $17,381,000 and $42,666,000 were recorded in accounts payable at June 30, 2008 and December 31, 2007, respectively. Expenses associated with this agreement included in cost of product sold (exclusive of depreciation and amortization) for the three month periods ended June 30, 2008 and 2007 totaled $907,915,000 and $344,607,000, respectively. For the six months ended June 30, 2008 and 2007, the Company recognized expenses of $1,674,128,000 and $520,914,000, respectively, associated with this agreement included in cost of product sold (exclusive of depreciation and amortization).

 

 

CVR measures segment profit as operating income for Petroleum and Nitrogen Fertilizer, CVR’s two reporting segments, based on the definitions provided in SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information . All operations of the segments are located within the United States.

 

Petroleum

 

Principal products of the Petroleum Segment are refined fuels, propane, and petroleum refining by-products including pet coke. CVR sells the pet coke to the Partnership for use in the manufacturing of nitrogen fertilizer at the adjacent nitrogen fertilizer plant. For CVR, a per-ton transfer price is used to record intercompany sales on the part of the Petroleum Segment and corresponding intercompany cost of product sold (exclusive of depreciation and amortization) for the Nitrogen Fertilizer Segment. The per ton transfer price paid, pursuant to the coke supply agreement that became effective October 24, 2007, is based on the lesser of a coke price derived from the priced

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

received by the fertilizer segment for UAN (subject to a UAN based price ceiling and floor) and a coke price index for pet coke. Prior to October 25, 2007 intercompany sales were based upon a price of $15 per ton. The intercompany transactions are eliminated in the Other Segment. Intercompany sales included in petroleum net sales were $2,800,000 and $1,301,000 for the three months ended June 30, 2008 and 2007, respectively. Intercompany sales included in petroleum net sales were $5,606,000 and $1,881,000 for the six months ended June 30, 2008 and 2007, respectively.

 

Intercompany cost of product sold (exclusive of depreciation and amortization) for the hydrogen sales described below under “— Nitrogen Fertilizer” was $2,600,000 and $5,189,000 for the three months ended June 30, 2008 and 2007, respectively. The intercompany cost of product sold (exclusive of depreciation and amortization) for the hydrogen sales described below under ‘‘— Nitrogen Fertilizer” was $7,891,000 and $8,018,000 for the six months ended June 30, 2008 and 2007, respectively.

 

Nitrogen Fertilizer

 

The principal product of the Nitrogen Fertilizer Segment is nitrogen fertilizer. Intercompany cost of product sold (exclusive of depreciation and amortization) for the coke transfer described above was $2,325,000 and $1,116,000 for the three months ended June 30, 2008 and 2007, respectively. Intercompany cost of product sold (exclusive of depreciation and amortization) for the coke transfer described above was $4,871,000 and $1,966,000 for the six months ended June 30, 2008 and 2007, respectively.

 

Beginning in 2008, the Nitrogen Fertilizer Segment changed the method of classification of intercompany hydrogen sales to the Petroleum Segment. In 2008, these amounts have been reflected as “Net Sales” for the fertilizer plant. Prior to 2008, the Nitrogen Fertilizer Segment reflected these transactions as a reduction of cost of product sold (exclusive of deprecation and amortization). For the quarters ended June 30, 2008 and 2007, the net sales generated from intercompany hydrogen sales were $2,600,000 and $5,189,000, respectively. For the six months ended June 30, 2008 and 2007, hydrogen sales were $7,891,000 and $8,018,000, respectively. As noted above, the net sales of $5,189,000 and $8,018,000 were included as a reduction to the cost of product sold (exclusive of depreciation and amortization) for the three and six months ended June 30, 2007. As these intercompany sales are eliminated, there is no financial statement impact on the consolidated financial statements.

 

 

 

 

 

Secondary Offering

 

CVR filed a registration statement with the SEC on June 19, 2008 in which CVR’s majority stockholders and chairman planned to offer 10 million shares of the Company’s common stock. The Company announced on July 30, 2008 that the majority stockholders elected not to proceed with the proposed secondary offering at the current time due to then-existing market conditions. The registration statement remains on file with the SEC, and the selling stockholders may elect to proceed with the equity offering in the future.

