UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
- --- EXCHANGE ACT OF 1934
For the quarterly period ended January 31, 2002
-------------------------
OR
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 1-3876
------
HOLLY CORPORATION
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Delaware 75-1056913
- --------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
100 Crescent Court, Suite 1600
Dallas, Texas 75201-6927
- ---------------------------------------- ------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (214) 871-3555
---------------------------
- --------------------------------------------------------------------------------
Former name, former address and former fiscal year, if changed since last report
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 X No
--- ---
15,580,528 shares of Common Stock, par value $.01 per share, were outstanding on
March 4, 2002.
HOLLY CORPORATION
INDEX
<Table>
<Caption>
Page No.
--------
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheet - (Unaudited)
January 31, 2002 and July 31, 2001 3
Consolidated Statement of Income (Unaudited) -
Three Months and Six Months Ended January 31, 2002 and 2001 4
Consolidated Statement of Cash Flows (Unaudited) -
Six Months Ended January 31, 2002 and 2001 5
Consolidated Statement of Comprehensive Income (Unaudited) -
Three Months and Six Months Ended January 31, 2002 and 2001 6
Notes to Consolidated Financial Statements (Unaudited) 7
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 25
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 6. Exhibits and Reports on Form 8-K 28
Signatures 29
</Table>
This Quarterly Report on Form 10-Q (including documents incorporated by
reference herein) contains statements with respect to the Company's expectations
or beliefs as to future events. These types of statements are "forward-looking"
and are subject to uncertainties. See "Factors Affecting Forward-Looking
Statements" on page 12.
2
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HOLLY CORPORATION
CONSOLIDATED BALANCE SHEET
Unaudited
<Table>
<Caption>
JANUARY 31, JULY 31,
2002 2001
------------ ------------
ASSETS (In thousands)
CURRENT ASSETS
Cash and cash equivalents ................................................................ $ 48,254 $ 65,840
Accounts receivable: Product ............................................................. 40,665 50,364
Crude oil resales ................................................... 62,965 95,710
------------ ------------
103,630 146,074
Inventories: Crude oil and refined products ...................................... 1,868 42,390
Materials and supplies .............................................. 10,049 10,092
Reserve for lower of cost or market ................................. (2,346) (2,346)
------------ ------------
59,571 50,136
Income taxes receivable ................................................................. 11,115 3,514
Prepayments and other .................................................................... 17,788 18,566
------------ ------------
TOTAL CURRENT ASSETS ................................................................ 240,358 284,130
Properties, plants and equipment, at cost ................................................... 397,070 384,783
Less accumulated depreciation, depletion and amortization ................................... (209,551) (200,628)
------------ ------------
187,519 184,155
Investments in and advances to joint ventures ............................................... 14,434 16,303
Other assets ................................................................................ 12,098 5,841
------------ ------------
TOTAL ASSETS ........................................................................ $ 454,409 $ 490,429
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable ......................................................................... $ 140,235 $ 181,182
Accrued liabilities ...................................................................... 30,872 31,985
Income taxes payable ..................................................................... -- 4,661
Current maturities of long-term debt ..................................................... 8,571 8,571
------------ ------------
TOTAL CURRENT LIABILITIES ........................................................... 179,678 226,399
Deferred income taxes ....................................................................... 29,821 28,010
Long-term debt, less current maturities ..................................................... 25,714 34,286
Commitments and contingencies
STOCKHOLDERS' EQUITY
Preferred stock, $1.00 par value - 1,000,000 shares authorized; none issued .............. -- --
Common stock, $.01 par value - 20,000,000 shares authorized;
16,688,596 and 16,580,096 shares issued as of January 31, 2002 and July 31, 2001 ....... 167 166
Additional capital ....................................................................... 13,073 11,568
Retained earnings ........................................................................ 214,750 198,118
------------ ------------
227,990 209,852
Common stock held in treasury, at cost -
1,108,068 and 1,099,468 shares as of January 31, 2002 and July 31, 2001 ................ (7,953) (7,793)
Accumulated other comprehensive income (loss) ............................................ (841) (325)
------------ ------------
TOTAL STOCKHOLDERS' EQUITY .......................................................... 219,196 201,734
------------ ------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY .......................................... $ 454,409 $ 490,429
============ ============
</Table>
See accompanying notes.
3
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF INCOME
Unaudited
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31, JANUARY 31,
----------------------------- -----------------------------
2002 2001 2002 2001
------------ ------------ ------------ ------------
(In thousands, except per share data)
SALES AND OTHER REVENUES ............................ $ 166,754 $ 283,140 $ 424,701 $ 609,103
OPERATING COSTS AND EXPENSES
Cost of products sold ............................ 134,022 224,761 326,006 478,996
Operating expenses ............................... 23,266 25,807 48,012 50,189
Selling, general and administrative expenses ..... 5,228 5,190 10,658 12,163
Depreciation, depletion and amortization ......... 6,714 6,407 13,145 12,959
Exploration expenses, including dry holes ........ 243 599 542 833
------------ ------------ ------------ ------------
TOTAL OPERATING COSTS AND EXPENSES .......... 169,473 262,764 398,363 555,140
------------ ------------ ------------ ------------
INCOME(LOSS) FROM OPERATIONS ........................ (2,719) 20,376 26,338 53,963
OTHER INCOME (EXPENSE)
Equity in earnings of joint ventures ............. 2,320 908 5,068 1,975
Interest income .................................. 365 823 1,047 1,399
Interest expense ................................. (758) (1,342) (1,698) (2,778)
Gain on sale of equity securities ................ -- -- 1,522 --
------------ ------------ ------------ ------------
1,927 389 5,939 596
------------ ------------ ------------ ------------
INCOME(LOSS) BEFORE INCOME TAXES .................... (792) 20,765 32,277 54,559
Income tax provision(benefit)
Current .......................................... (1,407) 7,765 11,290 20,778
Deferred ......................................... 1,100 458 1,250 827
------------ ------------ ------------ ------------
(307) 8,223 12,540 21,605
------------ ------------ ------------ ------------
NET INCOME(LOSS) .................................... $ (485) $ 12,542 $ 19,737 $ 32,954
============ ============ ============ ============
NET INCOME(LOSS) PER COMMON SHARE - BASIC ........... $ (0.03) $ 0.83 $ 1.27 $ 2.18
============ ============ ============ ============
NET INCOME(LOSS) PER COMMON SHARE - DILUTED ......... $ (0.03) $ 0.83 $ 1.24 $ 2.18
============ ============ ============ ============
CASH DIVIDENDS PAID PER COMMON SHARE ................ $ 0.10 $ 0.09 $ 0.20 $ 0.18
============ ============ ============ ============
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic ............................................ 15,559 15,102 15,533 15,102
Diluted .......................................... 15,996 15,140 15,961 15,106
</Table>
See accompanying notes.
