10-Q 1 wnr201293010q.htm 10-Q WNR 2012.9.30 10Q
 
 
 
 
 
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the quarterly period ended September 30, 2012
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from _____ to _____
Commission File Number: 001-32721
WESTERN REFINING, INC.
(Exact name of registrant as specified in its charter)
Delaware
 
20-3472415
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
 
 
123 W. Mills Ave., Suite 200
 
79901
El Paso, Texas
 
(Zip Code)
(Address of principal executive offices)
 
 
Registrant’s telephone number, including area code: (915) 534-1400
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). 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.
Large accelerated filer þ
 
Accelerated filer o
 
Non-accelerated filer o
 
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ



As of October 26, 2012, there were 88,412,556 shares outstanding, par value $0.01, of the registrant’s common stock.
 
 
 
 
 



WESTERN REFINING, INC. AND SUBSIDIARIES
INDEX

 
 
 
 
Condensed Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011
 
 
Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2012 and 2011
 
 
Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2012 and 2011
 
 
Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2012 and 2011
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Exhibit 31.1
 
 
 
Exhibit 31.2
 
 
 
Exhibit 32.1
 
 
 
Exhibit 32.2
 
 EX-31.1
 EX-31.2
 EX-32.1
 EX-32.2
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT





Forward-Looking Statements
As provided by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, certain statements included throughout this Quarterly Report on Form 10-Q, and in particular under the sections entitled Part I — Item 2, Management’s Discussion and Analysis of Financial Condition and Results of Operations relating to matters that are not historical fact are forward-looking statements that represent management’s beliefs and assumptions based on currently available information. These forward-looking statements relate to matters such as our industry, business strategy, future operations, our expectations for margins and crack spreads, the discount between West Texas Intermediate, or WTI, crude oil and Dated Brent crude oil as well as the discount between WTI Cushing and WTI Midland crude oils, additions to pipeline capacity at Cushing, Oklahoma, crude oil production in the Permian Basin, taxes, capital expenditures, liquidity and capital resources, our working capital requirements, our planned share repurchases, and other financial and operating information. Forward-looking statements also include those regarding the timing of completion of certain operational improvements we are making at our refineries, future operational and refinery efficiencies and cost savings, future refining capacity, timing of future maintenance turnarounds, the amount or sufficiency of future cash flows and earnings growth, future expenditures, future contributions related to pension and postretirement obligations, our ability to manage our inventory price exposure through commodity hedging instruments, the impact on our business of existing and future state and federal regulatory requirements, environmental loss contingency accruals, projected remediation costs or requirements, and the expected outcomes of legal proceedings in which we are involved. We have used the words “anticipate,” “assume,” “believe,” “budget,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “plan,” “potential,” “predict,” “project,” “will,” “future,” and similar terms and phrases to identify forward-looking statements in this report.
Forward-looking statements reflect our current expectations regarding future events, results, or outcomes. These expectations may or may not be realized. Some of these expectations may be based upon assumptions or judgments that prove to be incorrect. In addition, our business and operations involve numerous risks and uncertainties, many of which are beyond our control that could result in our expectations not being realized or otherwise materially affect our financial condition, results of operations, and cash flows.
Actual events, results, and outcomes may differ materially from our expectations due to a variety of factors. Although it is not possible to identify all of these factors, they include, among others, the following:
changes in the underlying demand for our refined products;
changes in crack spreads;
changes in the spread between WTI crude oil and West Texas Sour, or WTS, crude oil, also known as the sweet/sour spread;
changes in the spread between WTI crude oil and Dated Brent crude oil;
effects of, and exposure to risks related to, our commodity hedging strategies and transactions;
availability, costs, and price volatility of crude oil, other refinery feedstocks, and refined products;
construction of new, or expansion of existing product or crude pipelines, including in the Permian Basin and at Cushing, Oklahoma;
instability and volatility in the financial markets, including as a result of potential disruptions caused by economic uncertainties in Europe;
a potential economic recession in the United States and/or abroad;
availability of renewable fuels for blending and Renewal Identification Numbers, or RIN, to meet Renewable Fuel Standards, or RFS, obligations;
adverse changes in the credit ratings assigned to our debt instruments;
actions of customers and competitors;
changes in fuel and utility costs incurred by our refineries;
the effect of weather-related problems on our operations;
disruptions due to equipment interruption, pipeline disruptions, or failure at our or third-party facilities;
execution of planned capital projects, cost overruns relating to those projects, and failure to realize the expected benefits from those projects;

i


effects of, and costs relating to, compliance with current and future local, state, and federal environmental, economic, climate change, safety, tax and other laws, policies and regulations, including any that may result following the upcoming federal or state elections, and enforcement initiatives;
rulings, judgments, or settlements in litigation, tax, or other legal or regulatory matters, including unexpected environmental remediation costs in excess of any reserves or insurance coverage;
the price, availability, and acceptance of alternative fuels and alternative fuel vehicles;
operating hazards, natural disasters, casualty losses, acts of terrorism including cyber-attacks, and other matters beyond our control; and
other factors discussed in more detail under Part II — Item 1A. Risk Factors in this Form 10-Q and under Part I — Item 1A. Risk Factors in our Annual Report on Form 10-K for the year ended December 31, 2011, or 2011 10‑K, which are incorporated herein by this reference.
Any one of these factors or a combination of these factors could materially affect our results of operations and could influence whether any forward-looking statements ultimately prove to be accurate. You are urged to consider these factors carefully in evaluating any forward-looking statements and are cautioned not to place undue reliance on these forward-looking statements.
Although we believe that our plans, intentions, and expectations reflected in or suggested by the forward-looking statements we make in this report are reasonable, we can provide 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. The forward-looking statements included herein are made only as of the date of this report, and we are not required to update any information to reflect events or circumstances that may occur after the date of this report, except as required by applicable law.


ii


Part I
Financial Information
Item 1.
Financial Statements
WESTERN REFINING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
(In thousands, except share data)
 
September 30,
2012
 
December 31,
2011
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
509,844

 
$
170,829

Accounts receivable, trade, net of reserves for doubtful accounts of $1,390 and $1,884 for 2012 and 2011, respectively
423,514

 
275,478

Inventories
301,807

 
405,754

Prepaid expenses
100,900

 
163,530

Other current assets
131,557

 
195,064

Deferred income tax asset, net
9,586

 

Total current assets
1,477,208

 
1,210,655

Restricted cash

 
220,355

Property, plant, and equipment, net
1,065,444

 
995,316

Intangible assets, net
42,406

 
44,352

Other assets, net
35,072

 
99,666

Total assets
$
2,620,130

 
$
2,570,344

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
445,228

 
$
384,523

Accrued liabilities
331,010

 
172,001

Deferred income tax liability, net

 
105,555

Current portion of long-term debt
203

 
3,595

Total current liabilities
776,441

 
665,674

Long-term liabilities:
 
 
 
Long-term debt, less current portion
495,586

 
800,395

Deferred income tax liability, net
268,610

 
262,492

Other liabilities
80,222

 
21,955

Total long-term liabilities
844,418

 
1,084,842

Commitments and contingencies (Note 20)


 


Stockholders’ equity:
 
 
 
Common stock, par value $0.01, 240,000,000 shares authorized; 90,933,295 and 90,001,537 shares issued, respectively
909

 
900

Preferred stock, par value $0.01, 10,000,000 shares authorized; no shares issued or outstanding

 

Additional paid-in capital
609,954

 
599,645

Retained earnings
419,296

 
242,538

Accumulated other comprehensive loss, net of tax
(1,779
)
 
(1,812
)
Treasury stock, 994,370 and 698,006 shares, respectively at cost
(29,109
)
 
(21,443
)
Total stockholders’ equity
999,271

 
819,828

Total liabilities and stockholders’ equity
$
2,620,130

 
$
2,570,344


The accompanying notes are an integral part of these condensed consolidated financial statements.
1




WESTERN REFINING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net sales
$
2,446,317

 
$
2,397,139

 
$
7,254,877

 
$
6,794,611

Operating costs and expenses:
 
 
 
 
 
 
 