 

SemGroup L.P Bankruptcy

 

Subsequent to June 30, 2008 SemGroup, L.P., a customer, filed a petition for bankruptcy under Chapter 11 of the Bankruptcy Code. At June 30, 2008, SemGroup, L.P. owed the Company approximately $3.7 million. While the Company will seek payment of the pre-petition amount, the Company believes the likelihood of recovery is no longer probable. The receivable balance of $3.7 million was fully reserved as of June 30, 2008. The Company has no further exposure related to the bankruptcy filing of SemGroup, L.P.

 

Insurance Renewal

 

On July 1, 2008, we renewed and/or renegotiated our primary lines of insurance including workers compensation, automobile and general liability, umbrella and excess liability, property and business interruption, cargo, terrorism and crime. Due to a combination of factors including replacement cost escalation, our outstanding claim related to the flood of June 2007 and flooding in the Midwest in the spring of 2008, the cost of these primary lines of insurance, especially with respect to property and business interruption coverage, increased substantially. For the annual period of July 1, 2008 to July 1, 2009, the cost for these primary lines of coverage increased approximately 45% to $15.7 million from $10.8 million for the annual period of July 1, 2007 to July 1, 2008. The Company entered into an insurance premium financing agreement in July 2008 to finance $10.0 million of the $15.7 million insurance premium.

 

Convertible Notes Offering

 

On June 19, 2008, CVR filed a registration statement with the SEC in connection with a proposed offering of $125.0 million aggregate principal amount of CVR’s Convertible Senior Notes due 2013. CVR filed an amendment to the aforementioned registration statement on July 25, 2008. Under the proposed terms, CVR may sell up to an additional $18.75 million aggregate principal amount of notes upon exercise of an over-allotment option that CVR expects to grant to the underwriters in connection with the offering.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

As proposed, the notes will be convertible, under certain circumstances, into cash, shares of CVR common stock or a combination of cash and shares, at CVR’s election. It is CVR’s current intent to settle the principal amount of any conversions in cash for the principal amount of the notes and a combination of cash and shares for the excess, if any, of the conversion value above the principal amount. The coupon, conversion price and other terms of the notes will be determined at the time of pricing the offering. CVR intends to use the net proceeds from the offering for general corporate purposes, which may include using a portion of the proceeds for future capital investments. Any proceeds, net of fees, in excess of $125.0 million will be used to prepay a portion of the amounts owed to J. Aron under the revised deferral agreement. A portion of the proceeds will be used to purchase government securities in an amount equal to the first six interest payments due under the notes. The government securities will be deposited into an escrow account under a pledge and escrow agreement which will secure payment of the first six scheduled interest payments on the notes.

 

There can be no assurance that any such offering will be consummated on the terms discussed in the registration statement or at all.

 

The following discussion and analysis should be read in conjunction with the consolidated financial statements and related notes and with the statistical information and financial data appearing in this Quarterly Report on Form 10-Q for quarter ended June 30, 2008 as well as the Company’s Annual Report on Form 10-K/A for the year ended December 31, 2007. Results of operations for the three and six month periods ended June 30, 2008 are not necessarily indicative of results to be attained for any other period.

 

Forward-Looking Statements

 

This Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, contains “forward-looking statements” as defined by the SEC. Such statements are those concerning contemplated transactions and strategic plans, expectations and objectives for future operations. These include, without limitation:

 

 

Although we believe that our plans, intentions and expectations reflected in or suggested by the forward-looking statements we make in this Form 10-Q, including this Management’s Discussion and Analysis of Financial Condition and Results of Operations, are reasonable, we can give no assurance that such plans, intentions or expectations will be achieved. These statements are based on assumptions made by us based on our experience and perception of historical trends, current conditions, expected future developments and other factors that we believe are appropriate in the circumstances. Such statements are subject to a number of risks and uncertainties, many of which are beyond our control. You are cautioned that any such statements are not guarantees of future performance and actual results or developments may differ materially from those projected in the forward-looking statements as a result of various factors, including but not limited to those set forth under “Risk Factors” attached hereto as Exhibit 99.1.

 

All forward-looking statements contained in this Form 10-Q speak only as of the date of this document. We undertake no obligation to update or revise publicly any forward-looking statements to reflect events or circumstances that occur after the date of this Form 10-Q, or to reflect the occurrence of unanticipated events.