4
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Unaudited
<Table>
<Caption>
SIX MONTHS ENDED
JANUARY 31,
-----------------------------
2002 2001
------------ ------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ................................................... $ 19,737 $ 32,954
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization ................. 13,145 12,959
Deferred income taxes .................................... 1,250 827
Dry hole costs and leasehold impairment .................. -- 328
Equity in earnings of joint ventures ..................... (5,068) (1,975)
(Increase) decrease in current assets
Accounts receivable .................................... 42,014 42,186
Inventories ............................................ (9,435) (6,246)
Income taxes receivable ................................ (7,601) (2,629)
Prepayments and other .................................. 725 714
Increase (decrease) in current liabilities
Accounts payable ....................................... (40,947) (25,184)
Accrued liabilities .................................... (430) 1,945
Income taxes payable ................................... (4,661) (5,092)
Turnaround expenditures .................................. (13,909) (977)
Other, net ............................................... (1,292) 306
------------ ------------
NET CASH PROVIDED BY (USED FOR) OPERATING activities .... (6,472) 50,116
CASH FLOWS FROM FINANCING ACTIVITIES
Payment of long-term debt .................................... (8,572) (8,571)
Debt issuance costs .......................................... -- (100)
Issuance of common stock upon exercise of options ............ 1,506 --
Purchase of treasury stock ................................... (160) --
Cash dividends ............................................... (3,105) (2,718)
------------ ------------
NET CASH USED FOR FINANCING ACTIVITIES .................. (10,331) (11,389)
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to properties, plants and equipment ................ (12,683) (14,875)
Investments and advances to joint ventures ................... -- (1,049)
Distributions from joint ventures ............................ 7,400 2,100
Proceeds from sale of marketable equity securities ........... 4,500 --
------------ ------------
NET CASH USED FOR INVESTING ACTIVITIES .................. (783) (13,824)
------------ ------------
CASH AND CASH EQUIVALENTS
INCREASE (DECREASE) FOR THE PERIOD ........................... (17,586) 24,903
Beginning of year ............................................ 65,840 3,628
------------ ------------
END OF PERIOD ................................................ $ 48,254 $ 28,531
============ ============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during period for
Interest ................................................ $ 2,143 $ 2,970
Income taxes ............................................ $ 11,919 $ 28,404
</Table>
See accompanying notes.
5
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Unaudited
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31, JANUARY 31,
---------------------- ----------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands)
NET INCOME (LOSS) ............................................................ $ (485) $ 12,542 $ 19,737 $ 32,954
Other comprehensive income (loss)
Unrealized loss on securities available for sale .......................... -- (116) -- (1,972)
Reclassification adjustment to net income on sale of equity securities .... -- -- (1,522) --
Derivative instruments qualifying as cash flow hedging instruments
Change in fair value of derivative instruments ......................... (604) -- (1,406) --
Reclassification adjustment into net income ............................ 1,003 -- 2,087 --
--------- --------- --------- ---------
Total income on cash flow hedges .......................................... 399 -- 681 --
--------- --------- --------- ---------
Other comprehensive income (loss) before income taxes ...................... 399 (116) (841) (1,972)
Income tax expense (benefit) .............................................. 170 (46) (325) (786)
--------- --------- --------- ---------
Other comprehensive income (loss) ............................................ 229 (70) (516) (1,186)
--------- --------- --------- ---------
TOTAL COMPREHENSIVE INCOME (loss) ............................................ $ (256) $ 12,472 $ 19,221 $ 31,768
========= ========= ========= =========
</Table>
See accompanying notes.
6
HOLLY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note A - Presentation of Financial Statements
In the opinion of the Company, the accompanying consolidated financial
statements, which have not been audited by independent accountants, reflect all
adjustments (consisting only of normal recurring adjustments) necessary to
present fairly the Company's consolidated financial position as of January 31,
2002, the consolidated results of operations and comprehensive income for the
three months and six months ended January 31, 2002 and 2001, and consolidated
cash flows for the six months ended January 31, 2002 and 2001.
Certain notes and other information have been condensed or omitted.
Therefore, these financial statements should be read in conjunction with the
consolidated financial statements and related notes included in the Company's
Annual Report on Form 10-K for the fiscal year ended July 31, 2001.
References herein to the "Company" are for convenience of presentation
and may include obligations, commitments or contingencies that pertain solely to
one or more affiliates of the Company. Results of operations for the first six
months of fiscal 2002 are not necessarily indicative of the results to be
expected for the full year.
Note B - New Accounting Pronouncements
In June 2001, FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement changes how goodwill and other intangible assets are
accounted for subsequent to their initial recognition. SFAS No. 142 is effective
for fiscal years beginning after December 15, 2001, with early adoption
permitted; however all goodwill and intangible assets acquired after June 30,
2001 will be subject immediately to the provisions of this statement. The
Company has not completed evaluating the effects this statement will have on its
financial reporting and disclosures.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement requires that the fair value for an
asset retirement obligation be capitalized as part of the carrying amount of the
long-lived asset if a reasonable estimate of fair value can be made. SFAS No.
143 is effective for fiscal years beginning after June 15, 2002, with early
adoption permitted. The Company has not completed evaluating the effects this
statement will have on its financial reporting and disclosures.
In August 2001, FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of", but carries over the key
7
HOLLY CORPORATION
guidance from SFAS No. 121 in establishing the framework for the recognition and
measurement of long-lived assets to be disposed of by sale and addresses
significant implementation issues. SFAS No. 144 is effective for fiscal years
beginning after December 15, 2001, with early adoption permitted. The Company
has not completed evaluating the effects this statement will have on its
financial reporting and disclosures.
Note C - Earnings Per Share
Basic income per share is calculated as net income divided by average
number of shares of common stock outstanding. Diluted income per share assumes,
when dilutive, issuance of the net incremental shares from stock options. Income
per share amounts reflect the two-for one stock split in July 2001. The
following is a reconciliation of the numerators and denominators of the basic
and diluted per share computations for net income:
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31, JANUARY 31,
-------------------------- -------------------------
2002 2001 2002 2001
---------- ---------- ---------- ----------
(In thousands, except share data)
Net income (loss) ........................................ $ (485) $ 12,542 $ 19,737 $ 32,954
Average number of shares of common stock outstanding ..... 15,559 15,102 15,533 15,102
Effect of dilutive stock options ......................... 437 38 428 4
---------- ---------- ---------- ----------
Average number of shares of common stock
outstanding assuming dilution .................... 15,996 15,140 15,961 15,106
========== ========== ========== ==========
Income (loss)per share - basic ........................... $ (0.03) $ 0.83 $ 1.27 $ 2.18
========== ========== ========== ==========
Income (loss)per share - diluted ......................... $ (0.03) $ 0.83 $ 1.24 $ 2.18
========== ========== ========== ==========
</Table>
Note D - Stockholders' Equity
On October 30, 2001, the Company announced plans to repurchase up to
$20 million of the Company's common stock. Such repurchases are expected to be
made from time to time in open market purchases or privately negotiated
transactions, subject to price and availability. The repurchases will be
financed with currently available corporate funds. An amendment to the Company's
Credit Agreement was made to allow for the repurchases. During the six months
ended January 31, 2002, the Company repurchased 8,600 shares at a cost of
approximately $160,000.