Cost of products sold (exclusive of depreciation and amortization)
2,207,424

 
2,053,409

 
6,343,610

 
5,854,320

Direct operating expenses (exclusive of depreciation and amortization)
127,884

 
109,159

 
360,257

 
337,571

Selling, general, and administrative expenses
26,986

 
27,153

 
80,083

 
75,987

Gain on disposal of assets, net

 

 
(1,891
)
 
(3,630
)
Maintenance turnaround expense
31,065

 
632

 
33,377

 
1,336

Depreciation and amortization
23,577

 
35,581

 
69,108

 
105,301

Total operating costs and expenses
2,416,936

 
2,225,934

 
6,884,544

 
6,370,885

Operating income
29,381

 
171,205

 
370,333

 
423,726

Other income (expense):
 
 
 
 
 
 
 
Interest income
165

 
114

 
560

 
345

Interest expense and other financing costs
(18,000
)
 
(33,195
)
 
(63,930
)
 
(101,191
)
Amortization of loan fees
(1,641
)
 
(2,295
)
 
(5,219
)
 
(6,869
)
Loss on extinguishment of debt

 

 
(7,654
)
 
(4,641
)
Other, net
(646
)
 
(5,206
)
 
637

 
(4,038
)
Income before income taxes
9,259

 
130,623

 
294,727

 
307,332

Provision for income taxes
(2,961
)
 
(45,695
)
 
(103,429
)
 
(110,108
)
Net income
$
6,298

 
$
84,928

 
$
191,298

 
$
197,224

 
 
 
 
 
 
 
 
Net earnings per share:
 
 
 
 
 
 
 
Basic
$
0.07

 
$
0.94

 
$
2.11

 
$
2.17

Diluted
0.07

 
0.81

 
1.84

 
1.90

Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
90,134

 
89,176

 
89,835

 
88,878

Diluted
90,134

 
109,935

 
110,412

 
109,733

 
 
 
 
 
 
 
 
Cash dividends declared per common share
$
0.08

 
$

 
$
0.16

 
$






The accompanying notes are an integral part of these condensed consolidated financial statements.
2




WESTERN REFINING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
(In thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
Net income
$
6,298

 
$
84,928

 
$
191,298

 
$
197,224

Other comprehensive income before tax:
 
 
 
 
 
 
 
Defined benefit plans:
 
 
 
 
 
 
 
Reclassification of loss to income
18

 
22

 
53

 
64

Recognition of pension plan settlements

 
230

 

 
1,290

Other comprehensive income before tax
18

 
252

 
53

 
1,354

Income tax
(7
)
 
(111
)
 
(20
)
 
(587
)
Other comprehensive income, net of tax
11

 
141

 
33

 
767

Comprehensive income
$
6,309

 
$
85,069

 
$
191,331

 
$
197,991




The accompanying notes are an integral part of these condensed consolidated financial statements.
3




WESTERN REFINING, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended
 
September 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net income
$
191,298

 
$
197,224

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
69,108

 
105,301

Commodity hedging instrument mark-to-market net unrealized loss
311,191

 
114,913

Reserve for doubtful accounts
16

 
182

Amortization of loan fees and original issue discount
17,163

 
20,416

Loss on extinguishment of debt
7,654

 
4,641

Stock-based compensation expense
6,127

 
6,168

Deferred income taxes
(109,023
)
 
39,280

Excess tax benefit from stock-based compensation
4,191

 
3,218

(Gain) loss on disposal of assets
308

 
(3,803
)
Changes in operating assets and liabilities:
 
 
 

Accounts receivable
(148,052
)
 
(9,980
)
Inventories
103,947

 
(25,151
)
Prepaid expenses
62,630

 
(35,856
)
Other assets
(54,377
)
 
(40,052
)
Accounts payable and accrued liabilities
132,233

 
33,792

Other long-term liabilities
1,883

 
(9,742
)
Net cash provided by operating activities
596,297

 
400,551

Cash flows from investing activities:
 
 
 
Capital expenditures
(130,723
)
 
(44,655
)
Proceeds from the sale of assets
292

 
11,610

Decrease in restricted cash
220,355

 

Net cash provided by (used in) investing activities
89,924

 
(33,045
)
Cash flows from financing activities:
 
 
 
Payments on long-term debt
(322,858
)
 
(26,685
)
Debt retirement fees
(1,415
)
 

Proceeds from financing arrangement

 
12,322

Deferred financing costs

 
(7,202
)
Purchase of treasury stock
(4,202
)
 

Dividends paid
(14,540
)
 

Excess tax benefit from stock-based compensation
(4,191
)
 
(3,218
)
Net cash used in financing activities
(347,206
)
 
(24,783
)
Net increase in cash and cash equivalents
339,015

 
342,723

Cash and cash equivalents at beginning of period
170,829

 
59,912

Cash and cash equivalents at end of period
$
509,844

 
$
402,635



The accompanying notes are an integral part of these condensed consolidated financial statements.
4




WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. Organization
The “Company,” “Western,” “we,” “us,” and “our” may be used to refer to Western Refining, Inc. and, unless the context otherwise requires, our subsidiaries. Any references as of a date prior to September 16, 2005 (the date of Western Refining, Inc.’s formation) are to Western Refining Company, L.P. (“Western Refining LP”). On May 31, 2007, we completed the acquisition of Giant Industries, Inc. (“Giant”). Any references prior to this date exclude the operations of Giant.
We are an independent crude oil refiner and marketer of refined products and also operate service stations and convenience stores. We own and operate two refineries: one in El Paso, Texas and one near Gallup in the Four Corners region of Northern New Mexico. On December 29, 2011, we completed the sale of the Yorktown refining and terminal assets. Primarily, we operate in West Texas, Arizona, New Mexico, Colorado, and the Mid-Atlantic region. In addition to the refineries, we also operate stand-alone refined product distribution terminals in Bloomfield and Albuquerque, New Mexico, as well as asphalt terminals in Phoenix and Tucson, Arizona; Albuquerque; and El Paso. As of September 30, 2012, we also operated 222 retail service stations and convenience stores in Arizona, Colorado, New Mexico, and Texas; a fleet of crude oil and refined product truck transports; and a wholesale petroleum products distributor that operates in Arizona, California, Colorado, Nevada, New Mexico, Texas, Maryland, and Virginia.
Our operations include three business segments: the refining group, the wholesale group, and the retail group. See Note 3, Segment Information, for further discussion of our business segments.
2. Basis of Presentation, Significant Accounting Policies, and Recent Accounting Pronouncements
The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012, or for any other period.
The Condensed Consolidated Balance Sheet at December 31, 2011 has been derived from the audited financial statements at that date but does not include all of the information and footnotes required by GAAP for complete financial statements. The accompanying condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2011 (“2011 Form 10-K”).
The condensed consolidated financial statements include the accounts of Western Refining, Inc. and our wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated for all periods presented.
Restricted Cash
Restricted cash reported in the Condensed Consolidated Balance Sheets at December 31, 2011 relates to proceeds from the sale of the Yorktown refinery and certain portions of our Southwest pipeline system that had not been expended in accordance with restrictions of our Term Loan Agreement and Senior Secured Fixed Rate Notes Indenture. As of September 30, 2012, all of the restricted cash was used to either repay amounts outstanding under the Term Loan Agreement, to fund capital expenditures, or to pay taxes due on the sale of the Yorktown refinery and portions of our Southwest pipeline system.
Use of Estimates
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 and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Recent Accounting Pronouncements
The accounting provisions covering the presentation of comprehensive income were amended to allow an entity the option to present the total of comprehensive income (loss), the components of net income (loss), and the components of other comprehensive income (loss) either in a single continuous statement or in two separate but consecutive statements. These

