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 86,147,125 shares of the registrant’s common stock outstanding at November 11, 2008.

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

INDEX TO QUARTERLY REPORT ON FORM 10-Q

For The Quarter Ended September 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 vested 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 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 III LLC (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 IDRs 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 September 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.

 

In accordance with the Contribution, Conveyance, and Assumption Agreement, by and between the Partnership and the partners, dated as of October 24, 2007, if an initial private or public offering of the Partnership is not consummated by October 24, 2009, the managing general partner of the Partnership can require the Company to purchase the managing GP interest. This put right expires on the earlier of (1) October 24, 2012 or (2) the closing of

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

the Partnership’s initial private or public offering. If the Partnership’s initial private or public offering is not consummated by October 24, 2012, the Company has the right to require the managing general partner to sell the managing GP interest to the Company. This call right expires on the closing of the Partnership’s initial private or public offering. In the event of an exercise of a put right or a call right, the purchase price will be the fair market value of the managing GP interest at the time of the purchase determined by an independent investment banking firm selected by the Company and the managing general partner.

 

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 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.

 

As of September 30, 2008, the Partnership had distributed $50.0 million to CVR.

 

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 September 30, 2008 and December 31, 2007, the results of operations for the three and nine months ended September 30, 2008 and 2007, and the cash flows for the nine months ended September 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. GAAP 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, $4.2 million of deferred offering costs for the nine months ended September 30, 2007 were previously presented in operating activities in the interim financial statements. Such amounts have now been reflected as financing activities for the nine months ended September 30, 2007 in the accompanying Consolidated Statements of Cash Flows. The impact on the prior financial statements of this revision is not considered material.

 

 

On April 23, 2008, the Audit Committee of the Board of Directors and management of the Company concluded that the Company’s previously issued consolidated financial statements for the year ended December 31, 2007 and the related quarter ended September 30, 2007 contained errors. The Company arrived at this conclusion during the course of its closing process and review for the quarter ended March 31, 2008.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

The restatement principally related to errors in the calculation of the cost of crude oil purchased by the Company and associated financial transactions. Accordingly, the Company restated the previously issued financial statements for these periods. Restated financial information, as well as a discussion of the errors and the adjustments made as a result of the restatement, are contained in the Company’s amended Annual Report on Form 10K/A for the year ended December 31, 2007. The Company did not amend the Company’s previously filed Quarterly Report on Form 10-Q for the period ended September 30, 2007.

 

As a result of the restatement, for the three months ended September 30, 2007, net income decreased by $2.2 million, from $13.4 million to $11.2 million. In addition, for the nine months ended September 30, 2007, net loss increased by $2.2 million from $40.9 million to $43.1 million. These changes resulted from an increase in cost of product sold (exclusive of depreciation and amortization) of $7.1 million for both periods, with an associated increase in income tax benefit of $4.9 million for both periods.

 

Due to the restatement, accounts payable for the quarter ended September 30, 2007 increased by $7.1 million. Income tax receivable increased by $3.0 million, current deferred income tax asset increased by $4.2 million, and long term deferred income tax liability increased by $2.3 million.

 

The effect of the above adjustments on the condensed consolidated financial statements is set forth in the tables below. The restatement had no effect on net cash flow from operating, investing, or financing activities as shown in the Consolidated Statements of Cash Flows. The restatement did not have any impact on the Company’s covenant compliance under its debt facilities or its cash position as of September 30, 2007.

 

Notes 11, 12, 16, and 17 have been restated to reflect the adjustments described above.

 

 

 

 

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

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 September 30, 2008, the only financial assets and financial liabilities that are within the scope of SFAS 157 and measured at fair value on a recurring basis are the Company’s derivative instruments. See Note 15, “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.

 

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.

 

 

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 addition, in connection with the transfer of the managing general partner of the Partnership to CALLC III in October 2007, 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 through the performance commitment period, or in CVR’s case, through the vesting period. At September 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 in correlation with the percentage for

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

which the override units can share in conjunction with the benchmark value. The estimated fair value of the override units of CALLC III has been determined using a probability-weighted expected return method which utilizes CALLC III’s cash flow projections, which are representative of the nature of interests held by CALLC III in the Partnership.

 

The following table provides key information for the share-based compensation plans related to the override units of CALLC, CALLC II, and CALLC III. Compensation expense amounts are disclosed in thousands.

 

 

 

 

 

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 September 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 September 30, 2008 CVR closing common stock price to determine the Company’s equity value, the service phantom interest and performance phantom interest were valued at $17.54 and $7.06 per point, respectively. CVR has recorded approximately $7,984,000 and $29,217,000 in personnel accruals as of September 30, 2008 and December 31, 2007, respectively. Compensation expense for the three and nine month periods ending September 30, 2008 related to the Phantom Unit Appreciation Plan was reversed by $(17,977,000) and $(21,233,000), respectively. Compensation expense for the three and nine month periods ending September 30, 2007 was $4,062,000 and $9,641,000, respectively.