8
HOLLY CORPORATION
Note E - Derivative Instruments and Hedging Activities
During the quarter ended April 30, 2001, the Company entered into
commodity price swaps and collar options to help manage the exposure to price
volatility relating to forecasted purchases of natural gas from May 2001 to May
2002. These transactions were designated as cash flow hedges of forecasted
purchases. The values of the outstanding hedges were marked to the current fair
value as of January 31, 2002 and a resulting income of $681,000 is included in
first six months of fiscal 2002 comprehensive income. The accumulated loss
included in comprehensive income is $1.38 million. Gains (losses) on the natural
gas hedges will be reclassified from comprehensive income to operating expenses
through May 2002 when the forecasted transactions impact earnings.
Note F - Segment Information
The Company has two major business segments: Refining and Pipeline
Transportation. The Refining segment is engaged in the refining of crude oil and
wholesale marketing of refined products, such as gasoline, diesel fuel and jet
fuel, and includes the Company's Navajo Refinery and Montana Refinery. The
petroleum products produced by the Refining segment are marketed in the
southwestern United States, Montana and northern Mexico. Certain pipelines and
terminals operate in conjunction with the Refining segment as part of the supply
and distribution networks of the refineries. The Refining segment also includes
the equity earnings from the Company's 50% interest in NK Asphalt Partners,
which manufactures and markets asphalt and asphalt products in Arizona and New
Mexico. The Pipeline Transportation segment includes approximately 1,000 miles
of the Company's pipeline assets in Texas and New Mexico. Revenues from the
Pipeline Transportation segment are earned through transactions with
unaffiliated parties for pipeline transportation, rental and terminalling
operations. The Pipeline Transportation segment also includes the equity
earnings from the Company's 25% interest in Rio Grande Pipeline Company, which
provides petroleum products transportation. Operations of the Company that are
not included in the two reportable segments are included in Corporate and Other,
which includes costs of Holly Corporation, the parent company, consisting
primarily of general and administrative expenses and interest charges, as well
as a small-scale oil and gas exploration and production program, and a small
equity investment in retail gasoline stations and convenience stores.
The accounting policies for the segments are the same as those
described in the summary of significant accounting policies in the Company's
Annual Report on Form 10-K for the year ended July 31, 2001. The Company's
reportable segments are strategic business units that offer different products
and services.
9
HOLLY CORPORATION
<Table>
<Caption>
TOTAL FOR
PIPELINE REPORTABLE CORPORATE CONSOLIDATED
REFINING TRANSPORTATION SEGMENTS & OTHER TOTAL
--------- -------------- ---------- --------- ------------
(In thousands)
THREE MONTHS ENDED JANUARY 31, 2002
Sales and other revenues ....................... $ 161,863 $ 4,536 $ 166,399 $ 355 $ 166,754
EBITDA(1) ...................................... $ 5,136 $ 3,211 $ 8,347 $ (2,032) $ 6,315
Income (loss) from operations .................. $ (3,028) $ 2,504 $ (524) $ (2,195) $ (2,719)
Income (loss) before income taxes............... $ (1,093) $ 2,850 $ 1,757 $ (2,549) $ (792)
THREE MONTHS ENDED JANUARY 31, 2001
Sales and other revenues ....................... $ 277,394 $ 4,902 $ 282,296 $ 844 $ 283,140
EBITDA(1) ...................................... $ 25,582 $ 3,958 $ 29,540 $ (1,849) $ 27,691
Income (loss) from operations .................. $ 19,531 $ 2,834 $ 22,365 $ (1,989) $ 20,376
Income (loss) before income taxes............... $ 19,473 $ 3,576 $ 23,049 $ (2,284) $ 20,765
SIX MONTHS ENDED JANUARY 31, 2002
Sales and other revenues ....................... $ 414,675 $ 9,101 $ 423,776 $ 925 $ 424,701
EBITDA(1) ...................................... $ 42,215 $ 6,327 $ 48,542 $ (2,469) $ 46,073
Income (loss) from operations .................. $ 25,737 $ 4,986 $ 30,723 $ (4,385) $ 26,338
Income (loss) before income taxes............... $ 30,003 $ 5,617 $ 35,620 $ (3,343) $ 32,277
SIX MONTHS ENDED JANUARY 31, 2001
Sales and other revenues ....................... $ 597,747 $ 9,549 $ 607,296 $ 1,807 $ 609,103
EBITDA(1) ...................................... $ 65,587 $ 7,358 $ 72,945 $ (4,048) $ 68,897
Income (loss) from operations .................. $ 52,685 $ 5,654 $ 58,339 $ (4,376) $ 53,963
Income (loss) before income taxes............... $ 53,239 $ 6,605 $ 59,844 $ (5,285) $ 54,559
</Table>
(1) Earnings Before Interest, Taxes, Depreciation and Amortization.
Note G - Contingencies
In August 1998, a lawsuit (the "Longhorn Suit") was filed in state
district court in El Paso, Texas against the Company and two of its subsidiaries
(along with an Austin, Texas law firm which was subsequently dropped from the
case). The suit was filed by Longhorn Partners Pipeline, L.P. ("Longhorn
Partners"), a Delaware limited partnership composed of Longhorn Partners GP,
L.L.C. as general partner and affiliates of Exxon Pipeline Company, BP/Amoco
Pipeline Company, Williams Pipeline Company, and the Beacon Group Energy
Investment Fund, L.P. and Chisholm Holdings as limited partners. The suit, as
most recently amended by Longhorn Partners in September 2000, seeks damages
alleged to total up to $1,050,000,000 (after trebling) based on claims of
violations of the Texas Free Enterprise and Antitrust Act, unlawful interference
with existing and prospective contractual relations, and conspiracy to abuse
process. The specific actions of the Company complained of in the Longhorn Suit,
as currently amended, are alleged solicitation of and support for allegedly
baseless lawsuits brought by Texas ranchers in federal and state courts to
challenge the proposed Longhorn Pipeline project, support of allegedly
10
HOLLY CORPORATION
fraudulent public relations activities against the proposed Longhorn Pipeline
project, entry into a contractual "alliance" with Fina Oil and Chemical Company,
threatening litigation against certain partners in Longhorn Partners, and
alleged interference with the federal court settlement agreement that provided
for an Environmental Assessment of the Longhorn Pipeline. A hearing on the
Company's amended motion for summary judgment, which seeks a court ruling that
would terminate this litigation, was held January 3, 2001; as of the date of
this report, the court has not issued a ruling with respect to this motion. The
Company believes that the Longhorn Suit is wholly without merit and plans to
continue to defend itself vigorously. The Company also plans to pursue at the
appropriate time any affirmative remedies that may be available to it relating
to the Longhorn Suit.