5

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

provisions are effective for the first interim or annual period beginning after December 15, 2011, and are to be applied retrospectively, with early adoption permitted. The adoption of this guidance effective January 1, 2012 did not affect our financial position or results of operations because these requirements only affected disclosures.
The accounting provisions covering fair value measurements and disclosures were amended to clarify the application of existing fair value measurement requirements and to change certain fair value measurement and disclosure requirements. Amendments that change measurement and disclosure requirements relate to (i) fair value measurement of financial instruments that are managed within a portfolio, (ii) application of premiums and discounts in a fair value measurement, and (iii) additional disclosures about fair value measurements categorized within Level 3 of the fair value hierarchy. These provisions are effective for the first interim or annual period beginning after December 15, 2011. The adoption of this guidance effective January 1, 2012 did not affect our financial position or results of operations because these requirements only affected disclosures.
From time to time, new accounting pronouncements are issued by the Financial Accounting Standards Board or other standard setting bodies that may have an impact on our accounting and reporting. We believe that such recently issued accounting pronouncements and other authoritative guidance for which the effective date is in the future either will not have an impact on our accounting or reporting or that such impact will not be material to our financial position, results of operations, or cash flows when implemented.
3. Segment Information
Our operations are organized into three operating segments based on manufacturing and marketing criteria and the nature of our products and services, our production processes, and our types of customers. These segments are the refining group, the wholesale group, and the retail group. A description of each segment and the principal products follows:
Refining Group. Our refining group currently operates two refineries: one in El Paso, Texas (the “El Paso refinery”) and one near Gallup, New Mexico (the “Gallup refinery”). The refining group also operates a crude oil transportation and pipeline gathering system in New Mexico, an asphalt plant in El Paso, two stand-alone refined product distribution terminals, and four asphalt terminals. Our refineries make various grades of gasoline, diesel fuel, and other products from crude oil, other feedstocks, and blending components. We purchase crude oil, other feedstocks, and blending components from various third-party suppliers. We also acquire refined products through exchange agreements and from various third-party suppliers to supplement supply to our customers. We sell these products through our retail service stations, our wholesale group, other independent wholesalers and retailers, commercial accounts, and sales and exchanges with major oil companies. Net sales for the three and nine months ended September 30, 2012 includes $4.0 million in business interruption insurance recoveries related to a weather-related outage that occurred at our El Paso refinery in the first quarter of 2011.
Wholesale Group. Our wholesale group includes several lubricant and bulk petroleum distribution plants, unmanned fleet fueling operations, and a fleet of refined product and lubricant delivery trucks. Our wholesale group distributes commercial wholesale petroleum products primarily in Arizona, California, Colorado, Nevada, New Mexico, Texas, Maryland, and Virginia. The wholesale group purchases petroleum fuels and lubricants from our refining group and from third-party suppliers.
Prior to September 2012, the refined products sold by our wholesale group in the Mid-Atlantic region were purchased from various third parties. On August 31, 2012, we transferred all of our Northeast wholesale inventories to a third party and entered into an exclusive supply and marketing agreement ("Supply Agreement") with the third party ("Supplier") covering activities related to our refined product supply, hedging, and sales in the Mid-Atlantic region. We accounted for the refined product inventory transfer as a product exchange with the net difference in settlement recorded in cost of products sold. Under the Supply Agreement, we will receive monthly distribution amounts from the Supplier equal to one-half of the amount by which our refined product sales price exceeds the Supplier's costs of acquiring, transporting and hedging (including net realized and unrealized hedging gains and losses) the refined product ("Refined Product Costs"). To the extent our refined product sales price does not exceed the Refined Product Costs during any month, we will pay one-half of that amount to the Supplier. Our payments to the Supplier are limited in an aggregate annual amount of $2.0 million. Further, during any month that our refined product sales price does not exceed the Refined Product Costs by an aggregate amount of $4 million for the calendar year, we will not receive monthly distribution amounts from the Supplier. We accrued $0.7 million for amounts due to the Supplier for the three and nine months ended September 30, 2012. The change in operations did not have a material impact on our wholesale group's operations for the three or nine months ended September 30, 2012.
Retail Group. Our retail group operates service stations that include convenience stores. Our service stations sell various grades of gasoline, diesel fuel, general merchandise, and beverage and food products to the general public. Our wholesale group supplies the majority of the gasoline and diesel fuel that our retail group sells. We purchase general merchandise and beverage and food products from various third-party suppliers. At September 30, 2012, the retail group operated 222 service

6

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

stations and convenience stores or kiosks located in Arizona, New Mexico, Colorado, and Texas, compared to 172 service stations and convenience stores at September 30, 2011.
Segment Accounting Principles. Operating income for each segment consists of net sales less cost of products sold; direct operating expenses; selling, general, and administrative expenses; net gain on disposal of assets; maintenance turnaround expense; and depreciation and amortization. Cost of products sold includes net realized and unrealized gains and losses related to our commodity hedging activities and reflects current costs adjusted, where appropriate, for last-in, first-out (“LIFO”) and lower of cost or market (“LCM”) inventory adjustments. Intersegment sales are reported at prices that approximate market.
Activities of our business that are not included in the three operating segments mentioned above are included in the "Other" category. These activities consist primarily of corporate staff operations and other items that are not specific to the normal business of any one of our three operating segments. We do not allocate certain items of other income and expense, including income taxes, to the individual segments.
The total assets of each segment consist primarily of cash and cash equivalents; inventories; net accounts receivable; net property, plant, and equipment; and other assets directly associated with the individual segment’s operations. Included in the total assets of the corporate operations are cash and cash equivalents; various net accounts receivables; prepaid expenses; other current assets; net deferred income tax assets; net property, plant, and equipment; and other long-term assets.
Demand for gasoline is generally higher during the summer months than during the winter months. As a result, our operating results for the first and fourth calendar quarters are generally lower than those for the second and third calendar quarters of each year. The effects of seasonal demand for gasoline are partially offset by increased demand during the winter months for diesel fuel in the Southwest.
Disclosures regarding our reportable segments with reconciliations to consolidated totals for the three and nine months ended September 30, 2012 and 2011 are presented below:
 
For the Three Months Ended September 30, 2012
 
Refining
Group
 
Wholesale
Group
 
Retail
Group
 
Other
 
Consolidated
 
(In thousands)
Net sales to external customers
$
1,055,969

 
$
1,074,378

 
$
315,970

 
$

 
$
2,446,317

Intersegment sales (1)
1,045,852

 
229,372

 
6,089

 

 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (2)
$
40,814

 
$
473

 
$
4,759

 
$
(16,665
)
 
$
29,381

Other income (expense), net
 
 
 
 
 
 
 
 
(20,122
)
  Income before income taxes
 
 
 
 
 
 
 
 
$
9,259

 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
19,477

 
$
922

 
$
2,736

 
$
442

 
$
23,577

Capital expenditures
66,003

 
792

 
2,447

 
2,084

 
71,326

(1)
Intersegment sales of $1,281.3 million have been eliminated in consolidation.
(2)
The effect of our economic hedging activity is included within operating income of our refining and wholesale groups as a component of cost of products sold. Refining cost of products sold includes $199.9 million in net realized and unrealized economic hedging losses and wholesale cost of products sold includes $26.0 million in net realized economic hedging losses for the three months ended September 30, 2012.


7

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
For the Nine Months Ended September 30, 2012
 
Refining
Group
 
Wholesale
Group
 
Retail
Group
 
Other
 
Consolidated
 
(In thousands)
Net sales to external customers
$
3,264,768

 
$
3,100,396

 
$
889,713

 
$

 
$
7,254,877

Intersegment sales (1)
3,152,264

 
639,440

 
18,685

 

 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (2)
$
384,965

 
$
21,058

 
$
13,137

 
$
(48,827
)
 
$
370,333

Other income (expense), net
 
 
 
 
 
 
 
 
(75,606
)
  Income before income taxes
 
 
 
 
 
 
 
 
$
294,727

 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
56,828

 
$
2,826

 
$
7,858

 
$
1,596

 
$
69,108

Capital expenditures
120,320

 
2,415

 
5,325

 
2,663

 
130,723

Total assets at September 30, 2012
1,600,497

 
261,901

 
195,728

 
562,004

 
2,620,130

(1)
Intersegment sales of $3,810.4 million have been eliminated in consolidation.
(2)
The effect of our economic hedging activity is included within operating income of our refining and wholesale groups as a component of cost of products sold. Refining cost of products sold includes $396.1 million in net realized and unrealized economic hedging losses and wholesale cost of products sold includes $23.6 million in net realized economic hedging losses for the nine months ended September 30, 2012.