 

Company Overview

 

We are an independent refiner and marketer of high value transportation fuels. In addition, we currently own all of the interests (other than the managing general partner interest and associated IDRs) in a limited partnership which produces ammonia and urea ammonia nitrate, or UAN, fertilizers. At current natural gas and petroleum coke, or pet coke prices, the nitrogen fertilizer business is the lowest cost producer and marketer of ammonia and UAN fertilizers in North America.

 

We operate under two business segments: petroleum and nitrogen fertilizer. Our petroleum business includes a 115,000 barrel per day, or bpd, complex full coking medium sour crude refinery in Coffeyville, Kansas. In addition, supporting businesses include (1) a crude oil gathering system serving central Kansas, northern Oklahoma, and southwestern Nebraska, (2) storage and terminal facilities for asphalt and refined fuels in Phillipsburg, Kansas, (3) a 145,000 bpd pipeline system that transports crude oil to our refinery and associated crude oil storage tanks with a capacity of approximately 1.2 million barrels and (4) a rack marketing division supplying product through tanker trucks directly to customers located in close geographic proximity to Coffeyville and Phillipsburg and to customers at throughput terminals on Magellan Midstream Partners L.P.’s (Magellan) refined products distribution systems. In addition to rack sales (sales which are made at terminals into third party tanker trucks), we make bulk sales (sales through third party pipelines) into the mid-continent markets via Magellan and into Colorado and other destinations utilizing the product pipeline networks owned by Magellan, Enterprise Products Partners L.P. and NuStar Energy

L.P. Our refinery is situated approximately 100 miles from Cushing, Oklahoma, one of the largest crude oil trading and storage hubs in the United States. Cushing is supplied by numerous pipelines from locations including the U.S. Gulf Coast and Canada, providing us with access to virtually any crude variety in the world capable of being transported by pipeline.

 

The nitrogen fertilizer segment consists of our interest in CVR Partners, LP, a limited partnership controlled by our affiliates, which operates a nitrogen fertilizer plant and the nitrogen fertilizer business. The nitrogen fertilizer business is the lowest cost producer and marketer of ammonia and UAN in North America, at current natural gas and pet coke prices. The fertilizer plant is the only commercial facility in North America utilizing a coke gasification process to produce nitrogen fertilizers. The use of low cost by-product pet coke from our adjacent oil refinery as feedstock (rather than natural gas) to produce hydrogen provides the facility with a significant competitive advantage given the currently high and volatile natural gas prices. The plant’s competition utilizes natural gas to produce ammonia.

 

CVR Energy’s Initial Public Offering

 

On October 26, 2007 we completed an initial public offering of 23,000,000 shares of our common stock. The initial public offering price was $19.00 per share. The net proceeds to us from the sale of our common stock were approximately $408.5 million, after deducting underwriting discounts and commissions. We also incurred approximately $11.4 million of other costs related to the initial public offering. The net proceeds from the offering were used to repay $280.0 million of CVR’s outstanding term loan debt and to repay in full our $25.0 million secured credit facility and $25.0 million unsecured credit facility. We also repaid $50.0 million of indebtedness under our revolving credit facility. The balance of the net proceeds received were used for general corporate purposes.

 

In connection with the initial public offering, we also became the indirect owner of Coffeyville Resources, LLC and all of its refinery assets. This was accomplished by CVR issuing 62,866,720 shares of its common stock to certain entities controlled by its majority stockholders pursuant to a stock split in exchange for the interests in certain subsidiaries of CALLC. Immediately following the completion of the offering, there were 86,141,291 shares of common stock outstanding, excluding shares of non-vested stock issued.

 

CVR Partners’ Proposed Initial Public Offering

 

On February 28, 2008, the Partnership filed a registration statement with the SEC to effect an initial public offering of 5,250,000 common units representing limited partner interests. On June 13, 2008, the Company announced that the managing general partner of the Partnership had decided to postpone, indefinitely, the Partnership’s initial public offering due to then-existing market conditions for master limited partnerships. The Partnership subsequently withdrew the registration statement

 

CVR Energy’s Proposed Secondary Offering

 

CVR filed a registration statement with the SEC on June 19, 2008 in which its majority stockholders and chairman proposed to offer 10 million shares of the Company’s common stock. The Company announced on July 30, 2008 that the majority stockholders elected not to proceed with the proposed secondary offering at that time due to then-existing market conditions. The registration statement remains on file with the SEC, and the selling stockholders may elect to proceed with the equity offering in the future.