11
HOLLY CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
FACTORS AFFECTING FORWARD-LOOKING STATEMENTS
This Quarterly Report on Form 10-Q contains certain "forward-looking
statements" within the meaning of the U.S. Private Securities Litigation Reform
Act of 1995. All statements, other than statements of historical facts included
in this Form 10-Q, including without limitation those under "Results of
Operations," "Liquidity and Capital Resources" and "Additional Factors that May
Affect Future Results" (including "Risk Management") under this Item 2 regarding
the Company's financial position and results of operations and those in Item 1
"Legal Proceedings" in Part II, are forward-looking statements. Such statements
are subject to risks and uncertainties, including but not limited to risks and
uncertainties with respect to the actions of actual or potential competitive
suppliers of refined petroleum products in the Company's markets, the demand for
and supply of crude oil and refined products, the spread between market prices
for refined products and market prices for crude oil, the possibility of
constraints on the transportation of refined products, the possibility of
inefficiencies or shutdowns in refinery operations or pipelines, effects of
governmental regulations and policies, the availability and cost of financing to
the Company, the effectiveness of the Company's capital investments and
marketing strategies, the Company's efficiency in carrying out construction
projects, the costs of defense and the risk of an adverse decision in the
Longhorn Pipeline litigation, and general economic conditions. Should one or
more of these risks or uncertainties, among others as set forth in this Form
10-Q, materialize, actual results may vary materially from those estimated,
anticipated or projected. Although the Company believes that the expectations
reflected by such forward-looking statements are reasonable based on information
currently available to the Company, no assurances can be given that such
expectations will prove to have been correct. This summary discussion of risks
and uncertainties that may cause actual results to differ from those indicated
in forward-looking statements should be read in conjunction with the discussion
under the heading "Additional Factors That May Affect Future Results" included
in Item 7 of the Company's Annual Report on Form 10-K for the fiscal year ended
July 31, 2001 and in conjunction with the discussion below under the headings
"Liquidity and Capital Resources" and "Additional Factors That May Affect Future
Results." All forward-looking statements included in this Quarterly Report on
Form 10-Q and all subsequent oral forward-looking statements attributable to the
Company or persons acting on its behalf are expressly qualified in their
entirety by the cautionary statements set forth above.
12
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
RESULTS OF OPERATIONS
FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31, JANUARY 31,
------------------------ ------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
(In thousands, except share data)
Sales and other revenues ............................. $ 166,754 $ 283,140 $ 424,701 $ 609,103
Operating costs and expenses
Cost of products sold ............................. 134,022 224,761 326,006 478,996
Operating expenses ................................ 23,266 25,807 48,012 50,189
Selling, general and administrative expenses ...... 5,228 5,190 10,658 12,163
Depreciation, depletion and amortization .......... 6,714 6,407 13,145 12,959
Exploration expenses, including dry holes ......... 243 599 542 833
--------- --------- --------- ---------
Total operating costs and expenses ........... 169,473 262,764 398,363 555,140
--------- --------- --------- ---------
Income(loss) from operations ......................... (2,719) 20,376 26,338 53,963
Other income (expense)
Equity in earnings of joint ventures .............. 2,320 908 5,068 1,975
Interest expense, net ............................. (393) (519) (651) (1,379)
Gain on sale of equity securities ................. -- -- 1,522 --
--------- --------- --------- ---------
1,927 389 5,939 596
--------- --------- --------- ---------
Income(loss) before income taxes ..................... (792) 20,765 32,277 54,559
Income tax provision(benefit) ........................ (307) 8,223 12,540 21,605
--------- --------- --------- ---------
Net income(loss) ..................................... $ (485) $ 12,542 $ 19,737 $ 32,954
========= ========= ========= =========
Net income(loss) per common share - basic(1) ......... $ (0.03) $ 0.83 $ 1.27 $ 2.18
Net income(loss) per common share - diluted(1) ....... $ (0.03) $ 0.83 $ 1.24 $ 2.18
Average number of common shares outstanding(1):
Basic .............................................. 15,559 15,102 15,533 15,102
Diluted ............................................ 15,996 15,140 15,961 15,106
Sales and other revenues(2)
Refining .......................................... $ 161,863 $ 277,394 $ 414,675 $ 597,747
Pipeline Transportation ........................... 4,536 4,902 9,101 9,549
Corporate and Other ............................... 355 844 925 1,807
--------- --------- --------- ---------
Consolidated ...................................... $ 166,754 $ 283,140 $ 424,701 $ 609,103
========= ========= ========= =========
Income (loss) from operations(2)
Refining .......................................... $ (3,028) $ 19,531 $ 25,737 $ 52,685
Pipeline Transportation ........................... 2,504 2,834 4,986 5,654
Corporate and Other ............................... (2,195) (1,989) (4,385) (4,376)
--------- --------- --------- ---------
Consolidated ...................................... $ (2,719) $ 20,376 $ 26,338 $ 53,963
========= ========= ========= =========
</Table>
13
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
1) A two-for-one stock split was affected in July 2001. All references to
the number of shares and per share amounts have been adjusted to reflect
the split on a retroactive basis.
2) The Refining segment includes the Company's principal refinery in
Artesia, New Mexico, which is operated in conjunction with refining
facilities in Lovington, New Mexico (collectively, the Navajo Refinery) and
the Company's refinery near Great Falls, Montana. Included in the Refining
Segment are costs relating to pipelines and terminals that operate in
conjunction with the Refining segment as part of the supply and
distribution networks of the refineries. The Pipeline Transportation
segment includes approximately 1,000 miles of the Company's pipeline assets
in Texas and New Mexico. Revenues from the Pipeline Transportation segment
are earned through transactions with unaffiliated parties for pipeline
transportation, rental and terminalling operations.
REFINING SEGMENT OPERATING DATA (Unaudited)
<Table>
<Caption>
THREE MONTHS ENDED SIX MONTHS ENDED
JANUARY 31, JANUARY 31,
--------------------------- ---------------------------
2002 2001 2002 2001
----------- ----------- ----------- -----------
Crude charge (BPD)(1) ...................... 52,000 66,900 56,100 67,500
Average per barrel(2)
Refinery margin .......................... $ 5.02 $ 7.90 $ 7.36 $ 8.83
Cash operating costs(3) .................. 4.73 4.17 4.45 4.04
----------- ----------- ----------- -----------
Net cash operating margin ................ $ 0.29 $ 3.73 $ 2.91 $ 4.79
=========== =========== =========== ===========
Sales of produced refined products
Gasolines ................................ 59.0% 58.6% 55.5% 55.9%
Diesel fuels ............................. 20.8 22.8 21.1 22.9
Jet fuels ................................ 11.1 10.1 10.6 10.4
Asphalt .................................. 5.8 5.2 9.4 7.5
LPG and other ............................ 3.3 3.3 3.4 3.3
----------- ----------- ----------- -----------
Total ............................... 100.0% 100.0% 100.0% 100.0%
=========== =========== =========== ===========
</Table>
- ----------
(1) Barrels per day of crude oil processed.
(2) Represents average per barrel amounts for produced refined products
sold.
(3) Includes operating costs and selling, general and administrative
expenses of refineries, as well as pipeline expenses that are part of
refinery operations.
14
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
RESULTS OF OPERATIONS - THREE MONTHS AND SIX MONTHS ENDED JANUARY 31, 2002
COMPARED WITH THREE MONTHS AND SIX MONTHS ENDED JANUARY 31, 2001
Summary
The Company incurred a net loss for the three months ended January 31,
2002 of $485 thousand (($.03) per basic and diluted share) compared to net
income of $12.5 million ($.83 per basic and diluted share) for the three months
ended January 31, 2001. For the six months ended January 31, 2002, net income
was $19.7 million ($1.27 per basic share or $1.24 per diluted share) compared to
$33.0 million ($2.18 per basic and diluted share) for the six months ended
January 31, 2001.The fiscal 2002 second quarter loss and lower earnings for the
six months ended January 31, 2002, as compared to the prior year periods, were
primarily the result of significantly lower refined product margins and lower
refined product sales volumes due to a major maintenance turnaround at the
Artesia and Lovington facilities during the second quarter of fiscal 2002.