 
For the Three Months Ended September 30, 2011
 
Refining
Group
 
Wholesale
Group
 
Retail
Group
 
Other
 
Consolidated
 
(In thousands)
Net sales to external customers
$
1,089,496

 
$
1,056,128

 
$
251,515

 
$

 
$
2,397,139

Intersegment sales (1)
1,189,526

 
195,638

 
6,486

 

 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (2)
$
171,446

 
$
12,707

 
$
2,482

 
$
(15,430
)
 
$
171,205

Other income (expense), net
 
 
 
 
 
 
 
 
(40,582
)
Income before income taxes
 
 
 
 
 
 
 
 
$
130,623

 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
31,440

 
$
1,033

 
$
2,410

 
$
698

 
$
35,581

Capital expenditures
15,392

 
193

 
2,851

 
217

 
18,653

(1)
Intersegment sales of $1,391.7 million have been eliminated in consolidation.
(2)
The effect of our economic hedging activity is included within operating income of our refining and wholesale groups as a component of cost of products sold. Refining cost of products sold includes $115.4 million in net realized and unrealized economic hedging losses and wholesale cost of products sold includes $9.5 million in net realized and unrealized economic hedging gains for the three months ended September 30, 2011.


8

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

 
For the Nine Months Ended September 30, 2011
 
Refining
Group (2)
 
Wholesale
Group
 
Retail
Group
 
Other
 
Consolidated
 
(In thousands)
Net sales to external customers
$
3,119,809

 
$
3,024,418

 
$
650,384

 
$

 
$
6,794,611

Intersegment sales (1)
3,128,556

 
529,369

 
19,779

 

 
 
 
 
 
 
 
 
 
 
 
 
Operating income (loss) (3)
$
431,671

 
$
30,275

 
$
6,689

 
$
(44,909
)
 
$
423,726

Other income (expense), net
 
 
 
 
 
 
 
 
(116,394
)
Income before income taxes
 
 
 
 
 
 
 
 
$
307,332

 
 
 
 
 
 
 
 
 
 
Depreciation and amortization
$
92,633

 
$
3,257

 
$
7,232

 
$
2,179

 
$
105,301

Capital expenditures
33,918

 
1,641

 
8,171

 
925

 
44,655

Total assets at September 30, 2011
2,118,314

 
285,176

 
165,960

 
451,940

 
3,021,390

(1)
Intersegment sales of $3,677.7 million have been eliminated in consolidation.
(2)
Included in refining assets were $657.4 million in long-lived and intangible assets related to the Yorktown facility and a section of our New Mexico pipeline. On December 29, 2011, we completed sales transactions to dispose of these refining group assets.
(3)
The effect of our economic hedging activity is included within operating income of our refining and wholesale groups as a component of cost of products sold. Refining cost of products sold includes $179.5 million in net realized and unrealized economic hedging losses and wholesale cost of products sold includes $6.2 million in net realized and unrealized economic hedging gains for the nine months ended September 30, 2011.


9

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

4. Fair Value Measurement
We utilize the market approach when measuring fair value of our financial assets and liabilities. The market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities.
The fair value hierarchy consists of the following three levels:
Level 1
Inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities.
Level 2
Inputs are quoted prices for similar assets or liabilities in an active market, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable and market-corroborated inputs that are derived principally from or corroborated by observable market data.
Level 3
Inputs are derived from valuation techniques in which one or more significant inputs or value drivers are unobservable and cannot be corroborated by market data or other entity-specific inputs.
The carrying amounts of accounts receivable, accounts payable, and accrued liabilities approximated their fair values at September 30, 2012 and December 31, 2011 due to their short-term maturities. The following tables represent our assets and liabilities measured at fair value on a recurring basis as of September 30, 2012 and December 31, 2011, and the basis for that measurement:
 
 
 
Fair Value Measurement at September 30, 2012 Using
 
Carrying Value at September 30, 2012
 
Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
Financial assets:
 
 
 
 
 
 
 
Commodity hedging contracts
$
4,904

 
$

 
$
4,904

 
$

Financial liabilities:
 
 
 
 
 
 
 
Commodity hedging contracts
$
133,982

 
$

 
$
130,472

 
$
3,510


 
 
 
Fair Value Measurement at December 31, 2011 Using
 
Carrying Value at December 31, 2011
 
Quoted Prices in
Active Markets
for Identical
Assets or
Liabilities
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2)
 
Significant
Unobservable
Inputs
(Level 3)
 
(In thousands)
Financial assets:
 
 
 
 
 
 
 
Commodity hedging contracts
$
183,179

 
$

 
$
180,548

 
$
2,631

Financial liabilities:
 
 
 
 
 
 
 
Commodity hedging contracts
$
1,066

 
$

 
$
1,066

 
$

Commodity hedging contracts designated as Level 3 financial assets relate to jet fuel crack spread swaps with contract maturity dates in 2014 and 2015. We based the fair value of these instruments upon similar contracts with quoted market prices that have a strong historical correlation in pricing to the jet fuel crack spread swaps. Both historically and in observable future contracts, there has been an average differential of $0.756 per barrel greater for the jet fuel crack spread swaps to the quoted market prices for ultra-low sulfur diesel crack spread swaps. This differential was the basis for valuing the jet fuel crack spread swaps that mature in 2014 and 2015.
Carrying amounts of commodity hedging contracts reflected as financial assets are included in both current and non-current other assets in the Condensed Consolidated Balance Sheets. Carrying amounts of commodity hedging contracts reflected as financial liabilities are included in both accrued and other long-term liabilities in the Condensed Consolidated Balance Sheets. Included in the carrying amounts of commodity hedging contracts are fair value adjustments, respective to each counterparty with whom we enter into contracts, called credit valuation adjustments ("CVA"). CVAs are intended to adjust the

10

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

fair value of counterparty contracts as a function of a counterparty's credit rating and reflect the credit quality of each counterparty to arrive at contract fair values.
The following table presents the changes in fair value of our Level 3 assets and liabilities (all related to commodity price swap contracts) for the three and nine months ended September 30, 2012.
 
Three Months Ended
 
Nine Months Ended
 
September 30, 2012
 
(In thousands)
Asset amount at beginning of period
$
1,106

 
$
2,631

Change in fair value
(3,128
)
 
(3,629
)
Fair value of trades entered into during the period
(1,488
)
 
(2,512
)
Fair value on date of settlement of open contracts at beginning of period

 

Liability balance at end of period
$
(3,510
)
 
$
(3,510
)
A hypothetical change of 10% to the estimated future cash flows attributable to our Level 3 commodity price swaps would result in an estimated fair value change of $0.4 million.
As of September 30, 2012 and December 31, 2011, the carrying amount and estimated fair value of our debt was as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Carrying amount
$
495,789

 
$
803,990

Fair value
899,944

 
997,693

The carrying amount of our debt is the amount reflected in the Condensed Consolidated Balance Sheets, including the current portion. The fair value of the debt was determined using Level 2 inputs.
There have been no transfers between assets or liabilities whose fair value is determined through the use of quoted prices in active markets (Level 1) and those determined through the use of significant other observable inputs (Level 2).
5. Inventories
Inventories were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Refined products (1)
$
112,825

 
$
199,848

Crude oil and other raw materials
158,321

 
179,039

Lubricants
14,126

 
11,985

Convenience store merchandise
16,535

 
14,882

Inventories
$
301,807

 
$
405,754

(1)
Includes $18.5 million and $76.5 million of inventory valued using the first-in, first-out (“FIFO”) valuation method at September 30, 2012 and December 31, 2011, respectively. The decrease in our FIFO inventories from December 31, 2011 is primarily due to the sale of our wholesale group's Mid-Atlantic refined product inventories during the third quarter of 2012 in connection with the execution of an exclusive supply and marketing agreement with a third party. See Note 3, Segment Information for further discussion.
We value refinery inventories of crude oil, other raw materials, and asphalt inventories at the lower of cost or market using the LIFO valuation method. Other than refined products inventories valued using the FIFO method held by our retail and wholesale groups, refined products inventories are valued using the LIFO valuation method. Lubricants and convenience store merchandise are valued using the FIFO valuation method.