 

CVR Energy’s Proposed Convertible Debt Offering

 

CVR filed a registration statement with the SEC on June 19, 2008 in connection with a proposed offering of $125.0 million aggregate principal amount of CVR’s Convertible Senior Notes due 2013. Under the proposed terms, CVR may sell up to an additional $18.75 million aggregate principal amount of notes upon exercise of an over-allotment option that CVR expects to grant to the underwriters in connection with the offering.

Major Influences on Results of Operations

 

Petroleum Business.   Our earnings and cash flows from our petroleum operations are primarily affected by the relationship between refined product prices and the prices for crude oil and other feedstocks. Feedstocks are petroleum products, such as crude oil and natural gas liquids, that are processed and blended into refined products. The cost to acquire feedstocks and the price for which refined products are ultimately sold depend on factors beyond our control, including the supply of, and demand for, crude oil, as well as gasoline and other refined products which, in turn, depend on, among other factors, changes in domestic and foreign economies, weather conditions, domestic and foreign political affairs, production levels, the availability of imports, the marketing of competitive fuels and the extent of government regulation. Because we apply first-in, first-out, or FIFO, accounting to value our inventory, crude oil price movements may impact net income in the short term because of instantaneous changes in the value of the minimally required, unhedged on hand inventory. The effect of changes in crude oil prices on our results of operations is influenced by the rate at which the prices of refined products adjust to reflect these changes.

 

Feedstock and refined product prices are also affected by other factors, such as product pipeline capacity, local market conditions and the operating levels of competing refineries. Crude oil costs and the prices of refined products have, historically, been subject to wide fluctuations. An expansion or upgrade of our competitors’ facilities, price volatility, international political and economic developments and other factors beyond our control are likely to continue to play an important role in refining industry economics. These factors can impact, among other things, the level of inventories in the market, resulting in price volatility and reduction in product margins. Moreover, the refining industry typically experiences seasonal fluctuations in demand for refined products, such as increases in the demand for gasoline during the summer driving season and for home heating oil during the winter, primarily in the Northeast.

 

In order to assess our operating performance, we compare our refining margin, calculated as the difference between net sales and cost of product sold (exclusive of depreciation and amortization), against an industry refining margin benchmark. The industry refining margin is calculated by assuming that two barrels of benchmark light sweet crude oil is converted into one barrel of conventional gasoline and one barrel of distillate. This benchmark is referred to as the 2-1-1 crack spread. Because we calculate the benchmark margin using the market value of New York Mercantile Exchange (NYMEX) gasoline and heating oil against the market value of NYMEX WTI (WTI) crude oil, we refer to the benchmark as the NYMEX 2-1-1 crack spread, or simply, the 2-1-1 crack spread. The 2-1-1 crack spread is expressed in dollars per barrel and is a proxy for the per barrel margin that a sweet crude refinery would earn assuming it produced and sold the benchmark production of gasoline and heating oil.

 

Crude oil costs are at historic highs. West Texas Intermediate crude oil averaged $111 per barrel for the six months ended June 30, 2008, as compared to $62 per barrel during the comparable period in 2007. Crude oil costs continued to rise during the second quarter of 2008. WTI crude oil prices averaged over $134 per barrel in June 2008 and spiked to $140 per barrel on June 30, 2008. Every barrel of crude oil that we process yields approximately 88% high performance transportation fuels and approximately 12% less valuable byproducts such as pet coke, slurry and sulfur and volumetric losses (lost volume resulting from the change from liquid form to solid). Whereas crude oil costs have increased, sales prices for many byproducts have not increased in the same proportions, resulting in lower earnings. Refined product prices have also failed to keep pace with crude oil costs.

 

In the event refined product sales prices increase proportionally with crude oil prices, the loss on byproduct sales and volumetric loss on crude oil processed are more than offset by refined fuel margins, but in the recent crude price run up refined fuels have failed to keep pace with crude oil costs as evidence by the narrowed 2-1-1 crack spread as a percentage of crude oil prices. For the second quarter of 2007 the 2-1-1 crack spread as percentage of crude oil price was approximately 33.8% compared to only 13.7% in the second quarter of 2008.