Three Months Ended January 31, 2002 Compared with Three Months Ended January 31,
2001
For the second quarter of fiscal 2002, the Company experienced a net
loss of $485 thousand. During the quarter, the Company, and the refining
industry, saw significant declines in refining margins, especially significant
when compared to the very favorable refining margins that resulted in net income
of $12.5 million for the second quarter of fiscal 2001.
Revenues from the sale of refined products decreased to $161.9 million
in the second quarter of fiscal 2002 from $277.4 million in the second quarter
of fiscal 2001. The Company's average product sales prices decreased 35% to
$25.63 per barrel in the second quarter of fiscal 2002 from $39.26 per barrel in
the second quarter of fiscal 2001. Total product sales averaged 68,600 barrels
per day ("BPD") for the quarter ended January 2002, a decrease of 10% from the
quarter ended January 2001. Production of refined products in the quarter ended
January 2002 was reduced as a result of the extended 29-day planned maintenance
turnaround that involved a number of process units at the Artesia and Lovington
facilities.
Cost of sales for the second quarter of fiscal 2002 as compared to the
same quarter of fiscal 2001 declined by $91 million primarily reflecting lower
costs for purchased crude oil and lower production volumes due to the
maintenance turnaround in fiscal 2002. Operating expenses decreased 10% to $23.3
million in the second quarter of fiscal 2002 from $25.8 million in the second
quarter of fiscal 2001, principally due to lower costs for purchased utilities
in the second quarter of fiscal 2002. Other income improved in the second
quarter of fiscal 2002, as compared to the prior year's fiscal quarter, as the
Company realized additional revenues from the Company's share of earnings in an
asphalt joint venture formed in July 2000 with a subsidiary of Koch Industries,
Inc.
15
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Six Months Ended January 31, 2002 Compared with Six Months Ended January 31,
2001
Net income for the six months ended January 31, 2002 was $19.7 million
compared to $33.0 million for the six months ended January 31, 2001. Although
the Company's refinery margins in the first quarter of fiscal 2002 were only
slightly lower than the margins in the first quarter of fiscal 2001, the margins
in the second quarter of fiscal 2002 declined significantly compared to the
second quarter of fiscal 2001.
Revenues from the sale of refined products decreased to $414.7 million
in the six months of fiscal 2002 from $597.8 million in the six months of fiscal
2001. The Company's average product sales prices decreased 25% to $30.96 per
barrel for the first six months of fiscal 2002 from $41.19 per barrel for the
first six months of fiscal 2001. Total product sales averaged 73,500 BPD for the
six months ended January 2002, a decrease of 7% from the six months ended
January 2001.
The decrease in cost of sales for the six months ended January 31, 2002
as compared to the prior year's six-month period reflected lower costs for
purchased crude oil. Production of refined products was reduced during the six
months ended January 31, 2002 as a result of two planned maintenance
turnarounds. In August 2001, maintenance was performed on the Artesia crude
distillation unit. In late November and December 2001, a 29-day extended
maintenance turnaround that involved a number of process units at the Artesia
and Lovington facilities was performed. Operating expenses decreased 4%, to
$48.0 million for the first six months of fiscal 2002 from $50.2 million for the
first six months of fiscal 2001, principally as a result of lower costs for
purchased utilities.
Lower general and administrative expenses in the first six months of
fiscal 2002 were due to decreased costs associated with legal proceedings and
decreased compensation expense. Other income improved in the second quarter of
fiscal 2002, as compared to the prior year's fiscal quarter, as the Company
realized additional revenues from the Company's share of earnings in an asphalt
joint venture formed in July 2000 with a subsidiary of Koch Industries, Inc. In
the first quarter of fiscal 2002, the Company also realized a $1.5 million gain
on the sale of marketable equity securities held for investment.
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $17.6 million to $48.3 million
during the six months ended January 31, 2002. The negative cash flow from
operating activities, combined with cash required for investing activities,
scheduled debt repayment and dividends paid resulted in the cash decrease.
Working capital increased during the six months ended January 31, 2002 by $2.9
million to $60.7 million.
16
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
In April 2001, the Company entered into an agreement with a group of
banks led by Canadian Imperial Bank of Commerce to extend its Revolving Credit
Agreement. The expiration date of the Credit Agreement will be October 10, 2003
if there is a satisfactory resolution in the Longhorn Partners Pipeline lawsuit
prior to October 10, 2002 and the expiration date will be October 10, 2002 if
there is not such a satisfactory resolution by that date. Under the current
agreement, the Company has access to $90 million of commitments for both
revolving credit loans and letters of credit. Up to $45 million of this facility
may be used for revolving credit loans. At January 31, 2002, the Company had
letters of credit for $5.5 million outstanding under the facility and had no
borrowings outstanding under the facility.
On October 30, 2001, the Company announced plans to repurchase up to
$20 million of the Company's common stock. Such repurchases are expected to be
made from time to time in open market purchases or privately negotiated
transactions, subject to price and availability. An amendment to the Company's
Credit Agreement was made to allow for the repurchases. As of January 31, 2002,
8,600 shares had been repurchased for approximately $160,000. The Company
believes its internally generated cash flow, along with its Credit Agreement,
provides sufficient resources to fund planned capital projects, scheduled
repayments of the Senior Notes, planned stock repurchases, continued payment of
dividends (although dividend payments must be approved by the Board of Directors
and cannot be guaranteed) and the Company's liquidity needs.
In May 2000, the Company began implementing a cost reduction and
production efficiency program. By July 31, 2002, approximately $20 million of
annual pre-tax improvements should be in place. The cost reduction and
production efficiency program included productivity enhancements and a reduction
in workforce. As part of the implementation of cost reductions, the Company
offered a voluntary early retirement program to eligible employees under which
55 employees retired in fiscal 2001. The pre-tax cost of the voluntary early
retirement program was $6.8 million and was reflected in the Company's earnings
for the quarter ended July 31, 2000. Estimated capital expenditures of
approximately $8 million were included in the capital budgets for fiscal 2001
and 2002 to effectuate some of the production improvements.
Cash Flows from Operating Activities
Cash flows used in operating activities for the first six months of
fiscal 2002 were $6.5 million. For the comparable six month period of fiscal
2001, cash provided by operating activities was $50.1 million. The $56.6 million
decrease in cash provided by operations for the first six months of fiscal 2002
as compared to the first six months of fiscal 2001 was primarily the result of a
$13.2 million decrease in net income, a $12.9 million increase in expenditures
on turnarounds and the effect of changes in working capital. In the first six
months of fiscal 2002, changes in working capital used $20.3 million as compared
to fiscal 2001 when changes in working capital in the comparable period provided
$5.7 million. In the second quarter of fiscal 2002, $12.3 million of required
estimated income tax payments were made and inventories increased by $9 million.
17
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Cash Flows from Financing Activities
Cash flows used for financing activities were $10.3 million in the six
months ended January 2002, as compared to $11.4 million in the same period of
the prior year. Cash flows used for financing activities in the six months of
both fiscal years consisted principally of $3.1 million and $2.7 million
respectively of dividends paid to shareholders and, in each six month period,
repayment of $8.6 million of the Company's fixed rate term debt. In the first
six months of fiscal 2002, the Company received cash of $1.5 million from the
issuance of common stock upon exercise of options. The Company has not made any
bank borrowings during the current fiscal year. The next principal payment of
$8.6 million on the Company's Senior Notes is due in December 2002.