11

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

As of September 30, 2012 and December 31, 2011, refined products valued under the LIFO method and crude oil and other raw materials totaled 4.7 million barrels and 5.2 million barrels, respectively. At September 30, 2012, the excess of the current cost of these crude oil, refined product, and other feedstock and blendstock inventories over LIFO cost was $195.9 million. At December 31, 2011, the excess of the current cost of these crude oil, refined product, and other feedstock and blendstock inventories over LIFO cost was $213.7 million.
During the three months ended September 30, 2012 and 2011, cost of products sold included net non-cash charges of $60.0 million and net non-cash credits of $48.9 million, respectively, from changes in our LIFO reserves. During the nine months ended September 30, 2012 and 2011, cost of products sold included net non-cash credits of $17.8 million and net non-cash charges of $6.9 million, respectively, from changes in our LIFO reserves.
During the three and nine months ended September 30, 2011, we recorded LIFO liquidations caused by permanently decreased levels in inventory volumes that were consistent with our expectations of 2011 year-end inventory levels of certain refined products, crude oil, and other raw materials. The effect of these liquidations increased gross profit by $1.3 million, net income by $0.9 million, and net earnings per diluted share by $0.01 for the three months ended September 30, 2011. The effect of these liquidations increased gross profit by $1.3 million, net income by $0.8 million, and net earnings per diluted share by $0.01 for the nine months ended September 30, 2011. There were no LIFO liquidations during the nine months ended September 30, 2012.
Average LIFO cost per barrel of our refined products and crude oil and other raw materials inventories as of September 30, 2012 and December 31, 2011 was as follows:
 
September 30, 2012
 
December 31, 2011
 
Barrels
 
LIFO Cost
 
Average
LIFO
Cost Per
Barrel
 
Barrels
 
LIFO Cost
 
Average
LIFO
Cost Per
Barrel
 
(In thousands, except cost per barrel)
Refined products
1,640

 
$
94,334

 
$
57.52

 
1,896

 
$
123,335

 
$
65.05

Crude oil and other
3,053

 
158,321

 
51.86

 
3,289

 
179,039

 
54.44

 
4,693

 
$
252,655

 
53.84

 
5,185

 
$
302,374

 
58.32

6. Prepaid Expenses
Prepaid expenses were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Prepaid crude oil and other raw materials inventories
$
74,899

 
$
111,521

Prepaid insurance and other
26,001

 
52,009

Prepaid expenses
$
100,900

 
$
163,530

7. Other Current Assets
Other current assets were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Margin account deposits
$
71,076

 
$
10,820

Material and chemical inventories
26,343

 
27,196

Exchange and other receivables
17,854

 
6,797

Excise and other taxes receivable
11,103

 
22,149

Unrealized hedging gains
5,181

 
128,102

Other current assets
$
131,557

 
$
195,064


12

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

8. Property, Plant, and Equipment, Net
Property, plant, and equipment, net was as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Refinery facilities and related equipment
$
1,056,835

 
$
1,013,169

Pipelines, terminals, and transportation equipment
75,792

 
75,172

Retail and wholesale facilities and related equipment
215,673

 
198,060

Other
22,770

 
22,287

Construction in progress
122,904

 
55,062

 
1,493,974

 
1,363,750

Accumulated depreciation
(428,530
)
 
(368,434
)
Property, plant, and equipment, net
$
1,065,444

 
$
995,316

Depreciation expense was $22.8 million and $66.6 million for the three and nine months ended September 30, 2012, respectively, and $34.4 million and $101.8 million for the three and nine months ended September 30, 2011, respectively.
9. Intangible Assets, Net
Intangible assets, net were as follows:
 
September 30, 2012
 
December 31, 2011
 
Weighted Average Amortization Period (Years)
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
Gross
Carrying
Value
 
Accumulated
Amortization
 
Net
Carrying
Value
 
 
(In thousands)
 
 
Amortizable assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Licenses and permits
$
20,426

 
$
(8,574
)
 
$
11,852

 
$
20,426

 
$
(7,384
)
 
$
13,042

 
7.5

Customer relationships
7,300

 
(2,148
)
 
5,152

 
7,300

 
(1,758
)
 
5,542

 
9.9

Rights-of-way and other
7,658

 
(3,683
)
 
3,975

 
8,163

 
(3,346
)
 
4,817

 
4.6

 
35,384

 
(14,405
)
 
20,979

 
35,889

 
(12,488
)
 
23,401

 
 
Unamortizable assets:
 
 
 
 
 
 
 
 
 
 
 
 
 
Trademarks
4,800

 

 
4,800

 
4,800

 

 
4,800

 
 
Liquor licenses
16,627

 

 
16,627

 
16,151

 

 
16,151

 
 
 
$
56,811

 
$
(14,405
)
 
$
42,406

 
$
56,840

 
$
(12,488
)
 
$
44,352

 
 
Intangible asset amortization expense for the three and nine months ended September 30, 2012 was $0.7 million and $2.2 million, respectively, based on estimated useful lives ranging from 3 to 15 years. Intangible asset amortization expense for the three and nine months ended September 30, 2011 was $1.1 million and $3.2 million, respectively, based on estimated useful lives ranging from 6 to 20 years. Estimated amortization expense for the indicated periods is as follows (in thousands):
Remainder of 2012
$
812

2013
3,039

2014
2,849

2015
2,371

2016
2,200

2017
2,259


13

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

10. Other Assets, Net
Other assets, net of amortization, were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Unamortized loan fees
$
24,341

 
$
33,086

Unrealized hedging gains

 
54,208

Other
10,731

 
12,372

Other assets, net of amortization
$
35,072

 
$
99,666

11. Accrued and Other Long-Term Liabilities
Accrued liabilities were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Income taxes
$
110,311

 
$
52,795

Fair value of open commodity hedging positions, net
88,475

 
198

Payroll and related costs
36,057

 
42,111

Excise taxes
33,818

 
32,000

Property taxes
21,089

 
13,216

Professional and other
19,706

 
19,859

Interest
14,413

 
2,310

Environmental reserves
3,209

 
3,343

Banking fees and other financing
2,873

 
3,708

Pension obligation
1,059

 
2,461

Accrued liabilities
$
331,010

 
$
172,001

During the third quarter of 2012, we increased our property tax accrual estimate by $8.7 million resulting from revised property appraisal rolls for 2012. We believe the appraised property values to be in error and have filed a lawsuit in state district court to appeal this appraised value.
Other long-term liabilities were as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
Fair value of open commodity hedging positions, net
$
49,071

 
$

Capital lease obligations
10,196

 
3,337

Retiree plan obligations
5,866

 
5,745

Asset retirement obligations
4,988

 
4,736

Environmental reserves
4,783

 
2,428

Other
5,318

 
5,709

Other long-term liabilities
$
80,222

 
$
21,955

As of September 30, 2012, we had environmental liability accruals of $8.0 million, of which $3.2 million was in accrued liabilities. A portion of these liabilities have been recorded using an inflation factor of 2.7% and a discount rate of 7.1%. Environmental liabilities of $6.7 million accrued at September 30, 2012 have not been discounted. As of September 30, 2012, the unescalated, undiscounted environmental reserve related to discounted liabilities totaled $1.5 million, leaving $0.2 million to be accreted over time.

14

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

The table below summarizes our environmental liability accruals:
 
December 31,
2011
 
Increase
(Decrease)
 
Payments
 
September 30,
2012
 
(In thousands)
Discounted liabilities
$
4,295

 
$
(2,612
)
 
$
(358
)
 
$
1,325

Undiscounted liabilities
1,476

 
5,767

 
(576
)
 
6,667

Total environmental liabilities
$
5,771

 
$
3,155

 
$
(934
)
 
$
7,992

12. Long-Term Debt
Long-term debt was as follows:
 
September 30,
2012
 
December 31,
2011
 
(In thousands)
11.25% Senior Secured Notes, due 2017, net of unamortized discount of $19,775 and $21,986 for 2012 and 2011, respectively
$
305,225

 
$
303,014

5.75% Convertible Senior Notes, due 2014, net of conversion feature of $25,455 and $34,999 for 2012 and 2011, respectively
189,995

 
180,451

Term Loan, net of unamortized discount of $2,901 for 2011, with average interest rates of 7.50% and 8.56% for the nine months ended September 30, 2012 and 2011, respectively

 
319,661

5.50% promissory note, due 2015
569

 
864

Revolving Credit Agreement

 

     Long-term debt
495,789

 
803,990

Current portion of long-term debt
(203
)
 
(3,595
)
     Long-term debt, net of current portion
$
495,586

 
$
800,395


Outstanding amounts under the Revolving Credit Agreement, if any, are included in the current portion of long-term debt.