 

Although crack spreads are relatively low compared to historical levels as a percentage of crude oil price, the absolute value of the NYMEX 2-1-1 crack spread for the second quarter of 2008 was $17.02 per barrel, which is well above the fixed value of Cash Flow Swap for the quarter of $8.45 per barrel. Because the actual NYMEX 2-1-1 crack spread was greater than the Cash Flow Swap fixed value, we incurred a realized loss of $52.4 million for the quarter on 6.1 million hedged barrels. The absolute value NYMEX 2-1-1 crack spread will continue to have a significant impact on our financial results due to the Cash Flow Swap until June 30, 2009, when the number of

barrels subject to the Cash Flow Swap decreases from approximately 6.2 million barrels per quarter to 1.5 million barrels per quarter.

 

Although the 2-1-1 crack spread is a benchmark for our refinery margin, because our refinery has certain feedstock costs and/or logistical advantages as compared to a benchmark refinery and our product yield is less than total refinery throughput, the crack spread does not account for all the factors that affect refinery margin. Our refinery is able to process a blend of crude oil that includes quantities of heavy and medium sour crude oil that has historically cost less than WTI crude oil. We measure the cost advantage of our crude oil slate by calculating the spread between the price of our delivered crude oil to the price of WTI crude oil, a light sweet crude oil. The spread is referred to as our consumed crude differential. Our refinery margin can be impacted significantly by the consumed crude differential. Our consumed crude differential will move directionally with changes in the West Texas Sour (WTS) differential to WTI and the Western Canadian Select (WCS) differential to WTI as both these differentials indicate the relative price of heavier, more sour, slate to WTI. The WTI-WCS differential for the second quarter of 2008 was $22.94 a barrel as compared to $17.99 a barrel in the second quarter of 2007. The differential for the first quarter of 2008 was $19.84 a barrel. As a percentage of WTI, however, this metric averaged 72% of WTI in the 2007 period compared to 82% in the second quarter of 2008. The correlation between our consumed crude differential and published differentials will vary depending on the volume of light medium sour crude and heavy sour crude we purchase as a percent of our total crude volume and will correlate more closely with such published differentials than the heavier and more sour the crude oil slate.

 

Our petroleum business has been impacted by lower refining margins, reduced demand and our Cash Flow Swap. While improving somewhat from their recent lows, midcontinent refining margins remain below historical metrics when factoring in the high cost of crude. Increased throughput at our recently expanded refinery provides some offset of these factors. Historically, the strongest refining margins occur during the second and third quarters based on gasoline and diesel demand, and while crude oil prices have declined sharply from recent highs, crack spreads have not yet improved in line with the crude price declines due to continuing gasoline demand weakness.

 

We produce a high volume of high value products, such as gasoline and distillates. Approximately 40% of our product slate is ultra low sulfur diesel, which provides us with income tax credits and is currently selling at higher margins than gasoline. Gasoline production was approximately 44% of our second quarter production, down from 48% in the first quarter of 2008. We continue to maximize distillate production, which comprised 40% of our production in the second quarter of 2008 compared to 39% in the first quarter of 2008. The balance of our production is devoted to other products, including the petroleum coke used by the nitrogen fertilizer business. We benefit from the fact that our marketing region consumes more refined products than it produces so that the market prices of our products have to be high enough to cover the logistics cost for the U.S. Gulf Coast refineries to ship into our region. The result of this logistical advantage and the fact the actual product specification used to determine the NYMEX is different from the actual production in the refinery is that prices we realize are different than those used in determining the 2-1-1 crack spread. The difference between our price and the price used to calculate the 2-1-1 crack spread is referred to as gasoline PADD II, Group 3 vs. NYMEX basis, or gasoline basis, and heating oil PADD II, Group 3 vs. NYMEX basis, or heating oil basis. The Group 3 basis differential averaged $0.28 a barrel in the second quarter of 2008, compared to $7.83 a barrel in the comparable period of 2007. The Group 3 basis has returned to positive territory after being negative recently, and was $4.15 per barrel on August 12, 2008, which is in line with the 3-year basis average.

 

Our direct operating expense structure is also important to our profitability. Major direct operating expenses include energy, employee labor, maintenance, contract labor, and environmental compliance. Our predominant variable cost is energy which is comprised primarily of electrical cost and natural gas. We are therefore sensitive to the movements of natural gas prices.

 

Consistent, safe, and reliable operations at our refinery are key to our financial performance and results of operations. Unplanned downtime at our refinery may result in lost margin opportunity, increased maintenance expense and a temporary increase in working capital investment and related inventory position. We seek to mitigate the financial impact of planned downtime, such as major turnaround maintenance, through a diligent planning process that takes into account the margin environment, the availability of resources to perform needed maintenance, feedstock and other factors.

Nitrogen Fertilizer Business.   In the nitrogen fertilizer business, earnings and cash flow from operations are primarily affected by the relationship between nitrogen fertilizer product prices and direct operating expenses. Unlike its competitors, the nitrogen fertilizer business uses minimal natural gas as feedstock and, as a result, is not directly impacted in terms of cost by high or volatile swings in natural gas prices. Instead, our adjacent oil refinery supplies the majority of the pet coke feedstock needed by the nitrogen fertilizer business. The price at which nitrogen fertilizer products are ultimately sold depends on numerous factors, including the supply of, and the demand for, nitrogen fertilizer products which, in turn, depends on, among other factors, the price of natural gas, the cost and availability of fertilizer transportation infrastructure, changes in the world population, weather conditions, grain production levels, the availability of imports, and the extent of government intervention in agriculture markets. While net sales of the nitrogen fertilizer business could fluctuate significantly with movements in natural gas prices during periods when fertilizer markets are weak and nitrogen fertilizer products sell at the low, high natural gas prices do not force the nitrogen fertilizer business to shut down its operations because it employs pet coke as a feedstock to produce ammonia and UAN rather than natural gas.

 

Second quarter 2008 NYMEX natural gas prices averaged $11.47 per million Btus compared with $7.66 per million Btus for the comparable period in 2007. This rise in natural gas prices implies a minimum increase of $120 per ton in production costs for North American producers in an environment where our production cost is substantially unchanged.

 

Nitrogen fertilizer prices are also affected by other factors, such as local market conditions and the operating levels of competing facilities. Natural gas costs and the price of nitrogen fertilizer products have historically been subject to wide fluctuations. An expansion or upgrade of competitors’ facilities, price volatility, international political and economic developments and other factors are likely to continue to play an important role in nitrogen fertilizer industry economics. These factors can impact, among other things, the level of inventories in the market, resulting in price volatility and a reduction in product margins. Moreover, the industry typically experiences seasonal fluctuations in demand for nitrogen fertilizer products.

 

The demand for fertilizers is affected by the aggregate crop planting decisions and fertilizer application rate decisions of individual farmers. Individual farmers make planting decisions based largely on the prospective profitability of a harvest, while the specific varieties and amounts of fertilizer they apply depend on factors like crop prices, their current liquidity, soil conditions, weather patterns and the types of crops planted.

 

The value of nitrogen fertilizer products is also an important consideration in understanding our results. The nitrogen fertilizer business generally upgrades approximately two-thirds of its ammonia production into UAN, a product that presently generates a greater value than ammonia. It takes approximately .41 tons of ammonia to produce 1 ton of 32% UAN. UAN production is a major contributor to our profitability. We continue with plans for full conversion of our ammonia product line to UAN and for expansion of total UAN capacity from 2,000 to 3,000 tons per day. In order to assess the value of nitrogen fertilizer products, we calculate netbacks, also referred to as plant gate price. Netbacks refer to the unit price of fertilizer, in dollars per ton, offered on a delivered basis, less the costs to ship.

 

Prices for both ammonia and UAN for the quarter ended June 30, 2008 reflect strong current demand for these products. Ammonia plant gate prices averaged $528 per ton for the second quarter ended June 30, 2008, compared to $366 per ton during the comparable period in 2007. UAN prices averaged $303 per ton for the second quarter ended June 30, 2008, compared to $218 per ton during the comparable 2007 period. The prices of both ammonia and UAN continue to rise. Our order book as of July 31, 2008 contains an average net back price of ammonia and UAN of $760 and $360 per ton, respectively. As of mid-August 2008, ammonia prices exceeded $800 per ton for prompt shipment and $1,000 per ton for spring delivery, and UAN prices have exceeded $500 per ton. Industry forecasts for the second half of 2008 and the first half of 2009 for ammonia are in the $1,075 per ton range and for UAN are in the $540 per ton range. Actual future prices will depend on supply and demand and other factors described herein.

 

The direct operating expense structure of the nitrogen fertilizer business is also important to its profitability. Using a pet coke gasification process, the nitrogen fertilizer business has significantly higher fixed costs than natural gas-based fertilizer plants. Major direct operating expenses include electrical energy, employee labor, maintenance, including contract labor, and outside services. These costs comprise the fixed costs associated with the fertilizer plant.

The nitrogen fertilizer business generally undergoes a facility turnaround every two years. The turnaround typically lasts 15-20 days and requires approximately $2-3 million in direct costs per turnaround. The next facility turnaround is currently scheduled for the fourth quarter of 2008.

 

Factors Affecting Comparability of Our Financial Results

 

Our historical results of operations for the periods presented may not be comparable with prior periods or to our results of operations in the future for the reasons discussed below.

 

2007 Flood and Crude Oil Discharge

 

During the weekend of June 30, 2007, torrential rains in southeast Kansas caused the Verdigris River to overflow its banks and flood the town of Coffeyville, Kansas. Our refinery and nitrogen fertilizer plant, which are located in close proximity to the Verdigris River, were severely flooded, sustained major damage and required extensive repairs.

 

As a result of the flooding, our refinery and nitrogen fertilizer facilities stopped operating on June 30, 2007. The refinery started operating its reformer on August 6, 2007 and began to charge crude oil to the facility on August 9, 2007. Substantially all of the refinery’s units were in operation by August 20, 2007. The nitrogen fertilizer facility, situated on slightly higher ground, sustained less damage than the refinery. The nitrogen fertilizer facility initiated startup at its production facility on July 13, 2007. Due to the down time, we experienced a significant revenue loss attributable to the property damage during the period when the facilities were not in operation. Total gross costs incurred and recorded as of June 30, 2008 related to the third party costs to repair the refinery and fertilizer facilities were approximately $76.9 million and $4.3 million, respectively.

 

In addition, despite our efforts to secure the refinery prior to its evacuation as a result of the flood, we estimate that 1,919 barrels (80,600 gallons) of crude oil and 226 barrels of crude oil fractions were discharged from our refinery into the Verdigris River flood waters beginning on or about July 1, 2007. We substantially completed remediating the damage caused by the crude oil discharge in July 2008 and expect any remaining minor remedial actions to be completed by December 31, 2008. In 2007, the Company had received insurance proceeds of $10.0 million under its property insurance policy, and $10.0 million under its environmental policies related to recovery of certain costs associated with the crude oil discharge. In the first quarter of 2008 the Company received $1.5 million under its Builders Risk Insurance Policy. In July 2008 the Company received $13.0 million under its property insurance policy.

 

The Company also recently received sixteen notices of claims under the Oil Pollution Act from private claimants in an aggregate amount of approximately $4.4 million. No lawsuits related to these claims have yet been filed.

 

As of June 30, 2008, the Company has recorded total gross costs associated with the repair of, and other matters relating to the damage to the Company’s facilities and with third party and property damage remediation incurred due to the crude oil discharge of approximately $153.6 million. Total anticipated insurance recoveries of approximately $102.4 million have been recorded as of June 30, 2008 (of which $21.5 million had already been received as of June 30, 2008 by the Company from insurance carriers). At June 30, 2008, total accounts receivable from insurance were $80.9 million. The receivable balance is segregated between current and long-term in the Company’s Consolidated Balance Sheet in relation to the nature and classification of the items to be settled. As of June 30, 2008, $58.7 million of the amounts receivable from insurers were not anticipated to be collected in the next twelve months, and therefore has been classified as a non-current asset.

Below is a summary of the gross cost arising from the flood and crude oil discharge and a reconciliation of the related insurance receivable as of June 30, 2008 (in millions):

 

 

Refinancing and Prior Indebtedness