Cash Flows Used for Investing Activities
Cash flows used for investing activities were $0.8 million for the
first six months of fiscal 2002, as compared to $13.8 million for the same
period of the 2001 fiscal year. Cash expenditures on capital projects in the
first six months of the current and prior fiscal years were $12.7 million and
$14.9 million respectively. The Company's net cash flow used for investing
activities was reduced during the first six months of fiscal 2002 by a $1.9
million distribution to the Company from the Rio Grande Pipeline joint venture,
a $5.5 million distribution to the Company from the asphalt joint venture and by
$4.5 million of proceeds from the sale of marketable equity securities held for
investment.
In recent years, the Company has invested significant amounts in
capital expenditures to enhance the Navajo Refinery and expand its supply and
distributions network. For the 2002 fiscal year, the capital budget of Navajo
Refinery, including its supply and distribution network, totals approximately
$34 million. The components of this budget are $10 million for refinery
improvements, $20 million for costs to complete the hydrotreater project
described below, and $4 million for refinery-related pipeline and transportation
projects. In addition to these projects, the Company plans to expend in the 2002
fiscal year approximately $10 million on projects, principally for refinery
improvements, that were approved in previous capital budgets.
In December 2001, the Company received the necessary permitting for the
construction of a new gas oil hydrotreating unit at Navajo's Artesia, New Mexico
refining facility. In November 1997, a hydrotreating unit was purchased from a
closed refinery. The purchase gave the Company the ability to reconstruct the
unit at a substantial savings relative to the purchase cost of a new unit. The
hydrotreater will enhance higher value light products yields and expand the
Company's ability to meet California Air Resources Board ("CARB") standards,
which have been adopted in the Company's Phoenix market for winter months
beginning in the latter part of 2000, and to meet the recently proposed EPA
nationwide Low-Sulfur Gasoline requirements scheduled to become effective in
2004. Based on the current configuration of the Navajo Refinery, the Company can
18
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
supply current sales volumes for the Phoenix market under the CARB standards
prior to completion of the hydrotreater. Additionally, in fiscal 2001, the
Company completed the construction of a new sulfur recovery unit, which is
currently utilized to enhance sour crude processing capabilities and will
recover additional extracted sulfur when the hydrotreater is completed.
In December 2001, the Company also received the necessary permitting to
expand the crude refining capacity at the Artesia facility from 60,000 BPD to
70,000 BPD. Contemporaneous with completion of the hydrotreater project, the
refinery will be making necessary modifications to several processing units that
will increase crude oil refining capacity. The total cost of the gas oil
hydrotreater project and the expansion of the Navajo Refinery to 70,000 BPD is
currently estimated to be approximately $48 million, including approximately $15
million that has already been spent on engineering and the purchase and
relocation of equipment. The Company currently expects that the hydrotreater
project and the first phase of the expansion will be completed by the end of
2003. Certain additional permits will be required to implement needed
modifications at the Company's Lovington refinery which is operated in
conjunction with the Artesia facility. It is envisioned that these necessary
modifications to the Lovington facility would also be completed by the end of
2003. The permits received would also permit a second phase expansion of
Navajo's crude oil capacity from 70,000 to 80,000 BPD but a schedule for such
additional expansion has not been determined.
The Company has leased from Mid-America Pipeline Company more than 300
miles of 8" pipeline running from Chavez County to San Juan County, New Mexico
(the "Leased Pipeline"). The Company has completed a 12" pipeline from the
Navajo Refinery to the Leased Pipeline as well as terminalling facilities in
Bloomfield, New Mexico, which is located in the northwest corner of New Mexico,
and in Moriarty, which is 40 miles east of Albuquerque. Transportation of
petroleum products to markets in northwest New Mexico and diesel fuels to
Moriarty began in the last months of calendar 1999. In December 2001, the
Company completed its expansion of the Moriarty terminal and its pumping
capacity on the Leased Pipeline. The terminal expansion included the addition of
gasoline and jet fuel to the existing diesel fuel delivery capabilities, thus
permitting the Company to provide a full slate of light products to the growing
Albuquerque and Santa Fe, New Mexico areas. The enhanced pumping capabilities on
the Company's pipeline extending from the Artesia refinery through Moriarty to
Bloomfield will permit the Company to deliver a total of over 45,000 BPD of
light products to these locations. If needed, the addition of pump stations
could further increase the pipeline's capabilities in the future.
ADDITIONAL FACTORS THAT MAY AFFECT FUTURE RESULTS
This discussion should be read in conjunction with the discussion under
the heading "Additional Factors That May Affect Future Results" included in Item
7 of the Company's Annual Report on Form 10-K for the fiscal year ended July 31,
2001.
19
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
The proposed Longhorn Pipeline is an additional potential source of
pipeline transportation of refined products from Gulf Coast refineries to El
Paso. This pipeline is proposed to run approximately 700 miles from the Houston
area of the Gulf Coast to El Paso, utilizing a direct route. The owner of the
Longhorn Pipeline, Longhorn Partners Pipeline, L.P. ("Longhorn Partners"), is a
Delaware limited partnership that includes affiliates of Exxon Pipeline Company,
BP/Amoco Pipeline Company, Williams Pipeline Company, and the Beacon Group
Energy Investment Fund, L.P. and Chisholm Holdings as limited partners. Longhorn
Partners has proposed to use the pipeline initially to transport approximately
72,000 BPD of refined products from the Gulf Coast to El Paso and markets served
from El Paso, with an ultimate maximum capacity of 225,000 BPD. A critical
feature of this proposed petroleum products pipeline is that it would utilize,
for approximately 450 miles (including areas overlying the environmentally
sensitive Edwards Aquifer and Edwards-Trinity Aquifer and heavily populated
areas in the southern part of Austin, Texas) an existing pipeline (previously
owned by Exxon Pipeline Company) that was constructed in about 1950 for the
shipment of crude oil from West Texas to the Houston area.
The Longhorn Pipeline is not currently operating because of a federal
court injunction in August 1998 and a settlement agreement, accompanied by an
agreed court order, in March 1999 entered into by Longhorn Partners, the United
States Environmental Protection Agency ("EPA") and Department of Transportation
("DOT"), and the other parties to the federal lawsuit that had resulted in the
injunction and settlement. Additionally, the Longhorn Pipeline is not operating
because it lacks valid easements from the Texas General Land Office for crossing
certain stream and river beds and state-owned lands; the Texas Land Commissioner
has indicated that these easements will not be granted until he is satisfied
that the pipeline meets safety and other standards.
The March 1999 settlement agreement in the federal lawsuit that
resulted in the injunction against operation of the Longhorn Pipeline required
the preparation of an Environmental Assessment under the authority of the EPA
and the DOT while the federal court retained jurisdiction. A final Environmental
Assessment (the "Final EA") on the Longhorn Pipeline was released in November
2000. The Final EA is accompanied by a Finding of No Significant Impact that is
conditioned on the implementation by Longhorn Partners of a proposed mitigation
plan developed by Longhorn Partners which contains 40 mitigation measures,
including the replacement of approximately 19 miles of pipe in the Austin area
with new thick-walled pipe protected by a concrete barrier. Some elements of the
proposed mitigation plan are required to be completed before the Longhorn
Pipeline is allowed to operate, with the remainder required to be completed
later or to be implemented for as long as operations continue. The plaintiffs in
the federal court lawsuit that resulted in the Environmental Assessment of the
Longhorn Pipeline have challenged the Final EA in further federal court
proceedings that began in January 2001. In May
20
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
2001, one of the intervenor plaintiffs in the federal court lawsuit, the Lower
Colorado River Authority ("LCRA"), entered into a settlement agreement with
Longhorn Partners under the terms of which Longhorn Partners agreed to implement
specified additional mitigation measures relating to water supplies in certain
areas of Central Texas and the LCRA agreed to dismiss with prejudice its
participation as an intervenor in the federal court lawsuit; dismissal of the
LCRA's claims pursuant to this settlement was approved by the federal court in
March 2002. In December 2001, Longhorn Partners began construction on certain
pipeline improvements in the Austin, Texas area prior to a ruling by the federal
court on the pending legal challenges to the Final EA. At the date of this
report, it is not possible to predict the outcome of legal challenges to the
Longhorn Pipeline.
If the Longhorn Pipeline is allowed to operate as currently proposed,
the substantially lower requirement for capital investment permitted by the
direct route through Austin, Texas and over the Edwards Aquifers would permit
Longhorn Partners to give its shippers a cost advantage through lower tariffs
that could, at least for a period, result in significant downward pressure on
wholesale refined products prices and refined products margins in El Paso and
related markets. Although some current suppliers in the market might not compete
in such a climate, the Company's analyses indicate that, because of location,
recent capital improvements, and on-going enhancements to operational
efficiency, the Company's position in El Paso and markets served from El Paso
could withstand such a period of lower prices and margins. However, the
Company's results of operations could be adversely impacted if the Longhorn
Pipeline were allowed to operate as currently proposed. It is not possible to
predict whether and, if so, under what conditions, the Longhorn Pipeline
ultimately will be allowed to operate, nor is it possible to predict the
consequences for the Company of Longhorn Pipeline's operations if they occur.
In August 1998, a lawsuit (the "Longhorn Suit") was filed by Longhorn
Partners in state district court in El Paso, Texas against the Company and two
of its subsidiaries (along with an Austin, Texas law firm which was subsequently
dropped from the case). The suit, as most recently amended by Longhorn Partners
in September 2000, seeks damages alleged to total up to $1,050,000,000 (after
trebling) based on claims of violations of the Texas Free Enterprise and
Antitrust Act, unlawful interference with existing and prospective contractual
relations, and conspiracy to abuse process. The specific actions of the Company
complained of in the Longhorn Suit, as currently amended, are alleged
solicitation of and support for allegedly baseless lawsuits brought by Texas
ranchers in federal and state courts to challenge the proposed Longhorn Pipeline
project, support of allegedly fraudulent public relations activities against the
proposed Longhorn Pipeline project, entry into a contractual "alliance" with
Fina Oil and Chemical Company, threatening litigation against certain partners
in Longhorn Partners, and alleged interference with the federal court settlement
agreement that provided for the Environmental Assessment of the Longhorn
Pipeline. The Company believes that the Longhorn Suit is wholly without merit
and plans to continue to defend itself vigorously. However, because of the size
of the damages claimed and in spite of the apparent lack of merit in the claims
asserted, the Longhorn Suit has created
21
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
problems for the Company, including the exclusion of the Company from the
possibility of certain types of major corporate transactions, an adverse impact
on the cost and availability of debt financing for Company operations, and what
appears to be a continuing adverse effect on the market price of the Company's
common stock. The Company plans to pursue at the appropriate time any
affirmative remedies that may be available to it relating to the Longhorn Suit.
For additional information on the Longhorn Suit, see Part II "Other
Information," Item 1, "Legal Proceedings."
Other legal proceedings that could affect future results are described
in Part II "Other Information", Item 1, "Legal Proceedings."
RISK MANAGEMENT
The Company uses certain strategies to reduce some commodity price and
operational risks. The Company does not attempt to eliminate all market risk
exposures when the Company believes that the exposure relating to such risk
would not be significant to the Company's future earnings, financial position,
capital resources or liquidity or that the cost of reducing or eliminating the
exposure would outweigh the benefit.
The Company's profitability depends largely on the spread between
market prices for refined products and crude oil. A substantial or prolonged
decrease in this spread could have a significant negative effect on the
Company's earnings, financial condition and cash flows. At times, the Company
utilizes petroleum commodity futures contracts to minimize a portion of its
exposure to price fluctuations associated with crude oil and refined products.
During the quarter ended April 30, 2001, the Company entered into
commodity price swaps and collar options to help manage the exposure to price
volatility relating to forecasted purchases of natural gas from May 2001 to May
2002. At January 31, 2002, the Company has contracts outstanding for natural gas
hedges of approximately 0.4 million MMBtu, relating to approximately 50% of the
forecasted natural gas purchases for the Navajo Refinery. The price swaps and
collar options effectively established minimum and maximum prices to be paid for
the portion of natural gas hedged of $5.29 and $5.63 per MMBtu, respectively.
The values of the outstanding hedges were marked to the current fair value as of
January 31, 2002 and the accumulated loss included in comprehensive income is
$1.38 million. Gains (losses) on the natural gas hedges will be reclassified
from comprehensive income to operating expenses through May 2002 when the
forecasted transactions impact earnings.
At January 31, 2002, the Company had outstanding unsecured debt of
$34.3 million and had no borrowings outstanding under its Credit Agreement. The
Company does not have significant exposure to changing interest rates on its
unsecured debt because the interest rates are fixed; the average maturity is
approximately two years and such debt represent less than 15% of the Company's
total capitalization. As the interest rates on the Company's bank borrowings, if
any, under its Credit
22
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
Agreement are reset frequently based on either the bank's daily effective prime
rate or the LIBOR rate, interest rate market risk is very low. There were no
bank borrowings during fiscal 2001 or for the first six months of fiscal 2002.
Additionally, the Company invests any available cash only in investment grade,
highly liquid investments with maturities of three months or less and hence the
interest rate market risk implicit in these cash investments is low. A ten
percent change in the market interest rate over the next year would also not
materially impact the Company's earnings or cash flow, as the interest rates on
the Company's long-term debt are fixed, and the Company's borrowings under the
Credit Agreement and cash investments are at short-term market rates and such
interest has historically not been significant as compared to the total
operations of the Company. A ten percent change in the market interest rate over
the next year would also not materially impact the Company's financial
condition, since the average maturity of the Company's long-term debt is
approximately two years and such debt represents less than 15% of the Company's
total capitalization, and since the Company's borrowings, if any, under the
Credit Agreement and cash investments are at short-term market rates.
The Company's operations are subject to normal hazards of operations,
including fire, explosion and weather-related perils. The Company maintains
various insurance coverages, including business interruption insurance, subject
to certain deductibles. The Company is not fully insured against certain risks
because such risks are not fully insurable, coverage is unavailable or premium
costs, in the judgment of the Company, do not justify such expenditures.