15

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Interest expense and other financing costs were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Contractual interest:
 
 
 
 
 
 
 
11.25% Senior Secured Notes
$
9,141

 
$
9,141

 
$
27,422

 
$
27,422

Senior Secured Floating Rate Notes

 
7,555

 

 
22,418

5.75% Convertible Senior Notes
3,097

 
3,097

 
9,291

 
9,291

Term Loan

 
6,213

 
9,458

 
21,027

Revolving Credit Agreement

 

 

 
631

 
12,238

 
26,006

 
46,171

 
80,789

Amortization of original issuance discount:
 
 
 
 
 
 
 
11.25% Senior Secured Notes
766

 
561

 
2,212

 
1,949

Senior Secured Floating Rate Notes

 
1,008

 

 
3,012

5.75% Convertible Senior Notes
3,312

 
2,899

 
9,544

 
8,354

Term Loan

 
116

 
188

 
232

 
4,078

 
4,584

 
11,944

 
13,547

Other interest expense
2,100

 
2,726

 
7,275

 
8,520

Capitalized interest
(416
)
 
(121
)
 
(1,460
)
 
(1,665
)
Interest expense and other financing costs
$
18,000

 
$
33,195

 
$
63,930

 
$
101,191

We amortize original issue discounts using the effective interest method over the respective term of the debt.
On December 21, 2011, we redeemed the Senior Secured Floating Rate Notes at a repurchase price of $288.8 million, representing a premium on redemption of the notes of 5.0% above the face value of $275.0 million. Prior to December 21, 2011, the Senior Secured Floating Rate Notes paid interest quarterly at a per annum rate, reset quarterly, equal to three-month LIBOR (subject to a LIBOR floor of 3.25%) plus 7.50%.
The Convertible Senior Notes are presently convertible at the option of the holder. The current conversion rate is 93.3790 to each $1,000 of principal amount of Convertible Senior Notes. The Convertible Senior Notes will also be convertible in any future calendar quarter (prior to maturity) whenever the last reported sale price of our common stock exceeds 130% of the applicable conversion price in effect for the Notes on the last trading day of the immediately preceding calendar quarter for twenty days in the thirty consecutive trading day period ending on the last trading day of the immediately preceding calendar quarter. If any Convertible Senior Notes are surrendered for conversion, we may elect to satisfy our obligations upon conversion through the delivery of shares of our common stock, in cash, or a combination thereof.
     On March 29, 2011, we entered into an amended and restated Term Loan Credit Agreement ("Term Loan"). To effect this amendment and restatement, we paid $3.7 million in amendment fees. As a result of this amendment, we recognized a $4.6 million loss on extinguishment of debt. In addition to our scheduled Term Loan payment of $0.8 million made during the first quarter of 2012, we made non-mandatory prepayments of $30.0 million and $291.8 million during the first and second quarters of 2012, respectively. As a result of the repayment of the Term Loan, we recognized a loss on extinguishment of debt of $7.7 million.
On September 22, 2011, we entered into an amended and restated Revolving Credit Agreement. Lenders under the amended and restated Revolving Credit Agreement extended $1.0 billion in revolving commitments that mature on September 22, 2016, and incorporate a borrowing base tied to eligible accounts receivable and inventory. The amended and restated Revolving Credit Agreement also provides for letters of credit and swing line loans. The amended and restated Revolving Credit Agreement provides for a quarterly commitment fee of either 0.375% or 0.50% per annum subject to adjustment based upon the average excess availability under the amended and restated Revolving Credit Agreement and quarterly letter of credit fees ranging from 2.50% to 3.25% per annum subject to adjustment based upon the average excess availability. Borrowings can be either base rate loans plus a margin ranging from 1.50% to 2.25% or LIBOR loans plus a margin ranging from 2.50% to 3.25% in each case subject to adjustment based upon the average excess availability under the amended and restated Revolving Credit Agreement. The interest rate margins and letter of credit fees are to be reduced by 0.25% upon our achievement and

16

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

maintenance of a certain fixed charge coverage ratio. The amended and restated Revolving Credit Agreement provides for a cash dominion requirement that is in effect only if there is an event of default or the excess availability under the amended and restated Revolving Credit Agreement falls below the greater of (i) 15.0% of the Borrowing Base and (ii) $50.0 million. The amended and restated Revolving Credit Agreement is secured on a first priority basis by our cash and cash equivalents, trade accounts receivable, and inventory and on a second priority basis by the collateral securing the Term Loan, the Fixed Rate Notes, and any future other pari passu secured obligations, which consist of our fixed assets. The revolving facility is used to fund general working capital needs and letter of credit requirements. We paid $5.9 million in fees to effect the September 22, 2011 amendment and restatement to the Revolving Credit Agreement.
Prior to September 22, 2011, the Revolving Credit Agreement included commitments of $800.0 million composed of a $145.0 million tranche scheduled to mature on May 31, 2012 and a $655.0 million tranche scheduled to mature on January 1, 2015. Interest rates for the $145.0 million tranche were based on our consolidated leverage ratio and ranged from 3.75% to 4.50% over LIBOR. Interest rates for the $655.0 million tranche were based on our borrowing base capacity under the Revolving Credit Agreement and ranged from 3.00% to 3.75% over LIBOR.
As of September 30, 2012, we had gross availability under the Revolving Credit Agreement of $646.6 million, of which $295.9 million was used for outstanding letters of credit. We had no direct borrowings under the Revolving Credit Agreement at September 30, 2012.

17


13. Stockholders' Equity
Changes to stockholders' equity during the nine months ended September 30, 2012 were as follows:
 
Stockholders' Equity
 
(In thousands)
Balance at December 31, 2011
$
819,828

Net income
191,298

Other comprehensive income, net of tax
33

Dividends
(14,540
)
Stock-based compensation
6,127

Excess tax benefit from stock-based compensation
4,191

Purchase of treasury stock
(7,666
)
Balance at September 30, 2012
$
999,271


On July 18, 2012, our board of directors authorized a share repurchase program of up to $200 million. We may repurchase shares from time-to-time through open market transactions, block trades, privately negotiated transactions, accelerated share repurchase transactions, or otherwise subject to market conditions, as well as corporate, regulatory, and other considerations. Our board of directors authorized this share repurchase program through July 31, 2013, but may discontinue the program at its discretion at any time prior to that date. During the third quarter of 2012, we purchased 296,364 shares as part of our share repurchase program at a cost of $7.7 million. As of October 26, 2012, we have purchased an additional 2,239,091 shares at a cost of $55.1 million.
14. Income Taxes
Compared to the federal statutory rate of 35%, our effective tax rate for the three and nine months ended September 30, 2012 was 32.0% and 35.1%, respectively. The effective tax rate for the three months ended September 30, 2012 was lower than the statutory rate primarily due to various discrete items. The effective tax rate for the nine months ended September 30, 2012 was slightly higher than the statutory rate primarily due to state tax obligations offset, in part, by the generation of new federal tax credits. Compared to the federal statutory rate of 35%, our effective tax rate for the three and nine months ended September 30, 2011 was 35.0% and 35.8%, respectively. The effective tax rate for the nine month period was slightly higher than the statutory rate primarily due to state tax obligations.
The Internal Revenue Service (the “IRS”) is presently conducting an examination of our tax years ending December 31, 2009 and December 31, 2010. That examination is in progress, and no adjustments have been proposed. The IRS has completed an examination of our tax years ending December 31, 2007 and December 31, 2008. For the 2007 and 2008 years, the IRS has proposed adjustments, but we disagree with the proposed adjustments and are pursuing our administrative remedies. For our tax year ending December 31, 2006, the IRS has completed an examination and has proposed adjustments. We have filed a petition in Tax Court challenging the 2006 adjustments. We do not believe the results of any of these examinations, appeals, or litigation will have a material adverse effect on our financial position, operations or cash flows, but the timing and the results of final determinations on these matters remains uncertain.
We believe that it is more likely than not that the benefit from certain state net operating loss (“NOL”) carryforwards related to the Yorktown refinery will not be realized. Accordingly, a valuation allowance of $23.2 million was provided against the deferred tax assets relating to these NOL carryforwards at September 30, 2012. We have reduced the valuation allowance for the Yorktown NOL carryforwards by $0.5 million from December 31, 2011.
As of September 30, 2012, we have recorded a liability of $2.2 million for unrecognized tax benefits, all of which would affect our effective tax rate if recognized.
15. Retirement Plans
We fully recognize the obligations associated with single-employer defined benefit pension, retiree healthcare, and other postretirement plans in our financial statements.
Pensions
Through December 31, 2011, we had distributed $20.0 million from plan assets to plan participants of the Yorktown cash balance plan. No distributions were made during the nine months ended September 30, 2012. In connection with the sale of the