 

At September 30, 2008, assuming no change in the estimated fair value at September 30, 2008, there was approximately $2.9 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 September 24, 2008, options to purchase 9,100 shares of common stock at an exercise price of $11.01 per share were granted to an outside director upon his election to the Company’s board of directors.

 

As of September 30, 2008, there was approximately $0.4 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 September 30, 2008 and 2007 related to the non-vested common stock and common stock options was $102,000 and $0, respectively. Compensation expense recorded for the nine month periods ending September 30, 2008 and 2007 related to the non-vested common stock and common stock options was $288,000 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 September 30, 2008 and September 30, 2007 totaled approximately $244,000 and $2,877,000, respectively. Capitalized interest for the nine month periods ended September 30, 2008 and September 30, 2007 totaled approximately $1,565,000 and $9,285,000, respectively. Land and buildings that are under a capital lease obligation approximate $4,827,000.

 

 

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 recently completed a major scheduled turnaround in October 2008. The refinery started a major scheduled turnaround in February 2007 with completion in April 2007. Costs of $138,000 associated with the 2008 fertilizer plant turnaround were included in direct operating expenses (exclusive of depreciation and amortization) for the three and

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

nine months ended September 30, 2008. Costs of $0 and $76,754,000 associated with the 2007 refinery turnaround were included in direct operating expenses (exclusive of depreciation and amortization) for the three and nine months ending September 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 $605,000 and $595,000 for the three months ended September 30, 2008 and September 30, 2007, respectively. For the nine months ended September 30, 2008 and 2007 cost of product sold excludes depreciation and amortization of $1,816,000 and $1,791,000, 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 $19,486,000 and $9,582,000 for the three months ended September 30, 2008 and 2007, respectively. For the nine months ended September 30, 2008 and 2007, direct operating expenses excludes depreciation and amortization of $58,296,000 and $40,202,000, respectively. Direct operating expenses also exclude depreciation of $7,627,000 for both the three and nine months ended September 30, 2007 that is included in “Net costs associated with the flood” on the condensed consolidated statement of operations as a result of assets being idled due to the flood.

 

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 $518,000 and $304,000 for the three months ended September 30, 2008 and September 30, 2007, respectively. For the nine months ended September 30, 2008 and 2007, selling, general and administrative expenses excludes depreciation and amortization of $1,212,000 and $680,000, respectively.

 

 

The Company entered into an insurance premium finance agreement with Cananwill, Inc. in July 2008 and July 2007 to finance the purchase of its property, liability, cargo and terrorism policies. The original balances of these notes were $10.0 million and $7.6 million for 2008 and 2007, respectively. Both notes were to be repaid in equal installments with the final payment due for the 2008 note in June 2009. The balance due for the July 2007 note was paid in full in April 2008. As of September 30, 2008 and December 31, 2007 the Company owed $10.0 million and $3.4 million related to these notes.

 

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 September 30, 2008 and December 31, 2007 the lease obligations were recorded at approximately $1.1 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 $4.8 million. The capital lease obligation was $4.0 million as of September 30, 2008.

 

 

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

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 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, the insurers with respect to costs and damages related to the 2007 flood and crude oil discharge. See Note 13, “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 September 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 claims incurred due to the crude oil discharge of approximately $154.6 million. Total anticipated insurance recoveries of approximately $104.2 million have been recorded as of September 30, 2008 (of which $49.5 million had already been received as of September 30, 2008 by the Company from insurance carriers). At September 30, 2008, total accounts receivable from insurance were $54.7 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 September 30, 2008, $35.4 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, could do so and 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. In addition, the Company’s excess environmental liability insurance carrier has asserted that the pollution liability claims are for “cleanup,” which is not covered under its policy, rather than for “property damage,” which is covered to the limits of the policy. While the Company will vigorously contest the excess carrier’s position, the Company contends that if that position were upheld, the Company’s umbrella 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 property insurance lawsuit involved the Zone A/Zone B issue, and the pollution insurance lawsuit involved the cleanup/property damage issue described above. The Company intends to pursue the litigation vigorously. The Company’s primary pollution liability carrier has settled with the Company by paying the full $25.0 million policy limit and has been dismissed from the pollution insurance lawsuit. The $25.0 million payment from the Company’s environmental insurer is included within the $49.5 million of insurance proceeds at September 30, 2008. Considering the effect of the lawsuits, the Company continues to believe its remaining receivable as of September 30, 2008 of $54.7 million is probable of recovery.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 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 $50.4 million associated with both the flood and related crude oil discharge as discussed in Note 13, “Commitments and Contingent Liabilities.” This amount is net of anticipated insurance recoveries of $104.2 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 the third quarter of 2008, the Company received $13.0 million under its property insurance policy and $15.0 million was received from one environmental insurance carrier in settlement of their expected total obligation. In October 2008, the Company through certain wholly-owned subsidiaries submitted an advance payment proof of loss to certain of its insurers for unallocated property damage. The Company expects to receive an advance payment related thereto in the amount of approximately $10.1 million. As of November 6, 2008, the Company has received $9.8 million of the $10.1 million total increasing the total insurance recoveries received from $49.5 million at September 30, 2008 to $59.3 million as of November 6, 2008. The Company continues to reserve all rights under all relevant policies. See Note 13, “Commitments and Contingent Liabilities” for additional information regarding environmental and other contingencies relating to the crude oil discharge that occurred on July 1, 2007.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

 

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 September 30, 2008.