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, FASB issued SFAS No. 142, "Goodwill and Other Intangible
Assets." This statement changes how goodwill and other intangible assets are
accounted for subsequent to their initial recognition. SFAS No. 142 is effective
for fiscal years beginning after December 15, 2001, with early adoption
permitted; however all goodwill and intangible assets acquired after June 30,
2001 will be subject immediately to the provisions of this statement. The
Company has not completed evaluating the effects this statement will have on its
financial reporting and disclosures.
In June 2001, FASB issued SFAS No. 143, "Accounting for Asset
Retirement Obligations." This statement requires that the fair value for an
asset retirement obligation be capitalized as part of the carrying amount of the
long-lived asset if a reasonable estimate of fair value can be made. SFAS No.
143 is effective for fiscal years beginning after June 15, 2002, with early
adoption permitted. The Company has not completed evaluating the effects this
statement will have on its financial reporting and disclosures.
In August 2001, FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." This statement supersedes SFAS No.
121 "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to be Disposed of", but carries over the key guidance from SFAS No. 121
in establishing the framework for the recognition and measurement of long-lived
assets to be disposed of by sale and addresses significant implementation
issues.
23
HOLLY CORPORATION
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations (Continued)
SFAS No. 144 is effective for fiscal years beginning after December 15,
2001, with early adoption permitted. The Company has not completed evaluating
the effects this statement will have on its financial reporting and disclosures.
24
HOLLY CORPORATION
Item 3. Quantitative and Qualitative Disclosures About Market Risk
See "Risk Management" under "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
25
HOLLY CORPORATION
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
In August 1998, a lawsuit (the "Longhorn Suit") was filed in state
district court in El Paso, Texas against the Company and two of its subsidiaries
(along with an Austin, Texas law firm which was subsequently dropped from the
case). The suit was filed by Longhorn Partners Pipeline, L.P. ("Longhorn
Partners"), a Delaware limited partnership composed of Longhorn Partners GP,
L.L.C. as general partner and affiliates of Exxon Pipeline Company, BP/Amoco
Pipeline Company, Williams Pipeline Company, and the Beacon Group Energy
Investment Fund, L.P. and Chisholm Holdings as limited partners. The suit, as
most recently amended by Longhorn Partners in September 2000, seeks damages
alleged to total up to $1,050,000,000 (after trebling) based on claims of
violations of the Texas Free Enterprise and Antitrust Act, unlawful interference
with existing and prospective contractual relations, and conspiracy to abuse
process. The specific actions of the Company complained of in the Longhorn Suit,
as currently amended, are alleged solicitation of and support for allegedly
baseless lawsuits brought by Texas ranchers in federal and state courts to
challenge the proposed Longhorn Pipeline project, support of allegedly
fraudulent public relations activities against the proposed Longhorn Pipeline
project, entry into a contractual "alliance" with Fina Oil and Chemical Company,
threatening litigation against certain partners in Longhorn Partners, and
alleged interference with the federal court settlement agreement that provided
for an Environmental Assessment of the Longhorn Pipeline. A hearing on the
Company's amended motion for summary judgment, which was filed in October 2000
and seeks a court ruling that would terminate this litigation, was held January
3, 2001; as of the date of this report, the court has not issued a ruling with
respect to this motion. A motion filed by the Company to transfer the venue for
trial of the case from the El Paso court to another Texas court has been pending
since May 2000, and no hearing on this motion is currently scheduled. The
Company believes that the Longhorn Suit is wholly without merit and plans to
continue to defend itself vigorously. The Company also plans to pursue at the
appropriate time any affirmative remedies that may be available to it relating
to the Longhorn Suit.
On December 20, 2001, with the consent of the Company, a Consent Decree
(the "Consent Decree") was filed in the United States District Court for the
District of New Mexico in the case of United States of America v. Navajo
Refining Company, L.P. and Montana Refining Company. The filing of the Consent
Decree resulted from negotiations which were initiated by the Company and which
began in July 2001 involving representatives of the Company, the Environmental
Protection Agency, the New Mexico Environment Department, and the Montana
Department of Environmental Quality with respect to a possible global settlement
of issues concerning the application of air quality requirements to past and
future operations of the Company's refineries. The Consent Decree requires
investments by the Company expected to total between $10,000,000 and $20,000,000
over a number of years at the Company's New Mexico and Montana refineries for
the installation of certain state of the art pollution control equipment and
requires changes in operational practices at these refineries that go beyond
current regulatory requirements to reduce
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HOLY CORPORATION
emissions. In addition, the Consent Decree provides to the Company and its
subsidiaries releases from liability for enforcement actions with respect to a
number of possible issues relating to the application of environmental air
quality regulations to the Company's refineries. The Consent Decree also
provides for payment by the Company of penalties to Federal, New Mexico and
Montana regulatory authorities in the total amount of $750,000 and expenditures
of approximately $1.5 million for environmentally beneficial projects. As of the
date of this report, the Consent Decree has not been entered by the United
States District Court for the District of New Mexico but entry of the Consent
Decree is expected to occur before the end of March 2002. Entry of the Consent
Decree will result in the termination of proceedings concerning a Compliance
Order Requiring Compliance and Assessing a Civil Penalty issued by the New
Mexico Environment Department in May 2001 relating to alleged violations in the
period from 1992 to the present involving the fluid catalytic cracking unit at
the Company's Navajo Refinery.
In May and June 2001, the Company filed claims with the Department of
Defense under the Contract Disputes Act asserting that additional amounts are
due to the Company with respect to jet fuel sales to the Defense Fuel Supply
Center in the years 1982 through 1995. The total of all claims filed by the
Company is approximately $210 million. In November 2001, the Department of
Defense issued final decisions rejecting the Company's claims and asserting
counterclaims totaling approximately $8,000,000 if part or all of the Company's
claims are allowed. Any recovery by the Company with respect to the claims would
require further proceedings. It is not possible at the date of this report to
predict what amount, if any, will ultimately be payable to the Company with
respect to these claims.
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HOLY CORPORATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits: None.
(b) Reports on Form 8-K:
On December 20, 2001, a Current Report on Form 8-K was filed
under Item 5. Other Events, regarding a Clean Air Act agreement
reached between the Company and the U.S. Environmental Protection
Agency, the New Mexico Environment Department and the Montana
Department of Environmental Quality.
On January 8, 2002, a Current Report on Form 8-K was filed under
Item 5. Other Events, relating to the receipt of the permits
necessary for the construction of a new gas oil hydrotreating
unit at the Artesia refinery and relating to a proposed expansion
at the Artesia refinery to increase the crude oil refining
capacity from 60,000 BPD to 70,000 BPD.
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SIGNATURE
Pursuant to the requirements of the Securities and Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned thereunto duly authorized.
HOLLY CORPORATION
---------------------------------------------
(Registrant)
Date: March 8, 2002 By /s/ Kathryn H. Walker
--------------- ------------------------------------------
Kathryn H. Walker
Vice President, Accounting
(Principal Accounting Officer)
By /s/ Stephen J. McDonnell
-------------------------------------------
Stephen J. McDonnell
Vice President and Chief Financial
Officer
(Principal Financial Officer)
29