18

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Yorktown refinery during the fourth quarter of 2011, we announced our intent to terminate the Yorktown cash balance plan covering certain previous Yorktown refinery employees. Such termination is subject to regulatory approval and may take several months. We have contributed $1.5 million to the Yorktown cash balance plan through September 30, 2012, and expect to contribute an additional $1.0 million during 2012, depending upon the plan's status at the end of 2012.
The components of the net periodic benefit cost associated with our pension plan for certain previous employees of the Yorktown refinery were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Net periodic benefit cost includes:
 
 
 
 
 
 
 
Service cost
$

 
$

 
$

 
$

Interest cost
55

 
125

 
165

 
375

Amortization of net actuarial loss
8

 
25

 
23

 
75

Expected return on assets
(23
)
 
(33
)
 
(68
)
 
(98
)
Settlement expense

 
230

 

 
1,290

Plan amendments

 
(105
)
 

 
(105
)
Net periodic benefit cost
$
40

 
$
242

 
$
120

 
$
1,537

Our benefit obligation at December 31, 2011 for the Yorktown benefit plan was $7.3 million and the benefit plan held $4.8 million in assets.

19

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

Postretirement Obligations
The components of the net periodic benefit cost associated with our postretirement medical benefit plans covering certain employees at our El Paso refinery and previous employees of the Yorktown refinery were as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Net periodic benefit cost includes:
 
 
 
 
 
 
 
Service cost
$
33

 
$
20

 
$
98

 
$
60

Interest cost
62

 
56

 
187

 
169

Amortization of net actuarial (gain) loss
10

 
(3
)
 
30

 
(11
)
Net periodic benefit cost
$
105

 
$
73

 
$
315

 
$
218

Our benefit obligation at December 31, 2011 for our postretirement medical benefit plans was $6.0 million. We fund our medical benefit plans on an as-needed basis.
Defined Contribution Plan
We sponsor a 401(k) defined contribution plan under which participants may contribute a percentage of their eligible compensation to the plan and invest in various investment options. We make a Safe Harbor matching contribution to the account of each participant who is covered under the collective bargaining agreement with the International Union of Operating Engineers in El Paso and who has completed 12 months of service equal to 250% of the first 4% of compensation beginning February 1, 2012. During January 2012, the safe harbor matching contribution was 200% of the first 4% of compensation. In addition, participants who were covered by the settlement agreement with the International Union of Operating Engineers in El Paso received a contribution equal to 3% of the compensation paid between January 1, 2012 and January 31, 2012. For all other employees, we matched 1% up to a maximum of 4% of eligible compensation for each 1% of eligible compensation contributed, provided the participant had a minimum of one year of service with Western. For the three and nine months ended September 30, 2012 and 2011, we expensed $1.3 million, $3.8 million, $1.5 million, and $4.3 million, respectively, in connection with this plan.
16. Crude Oil and Refined Product Risk Management
We enter into crude oil forward contracts to facilitate the supply of crude oil to the refineries. During the nine months ended September 30, 2012, we entered into net forward, fixed-price contracts to physically receive and deliver crude oil that qualify as normal purchases and normal sales and are exempt from derivative reporting requirements.
We use crude oil and refined products futures, swap contracts, or options to mitigate the change in value for a portion of our LIFO inventory volumes subject to market price fluctuations and swap contracts to fix the margin on a portion of our future gasoline and distillate production. The physical volumes are not exchanged, and these contracts are net settled with cash. For instruments used to mitigate the change in value of volumes subject to market prices, we elected not to pursue hedge accounting treatment for financial accounting purposes, generally because of the difficulty of establishing the required documentation that would allow for hedge accounting at the date that the hedging instrument is entered into. The swap contracts used to fix the margin on a portion of our future gasoline and distillate production do not qualify for hedge accounting treatment.
The fair value of these contracts is reflected in the Condensed Consolidated Balance Sheets and the related net gain or loss is recorded within cost of products sold in the Condensed Consolidated Statements of Operations. Quoted prices for similar assets or liabilities in active markets (Level 2) are considered to determine the fair values for the purpose of marking the hedging instruments to market at each period end. At September 30, 2012, we had open commodity hedging instruments consisting of crude oil and refined product futures and price swaps on 117,429 net barrels to protect the value of certain crude oil, refined product, and blendstock inventories and crack spread swaps on 27,432,500 barrels primarily to fix the margin on a portion of our future gasoline and distillate production. The fair value of the outstanding contracts at September 30, 2012 was a net unrealized loss of $129.1 million comprised of both short-term and long-term unrealized gains and losses. The September 30, 2012 net unrealized loss consists of $9.4 million in other current assets, $89.4 million in current liabilities, and $49.1 million in other long-term liabilities. At December 31, 2011, we had open commodity hedging instruments consisting of crude oil and refined product futures and price swaps on 933,000 barrels and refined product price and crack spread swaps on

20

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

29,282,500 barrels. The fair value of the outstanding contracts at December 31, 2011 was a net unrealized gain of $182.1 million comprised of both short-term and long-term unrealized gains and losses. The December 31, 2011 net unrealized gain consists of $128.1 million in other current assets, $54.2 million in other assets, and $0.2 million in other long-term liabilities.
Our commodity hedging activities are initiated within guidelines established by management and approved by our board of directors. Commodity hedging transactions are executed centrally on behalf of all of our operating segments to minimize transaction costs, monitor consolidated net exposures, and to allow for increased responsiveness to changes in market factors. Due to mark-to-market accounting during the term of the various commodity hedging contracts, significant unrealized non-cash net gains and losses could be recorded in our results of operations. Additionally, we may be required to collateralize any mark-to-market losses on outstanding commodity hedging contracts.
As of September 30, 2012, we had the following outstanding crude oil and refined product hedging instruments that were entered into as economic hedges. The information presents the notional volume of outstanding contracts by type of instrument and year of maturity (volumes in thousands of barrels):
 
Notional Contract Volumes by Year of Maturity
 
2012
 
2013
 
2014
 
2015
Inventory positions (futures and swaps):
 
 
 
 
 
 
 
Crude oil and refined products — net short (long) positions
122

 
(5
)
 

 

Refined product positions (crack spread swaps):
 
 
 
 
 
 
 
Distillate — net short positions
2,200

 
9,108

 
8,400

 
3,750

Unleaded gasoline — net short positions
2,450

 
1,375

 
150

 

Cost of products sold for the three months ended September 30, 2012 includes $73.1 million in realized losses and $152.8 million in non-cash unrealized net losses from our economic hedging activities. For the nine months ended September 30, 2012, the realized net loss was $108.5 million and the non-cash unrealized net loss was $311.2 million from our economic hedging activities. Cost of products sold for the three months ended September 30, 2011, includes $11.3 million in realized and $94.6 million in non-cash unrealized net losses. For the nine months ended September 30, 2011, we recognized $58.4 million in realized and $114.9 million in non-cash unrealized net losses.
17. Stock-Based Compensation
We have two share-based compensation plans, the Western Refining 2006 Long-Term Incentive Plan (the “2006 LTIP”) and the 2010 Incentive Plan of Western Refining (the “2010 Incentive Plan”) that allow for restricted share awards and restricted share unit awards. As of September 30, 2012, there were 39,896 and 3,207,611 shares of common stock reserved for future grants under the 2006 LTIP and the 2010 Incentive Plan, respectively. Awards granted under both plans generally vest over a three-year period and their market value at the date of the grant is amortized over the restricted period on a straight-line basis.
As of September 30, 2012, there were 712,722 and 399,476 restricted shares and restricted share units not vested, respectively, outstanding.
We recorded stock compensation expense of $1.9 million and $6.1 million for the three and nine months ended September 30, 2012 of which $0.1 million and $0.3 million was included in direct operating expenses and $1.8 million and $5.8 million in selling, general, and administrative expenses, respectively. The excess tax benefit related to the restricted shares that vested during the three and nine months ended September 30, 2012 was $0.5 million and $3.9 million, respectively, using a statutory blended rate of 37.54%. The aggregate fair value at the grant date of the restricted shares that vested during the three and nine months ended September 30, 2012 was $0.4 million and $5.3 million, respectively. The related aggregate intrinsic value of these restricted shares for the three and nine months ended September 30, 2012 was $1.7 million and $15.7 million, respectively, at the vesting date.
The excess tax benefit related to the restricted share units that vested during both the three and nine months ended September 30, 2012 was $0.2 million and $0.3 million, respectively, using a statutory blended rate of 37.54%. The aggregate fair value at the grant date of the restricted share units that vested during both the three and nine months ended September 30, 2012 was $0.8 million and $2.1 million, respectively. The related aggregate intrinsic value of these restricted share units for the three and nine months ended September 30, 2012 was $1.4 million and $2.9 million, respectively, at the vesting date.

21

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

We recorded stock compensation expense of $2.0 million and $6.2 million for the three and nine months ended September 30, 2011 of which $0.2 million and $0.8 million was included in direct operating expenses and $1.8 million and $5.4 million in selling, general, and administrative expenses, respectively. The excess tax benefit related to the shares that vested during the three and nine months ended September 30, 2011 was $0.3 million and $3.1 million using a statutory blended rate of 37.54%. The aggregate fair value at the grant date of the shares that vested during the three and nine months ended September 30, 2011 was $0.9 million and $7.3 million, respectively. The related aggregate intrinsic value of these shares was $1.7 million and $15.7 million, respectively, at the vesting date.
As of September 30, 2012, the aggregate fair value at grant date of outstanding restricted shares and restricted share units was $4.2 million and $7.2 million, respectively. The aggregate intrinsic value of outstanding restricted shares and restricted share units was $18.7 million and $10.5 million, respectively. The unrecognized compensation cost of restricted shares and restricted share units not vested was $2.3 million and $5.5 million, respectively. Unrecognized compensation costs for restricted shares and restricted share units will be recognized over a weighted average period of approximately 0.58 years and 2.08 years, respectively.
The following table summarizes our restricted share unit and restricted share activity for the three and nine months ended September 30, 2012:
 
Restricted Share Units
 
Restricted Shares
 
Number
of Units
 
Weighted Average
Grant Date
Fair Value
 
Number
of Shares
 
Weighted Average
Grant Date
Fair Value
Not vested at December 31, 2011
316,917

 
$
16.09

 
1,511,242

 
$
6.29

Awards granted
162,748

 
18.13

 

 

Awards vested

 

 
(698,771
)
 
6.61

Awards forfeited
(2,980
)
 
16.78

 

 

Not vested at March 31, 2012
476,685

 
16.78

 
812,471

 
6.06

Awards granted
30,444

 
19.71

 

 

Awards vested
(77,447
)
 
16.35

 
(34,643
)
 
9.02

Awards forfeited

 

 

 

Not vested at June 30, 2012
429,682

 
17.07

 
777,828

 
5.92

Awards granted
25,585

 
26.69

 

 

Awards vested
(55,791
)
 
15.35

 
(65,106
)
 
5.71

Awards forfeited

 

 

 

Not vested at September 30, 2012
399,476

 
17.93

 
712,722

 
5.94

18. Earnings Per Share
We follow the provisions related to the accounting treatment of certain participating securities for the purpose of determining earnings per share. These provisions address share-based payment awards that have not vested and that contain nonforfeitable rights to dividends or dividend equivalents and states that they are participating securities and should be included in the computation of earnings per share pursuant to the two-class method. As discussed in Note 17, Stock-Based Compensation, we granted shares of restricted stock to certain employees and outside directors. Although ownership of these shares does not transfer to the recipients until the shares have vested, recipients have voting and nonforfeitable dividend rights on these shares from the date of grant. Accordingly, we utilize the two-class method to determine our earnings per share.

22

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)


The computation of basic and diluted earnings per share under the two-class method is presented as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per share data)
Basic earnings per common share:
 
 
 
 
 
 
 
Allocation of earnings:
 
 
 
 
 
 
 
Net income
$
6,298

 
$
84,928

 
$
191,298

 
$
197,224

Distributed earnings
(7,274
)
 

 
(14,540
)
 

Income allocated to participating securities

 
(1,533
)
 
(1,974
)
 
(4,193
)
Undistributed income (loss) available to common shareholders
$
(976
)
 
$
83,395

 
$
174,784

 
$
193,031

 
 
 
 
 
 
 
 
Weighted-average number of common shares outstanding:
90,134

 
89,176

 
89,835

 
88,878

Basic earnings per common share:
 
 
 
 
 
 
 
Distributed earnings per share
$
0.08

 
$

 
$
0.16

 
$

Undistributed earnings (loss) per share
(0.01
)
 
0.94

 
1.95

 
2.17

Basic earnings per common share
$
0.07

 
$
0.94

 
$
2.11

 
$
2.17

 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands, except per share data)
Diluted earnings per common share:
 
 
 
 
 
 
 
Net income
$
6,298

 
$
84,928

 
$
191,298

 
$
197,224

Tax effected interest related to convertible debt

 
3,745

 
11,765

 
11,021

Net income available to common stockholders, assuming dilution
$
6,298

 
$
88,673

 
$
203,063

 
$
208,245

 
 
 
 
 
 
 
 
Weighted-average diluted common shares outstanding:
90,134

 
109,935

 
110,412

 
109,733

 
 
 
 
 
 
 
 
Diluted earnings per common share:
$
0.07

 
$
0.81

 
$
1.84

 
$
1.90


The following table reflects potentially dilutive securities that were excluded from the diluted earnings per common share calculation as the effect of including such shares would have been antidilutive:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2012
 
2011
 
2012
 
2011
 
(In thousands)
Common equivalent shares from Convertible Senior Notes
20,119

 

 

 

Restricted stock
513

 

 

 





23

WESTERN REFINING, INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

A shareholder's interest in our common stock could become diluted as a result of vestings of restricted shares and restricted share units and the conversion of our Convertible Senior Notes into actual shares of our common stock. In calculating our fully diluted earnings per common share, we consider the impact of restricted shares and restricted share units that have not vested and common equivalent shares related to our Convertible Senior Notes. We include restricted shares and restricted share units that have not vested in our diluted earnings calculation when the trading price of our common stock equals or exceeds the per share or per share unit grant price. Common equivalent shares from our Convertible Senior Notes are generally included in our diluted earnings calculation when net income exceeds certain thresholds above which the effect of the shares becomes dilutive. We calculate the volume of these shares by applying the current 2012 conversion rate of 93.3790 to each $1,000 of principal amount of Convertible Senior Notes. Prior to 2012, the conversion rate was 92.5926.
The table below summarizes our cash dividends declared and paid through October 26, 2012:
 
2012
 
Declaration Date
 
Record Date
 
Payment Date
 
Dividend per common share
 
Total Payment (in thousands)
First quarter
January 4
 
January 19
 
February 13
 
$
0.04

 
$
3,633

Second quarter