 

As of September 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. An examination of the Company’s 2004 through 2007 Texas franchise recently commenced. The Company has not been subject to any other U.S. federal or state income or franchise tax examinations by taxing authorities with respect to other income and franchise tax returns. The Company’s U.S. federal and state tax years subject to examination as of October 31, 2008 are 2005 to 2007.

 

The Company’s effective tax rate for the nine months ended September 30, 2008 and 2007 was 25.1% and 69.3%, respectively, as compared to the Company’s combined federal and state expected statutory tax rate of 39.9%. The effective tax rate is lower than the expected statutory tax rate for the nine months ended September 30, 2008 due primarily 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 each year in relative comparison with the projected pre-tax loss level in 2007 and pre-tax income level in 2008.

 

 

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 the Company and Basis of Presentation”.

 

 

Outstanding stock options totaling 32,350 common shares were excluded from the diluted earnings per share calculation for the three and nine months ended September 30, 2008 as they were antidilutive.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

2007 Earnings (Loss) Per Share

 

The computation of basic and diluted loss per share for the three and nine months ended September 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.

 

Pro forma earnings (loss) per share for the three and nine months ended September 30, 2007 is calculated as noted below. For the nine months ended September 30, 2007, 17,500 non-vested shares of common stock have been excluded from the calculation of pro forma diluted earnings per share because the inclusion of such common stock equivalents in the number of weighted average shares outstanding would be anti-dilutive:

 

 

 

 

 

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

 

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 September 30, 2008 and 2007, lease expense totaled $1,102,000 and $850,000, respectively. For the nine months ended September 30, 2008 and 2007, lease expense totaled $3,176,000 and $2,812,000, 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.

 

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. In connection with that discharge, the Company received in May 2008 notices of claims from sixteen private claimants under the Oil Pollution Act in aggregate amount of approximately $4.4 million. In August 2008, those claimants filed suit against the Company in the United States District Court for the District of Kansas in Wichita. The Company believes that the resolution of these claims will not have a material adverse effect on the consolidated financial statements.

 

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 September 30, 2008, the total gross costs recorded associated with remediation and third party property damage as a result of the crude oil discharge approximated $52.9 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, penalties or lawsuits would be material nor can be estimated.

 

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, resolution of class action lawsuits, and other claims brought by regulatory authorities. Our excess environmental liability insurance carrier has asserted that our pollution liability claims are for “cleanup,” which is not covered by such policy, rather than for “property damage,” which is covered to the limits of the policy. While we will vigorously contest the excess carrier’s position, we contend that if that position were upheld, our umbrella 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 substantial sums under the environmental and liability insurance

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

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 primary environmental liability insurance policy in 2007 and received an additional $15.0 million in September 2008 from that carrier, which two payments together constituted full payment to the Company of the primary pollution liability policy limit.

 

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 September 30, 2008 and December 31, 2007, environmental accruals of $7,079,000 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 $2,514,000 and $2,802,000, respectively, included in other current liabilities. The Company’s accruals were determined based on an estimate of payment costs through 2031, which scope of remediation was arranged with the EPA and are discounted at the appropriate risk free rates at September 30, 2008 and December 31, 2007, respectively. The accruals include estimated closure and post-closure costs of $1,524,000

 

 

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’s 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 $10.1 million in the first nine months of 2008 and, based on information currently available, anticipates spending approximately $6.4 million in the last three months of 2008, $41.6 million in 2009, and $5.0 million in 2010 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 September 30, 2008 and 2007, capital expenditures were $5,481,000 and $16,195,000, respectively. For the nine month periods ended September 30, 2008 and 2007, capital expenditures were $34,842,000 and $102,775,000, 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 September 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 16, “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 September 30, 2008 the notional open amounts under the swap agreements were 23,883,250 barrels of crude oil, 501,548,250 gallons of heating oil and 501,548,250 gallons of unleaded gasoline.

 

CVR ENERGY, INC. AND SUBSIDIARIES

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS — (Continued)

 

Interest Rate Swap

 

At September 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 16, “Related Party Transactions”), and the other half are held with a financial institution that is a lender under CRLLC’s long-term debt agreement. The swap agreements carry the following terms:

 

 

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 3 to the Condensed Consolidated Financial Statements. As of September 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: