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 September 30, 2003
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 fiscal year-end: July 31
- -------------------------------------------------------------------------------
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___
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). Yes [X] No___
15,510,028 shares of Common Stock, par value $.01 per share, were outstanding on
November 11, 2003.
HOLLY CORPORATION
INDEX
<Table>
<Caption>
Page No.
--------
PART I. FINANCIAL INFORMATION
Forward-Looking Statements 3
Item 1. Financial Statements
Consolidated Balance Sheet - (Unaudited) -
September 30, 2003, December 31, 2002, and July 31, 2002 4
Consolidated Statement of Income (Unaudited) -
Three Months and Nine Months Ended September 30, 2003 and 2002 5
Two Months Ended June 30, 2003 and 2002 6
Consolidated Statement of Cash Flows (Unaudited) -
Nine Months Ended September 30, 2003 and 2002 7
Consolidated Statement of Comprehensive Income (Unaudited) -
Three Months and Nine Months Ended September 30, 2003 and 2002 8
Two Months Ended June 30, 2003 and 2002 8
Notes to Consolidated Financial Statements (Unaudited) 9
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 22
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 38
Item 4. Controls and Procedures 38
PART II. OTHER INFORMATION
Item 1. Legal Proceedings 39
Item 6. Exhibits and Reports on Form 8-K 42
Signatures 44
Certifications 45
</Table>
PART I
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") regarding the Company's
financial position and results of operations in Item 2 "Management's Discussion
and Analysis of Financial Condition and Results of Operations" in Part I 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 successful integration of the Woods Cross Refinery, the outcome of
litigation with Frontier Oil Corporation, the possibility of terrorist attacks
and the consequences of any such attacks, 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 Form 10-Q also
contains cautionary statements identifying important factors that could cause
actual results to differ materially from the Company's expectations reflected by
its forward looking statements included in this Form 10-Q. This summary
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/A, as amended, for the fiscal year ended
July 31, 2002 and in conjunction with the discussion in this Form 10-Q in
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" 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. The
forward-looking statements speak only as of the date made, and the Company
undertakes no obligation to publicly update or revise any forward-looking
statements, whether as a result of new information, future events or otherwise.
3
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
HOLLY CORPORATION
CONSOLIDATED BALANCE SHEET
Unaudited
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31, JULY 31,
2003 2002 2002
---------------- ---------------- ----------------
(In thousands, except share data)
ASSETS
CURRENT ASSETS
Cash and cash equivalents ..................................... $ 8,493 $ 24,266 $ 71,630
Accounts receivable: Product ............................. 66,698 51,141 46,929
Crude oil resales ................... 96,419 97,017 88,466
---------------- ---------------- ----------------
163,117 148,158 135,395
Inventories: Crude oil and refined products ...... 80,030 50,808 35,120
Materials and supplies .............. 10,793 10,329 10,188
---------------- ---------------- ----------------
90,823 61,137 45,308
Income taxes receivable ...................................... -- 647 8,699
Prepayments and other ......................................... 16,318 19,026 17,812
---------------- ---------------- ----------------
TOTAL CURRENT ASSETS ..................................... 278,751 253,234 278,844
Properties, plants and equipment, at cost ........................ 486,113 434,292 410,987
Less accumulated depreciation, depletion and amortization ........ (225,741) (220,142) (211,526)
---------------- ---------------- ----------------
260,372 214,150 199,461
Investments in and advances to joint ventures .................... 44,871 15,955 15,732
Other assets: Prepaid transportation .............. 25,000 25,000 --
Refinery acquisition deposit ........ -- 2,500 --
Other, net .......................... 5,672 3,841 8,269
---------------- ---------------- ----------------
30,672 31,341 8,269
---------------- ---------------- ----------------
TOTAL ASSETS ............................................. $ 614,666 $ 514,680 $ 502,306
================ ================ ================
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES
Accounts payable .............................................. $ 218,311 $ 207,418 $ 185,058
Accrued liabilities ........................................... 35,571 23,722 25,342
Dividend payable .............................................. 1,706 -- --
Income taxes payable .......................................... 7,522 -- --
Credit agreement borrowings ................................... 15,000 -- --
Current maturities of long-term debt .......................... 8,571 8,571 8,571
---------------- ---------------- ----------------
TOTAL CURRENT LIABILITIES ................................ 286,681 239,711 218,971
Deferred income taxes ............................................ 39,694 28,254 29,065
Long-term debt, less current maturities .......................... 17,143 17,143 25,714
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;
16,877,897, 16,846,696 and 16,759,396 shares issued as of
September 30, 2003, December 31, 2002, and July 31, 2002 .... 169 168 168
Additional capital ............................................ 15,701 15,221 14,013
Retained earnings ............................................. 267,777 225,759 223,770
---------------- ---------------- ----------------
283,647 241,148 237,951
Common stock held in treasury, at cost -
1,371,868, 1,328,868, and 1,197,968 shares as of
September 30, 2003, December 31, 2002, and July 31, 2002 ... (12,499) (11,605) (9,395)
Accumulated other comprehensive loss .......................... -- 29 --
---------------- ---------------- ----------------
TOTAL STOCKHOLDERS' EQUITY ............................... 271,148 229,572 228,556
---------------- ---------------- ----------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY ............... $ 614,666 $ 514,680 $ 502,306
================ ================ ================
</Table>
See accompanying notes
4
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF INCOME
Unaudited
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands, except per share data)
SALES AND OTHER REVENUES ....................................... $ 412,152 $ 266,467 $ 1,050,351 $ 703,572
OPERATING COSTS AND EXPENSES
Cost of products sold (exclusive of
depreciation,depletion, and amortization) ............. 327,719 224,158 863,305 572,474
Operating expenses (exclusive of
depreciation,depletion, and amortization) ............. 37,390 25,381 93,672 72,155
Selling, general and administrative expenses
(exclusive of depreciation,depletion, and
amortization) ......................................... 10,023 6,094 22,335 16,654
Depreciation, depletion and amortization .................... 9,104 7,706 26,029 21,497
Exploration expenses, including dry holes ................... 160 231 623 1,048
------------ ------------ ------------ ------------
TOTAL OPERATING COSTS AND EXPENSES ..................... 384,396 263,570 1,005,964 683,828
------------ ------------ ------------ ------------
GAIN (LOSS) ON SALE OF ASSETS .................................. (393) -- 15,814 --
------------ ------------ ------------ ------------
INCOME FROM OPERATIONS ......................................... 27,363 2,897 60,201 19,744
OTHER INCOME (EXPENSE)
Equity in earnings of joint ventures ........................ 1,860 1,797 1,853 4,362
Interest income ............................................. 82 263 385 746
Interest expense ............................................ (755) (667) (1,292) (1,934)
Reparations payment received ................................ 104 -- 15,330 --
------------ ------------ ------------ ------------
1,291 1,393 16,276 3,174
------------ ------------ ------------ ------------
INCOME BEFORE INCOME TAXES ..................................... 28,654 4,290 76,477 22,918
Income tax provision
Current ..................................................... 6,799 171 19,055 3,915
Deferred .................................................... 4,305 959 10,288 4,084
------------ ------------ ------------ ------------
11,104 1,130 29,343 7,999
------------ ------------ ------------ ------------
NET INCOME ..................................................... $ 17,550 $ 3,160 $ 47,134 $ 14,919
============ ============ ============ ============
NET INCOME PER COMMON SHARE - BASIC ............................ $ 1.13 $ 0.20 $ 3.04 $ 0.96
============ ============ ============ ============
NET INCOME PER COMMON SHARE - DILUTED .......................... $ 1.09 $ 0.20 $ 2.94 $ 0.94
============ ============ ============ ============
CASH DIVIDENDS DECLARED PER COMMON SHARE ....................... $ 0.11 $ 0.11 $ 0.33 $ 0.33
============ ============ ============ ============
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic ....................................................... 15,506 15,555 15,503 15,573
Diluted ..................................................... 16,029 15,912 16,012 15,954
</Table>
See accompanying notes.
5
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF INCOME
Unaudited
<Table>
<Caption>
TWO MONTHS ENDED
JUNE 30,
----------------------------------------
2003 2002
------------------ ------------------
(In thousands, except per share data)
SALES AND OTHER REVENUES ..................................... $ 228,638 $ 166,646
OPERATING COSTS AND EXPENSES
Cost of products sold (exclusive of
depreciation,depletion, and amortization) ........... 193,360 136,275
Operating expenses (exclusive of
depreciation,depletion, and amortization) ........... 19,019 15,546
Selling, general and administrative expenses
(exclusive of depreciation,depletion, and
amortization) ....................................... 3,801 3,486
Depreciation, depletion and amortization .................. 5,315 4,637
Exploration expenses, including dry holes ................. 144 449
------------------ ------------------
TOTAL OPERATING COSTS AND EXPENSES ................... 221,639 160,393
Loss on sale of assets .................................... (240) --
------------------ ------------------
INCOME FROM OPERATIONS ....................................... 6,759 6,253
OTHER INCOME (EXPENSE)
Equity in earnings of joint ventures ...................... 805 963
Interest income ........................................... 69 182
Interest expense .......................................... (327) (426)
------------------ ------------------
547 719
------------------ ------------------
INCOME BEFORE INCOME TAXES ................................... 7,306 6,972
Income tax provision
Current ................................................... 1,966 1,692
Deferred .................................................. 705 850
------------------ ------------------
2,671 2,542
------------------ ------------------
NET INCOME ................................................... $ 4,635 $ 4,430
================== ==================
NET INCOME PER COMMON SHARE - BASIC .......................... $ 0.30 $ 0.28
================== ==================
NET INCOME PER COMMON SHARE - DILUTED ........................ $ 0.29 $ 0.28
================== ==================
CASH DIVIDENDS DECLARED PER COMMON SHARE ..................... $ 0.11 $ 0.11
================== ==================
AVERAGE NUMBER OF COMMON SHARES OUTSTANDING:
Basic ..................................................... 15,503 15,587
Diluted ................................................... 16,050 15,933
</Table>
See accompanying notes.
6
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF CASH FLOWS
Unaudited
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2003 2002
-------------- --------------
(In thousands)
CASH FLOWS FROM OPERATING ACTIVITIES
Net income ...................................................... $ 47,134 $ 14,919
Adjustments to reconcile net income to net cash
provided by operating activities
Depreciation, depletion and amortization .................... 26,029 21,497
Deferred income taxes ....................................... 10,288 4,084
Dry hole costs and leasehold impairment ..................... -- 289
Equity in earnings of joint ventures ........................ (1,853) (4,362)
Gain on sale of assets ...................................... (15,814) --
(Increase) decrease in current assets
Accounts receivable ....................................... (14,959) (35,007)
Inventories ............................................... 4,071 2,177
Income taxes receivable ................................... 647 (332)
Prepayments and other ..................................... 3,916 (3,341)
Increase (decrease) in current liabilities
Accounts payable .......................................... 6,514 37,861
Accrued liabilities ....................................... 11,849 (3,002)
Income taxes payable ...................................... 7,522 (468)
Turnaround expenditures ..................................... (5,079) --
Other, net .................................................. (4,014) (19)
-------------- --------------
NET CASH PROVIDED BY OPERATING ACTIVITIES .................. 76,251 34,296
CASH FLOWS FROM INVESTING ACTIVITIES
Additions to properties, plants and equipment ................... (52,579) (31,178)
Refinery and retail stations acquisitions ....................... (55,837) --
Investments and advances to joint ventures ...................... (3,328) (3,250)
Purchase of additional interest in joint venture ................ (28,653) --
Distributions from joint ventures ............................... 4,918 10,500
Proceeds from the sale of partial interest in joint venture ..... -- 460
Proceeds from sale of retail stations ........................... 8,462 --
Proceeds from the sale of pipeline assets ....................... 24,000 --
-------------- --------------
NET CASH USED FOR INVESTING ACTIVITIES ..................... (103,017) (23,468)
CASH FLOWS FROM FINANCING ACTIVITIES
Increase in borrowings, net under revolving credit agreement .... 15,000 --
Debt issuance costs ............................................. (185) (625)
Issuance of common stock upon exercise of options ............... 481 1,340
Purchase of treasury stock ...................................... (894) (2,500)
Cash dividends .................................................. (3,409) (3,272)
-------------- --------------
NET CASH PROVIDED BY (USED FOR) FINANCING ACTIVITIES ....... 10,993 (5,057)
CASH AND CASH EQUIVALENTS
INCREASE (DECREASE) FOR THE PERIOD .............................. (15,773) 5,771
Beginning of year ............................................... 24,266 56,633
-------------- --------------
END OF PERIOD ................................................... $ 8,493 $ 62,404
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION
Cash paid during period for
Interest ................................................... $ 1,282 $ 1,818
Income taxes ............................................... $ 10,907 $ 12,216
</Table>
See accompanying notes
7
HOLLY CORPORATION
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
Unaudited
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- --------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands)
NET INCOME ................................................. $ 17,550 $ 3,160 $ 47,134 $ 14,919
Other comprehensive income (loss)
Derivative instruments qualifying as cash flow
hedging instruments
Change in fair value of derivative instruments ....... -- -- (155) (41)
Reclassification adjustment into net income .......... -- -- 108 1,501
-------------- -------------- -------------- --------------
Total income (loss) on cash flow hedges ................. -- -- (47) 1,460
-------------- -------------- -------------- --------------
Other comprehensive income (loss) before income taxes ... -- -- (47) 1,460
Income tax expense (benefit) ............................ -- -- (18) 570
-------------- -------------- -------------- --------------
Other comprehensive income (loss) ......................... -- -- (29) 890
-------------- -------------- -------------- --------------
TOTAL COMPREHENSIVE INCOME ................................. $ 17,550 $ 3,160 $ 47,105 $ 15,809
============== ============== ============== ==============
</Table>
See accompanying notes
<Table>
<Caption>
TWO MONTHS ENDED
JUNE 30,
-------------------------------
2003 2002
-------------- --------------
(In thousands)
NET INCOME ............................................... $ 4,635 $ 4,430
Other comprehensive income
Derivative instruments qualifying as cash flow
hedging instruments
Change in fair value of derivative instruments ..... -- --
Reclassification adjustment into net income ........ -- 134
-------------- --------------
Total income on cash flow hedges ...................... -- 134
-------------- --------------
Other comprehensive income before income taxes ......... -- 134
Income tax expense .................................... -- 52
-------------- --------------
Other comprehensive income ............................... -- 82
-------------- --------------
TOTAL COMPREHENSIVE INCOME ............................... $ 4,635 $ 4,512
============== ==============
</Table>
See accompanying notes
8
HOLLY CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Note A - Presentation of Financial Statements
On July 30, 2003, Holly Corporation (the "Company"), by action of the
Executive Committee of the Board of Directors, determined to change its fiscal
year from a July 31 fiscal year-end to a December 31 fiscal year-end. As
required by Rule 13a-10 under the Securities Exchange Act of 1934, the Company
filed a report on Form 10-Q on September 12, 2003, covering the transition
period from August 1, 2002 through December 31, 2002, which was subsequently
amended on a Form 10-Q/A filed by the Company on November 4, 2003. As a result
of the Company's change in its fiscal year-end, the last quarterly report filed
on Form 10-Q was for the three months and nine months ended April 30, 2003 and
2002. This current Form 10-Q for the three months and nine months ended
September 30, 2003 and 2002 includes the results of operations and comprehensive
income for the two months ended June 30, 2003 and 2002.
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 September 30,
2003, the consolidated results of operations and comprehensive income for the
three months and nine months ended September 30, 2003 and 2002, the two months
ended June 30, 2003 and 2002, and consolidated cash flows for the nine months
ended September 30, 2003 and 2002.
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/A, as amended, for the fiscal year ended July 31,
2002. Certain reclassifications have been made to prior reported amounts to
conform to current classifications.
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 nine
months of 2003 are not necessarily indicative of the results to be expected for
the full year.
Note B - New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 142 "Goodwill and Other
Intangible Assets" which 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, are immediately subject to the provisions of this statement. The Company
adopted the standard effective August 1, 2002 and there was no material effect
on its financial condition, results of operations, or cash flows.
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations" which 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
9
HOLLY CORPORATION
No. 143 is effective for fiscal years beginning after June 15, 2002, with early
adoption permitted. The Company adopted the standard effective August 1, 2002
and there was no material effect on the Company's financial condition, results
of operations, or cash flows.
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. SFAS No. 144 is effective for fiscal years beginning after December 15,
2001, with early adoption permitted. The Company adopted the standard effective
August 1, 2002 and there was no material effect on its financial condition,
results of operations, or cash flows.
In June 2002, FASB issued SFAS No. 146 "Accounting for Certain Costs
Associated with Exit or Disposal Activities" which nullifies Emerging Issues
Task Force ("EITF") 94-3 and requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
and establishes fair value as the objective for initial measurement of
liabilities. This differs from EITF 94-3 which stated that liabilities for exit
costs were to be recognized as of the date of an entity's commitment to an exit
plan. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company adopted the standard on January
1, 2003, and there was no material effect on its financial condition, results of
operations, or cash flows.
In December 2002, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure," an amendment of SFAS No. 123. This
statement provides alternative methods of transition to SFAS 123's fair value
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS 123 to require disclosures
in both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. SFAS 148's amendment of the disclosure requirements is
effective for interim periods beginning after December 15, 2002. SFAS 148's
amendment of the transition and annual disclosure requirements of SFAS 123 is
effective for fiscal years ending after December 15, 2002. See Note D to the
Consolidated Financial Statements for effect of this standard on the Company's
financial condition, results of operations, or cash flows.
In January 2003, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirement for Guarantees, including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 requires an entity to
recognize a liability for the obligations it has undertaken in issuing a
guarantee. This liability would be recorded at the inception of a guarantee and
would be measured at fair value. Certain guarantees are excluded from the
measurement and disclosure provisions while certain other guarantees are
excluded from the measurement provisions of the interpretation. The Company
adopted the standard on January 1, 2003 and there was no material effect on its
financial condition, results of operations, or cash flows.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires an entity to consolidate
a variable interest entity if it is designated as the primary beneficiary of
that entity and if the entity does not have a majority of voting interests. A
variable interest entity is generally defined as an entity where its equity is
10
HOLLY CORPORATION
unable to finance its activities or where the owners of the entity lack the risk
and rewards of ownership. The provisions of FIN 46 apply at inception for any
entity created after January 31, 2003. For an entity created before February 1,
2003, the provisions of this interpretation must be applied at the beginning of
the first interim period beginning after June 15, 2003. The Company is not the
primary beneficiary of any variable interest entities, and accordingly, the
adoption of FIN 46 by the Company on July 1, 2003 had no material effect on the
Company's financial condition, results of operations, or cash flows.
In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. This
statement will result in a more complete depiction of an entity's liabilities
and equity and will thereby assist investors and creditors in assessing the
amount, timing, and likelihood of potential future cash outflows and equity
share issuances. This statement is effective for financial instruments entered
into or modified after May 31, 2003 and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. It is to be
implemented by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance date of the
statement and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. The Company adopted the standard on July 1, 2003,
and there was no material effect on its financial condition, results of
operations, or cash flows.
The American Institute of Certified Public Accountants has issued an
Exposure Draft for a Proposed Statement of Position, "Accounting for Certain
Costs and Activities Related to Property, Plant and Equipment," which would
require major maintenance activities to be expensed as costs are incurred. As of
September 30, 2003, the Company had approximately $7.8 million of deferred
maintenance costs, all relating to refinery turnarounds in prior periods, which
are being amortized over various benefit periods. The current monthly
amortization is $799,000. If this proposed Statement of Position had been
adopted in its current form, as of September 30, 2003, the Company would have
been required to expense $7.8 million of deferred maintenance costs and would be
required to expense all future turnaround costs as incurred.
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. In the
nine months ended September 30, 2002, options to purchase 50,000 shares of
common stock were not included in computing diluted income per share because
their effects were antidilutive. The following is a reconciliation of the
numerators and denominators of the basic and diluted per share computations for
net income:
11
HOLLY CORPORATION
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------- ---------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands, except per share data)
Net income ............................................... $ 17,550 $ 3,160 $ 47,134 $ 14,919
Average number of shares of common stock outstanding ..... 15,506 15,555 15,503 15,573
Effect of dilutive stock options ......................... 523 357 509 381
------------ ------------ ------------ ------------
Average number of shares of common stock
outstanding assuming dilution .................... 16,029 15,912 16,012 15,954
============ ============ ============ ============
Income per share - basic ................................. $ 1.13 $ 0.20 $ 3.04 $ 0.96
============ ============ ============ ============
Income per share - diluted ............................... $ 1.09 $ 0.20 $ 2.94 $ 0.94
============ ============ ============ ============
</Table>
<Table>
<Caption>
TWO MONTHS ENDED
JUNE 30,
---------------------------------------
2003 2002
------------------ ------------------
(In thousands, except per share data)
Net income ............................................... $ 4,635 $ 4,430
Average number of shares of common stock outstanding ..... 15,503 15,587
Effect of dilutive stock options ......................... 547 346
------------------ ------------------
Average number of shares of common stock
outstanding assuming dilution .................... 16,050 15,933
================== ==================
Income per share - basic ................................. $ 0.30 $ 0.28
================== ==================
Income per share - diluted ............................... $ 0.29 $ 0.28
================== ==================
</Table>
Note D - Stock-based Compensation
The Company has compensation plans under which certain officers and
employees have been granted stock options. All the options have been granted at
prices equal to the market value of the shares at the time of the grant and
normally expire on the tenth anniversary of the grant date. The Company's
stock-based compensation is measured in accordance with the provisions of
Accounting Principles Board Opinion No. 25 (APB 25), "Accounting for Stock
Issued to Employees" and related interpretations. Accordingly, no compensation
expense is recognized for fixed option plans because the exercise prices of
employee stock options equal or exceed the market prices of the underlying stock
on the dates of grant.
The following table represents the effect on net income and earnings
per share as if the Company had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," to stock based employee compensation.
12
HOLLY CORPORATION
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands, except share data)
Net income, as reported ................................. $ 17,550 $ 3,160 $ 47,134 $ 14,919
Deduct: Total stock-based employee compensation
expense determined under the fair value
method for all awards, net of related tax effects ..... 113 113 339 339
-------------- -------------- -------------- --------------
Pro forma net income .................................... $ 17,437 $ 3,047 $ 46,795 $ 14,580
============== ============== ============== ==============
Net income per share - basic
As reported ........................................... $ 1.13 $ 0.20 $ 3.04 $ 0.96
Pro forma ............................................. $ 1.12 $ 0.20 $ 3.02 $ 0.94
Net income per share - diluted
As reported ........................................... $ 1.09 $ 0.20 $ 2.94 $ 0.94
Pro forma ............................................. $ 1.09 $ 0.19 $ 2.92 $ 0.91
</Table>
<Table>
<Caption>
Two Months Ended
June 30,
---------------------------------------
2003 2002
------------------ ------------------
(In thousands, except share data)
Net income, as reported ................................... $ 4,635 $ 4,430
Deduct: Total stock-based employee compensation
expense determined under the fair value
method for all awards, net of related tax effects ....... 75 75
------------------ ------------------
Pro forma net income ...................................... $ 4,560 $ 4,355
================== ==================
Net income per share - basic
As reported ............................................. $ 0.30 $ 0.28
Pro forma ............................................... $ 0.29 $ 0.28
Net income per share - diluted
As reported ............................................. $ 0.29 $ 0.28
Pro forma ............................................... $ 0.28 $ 0.27
</Table>
Note E - Investments in Joint Ventures
The Company currently has a 49% interest in NK Asphalt Partners, a
joint venture that manufactures and markets asphalt products from various
terminals in Arizona and New Mexico. The Company accounts for this investment
using the equity method. All asphalt produced at the Navajo Refinery is sold at
market prices to the joint venture under a supply agreement. Sales to the joint
venture during the three months ended September 30, 2003 and 2002 were $10.7
million and $7.5 million, respectively. Sales to the joint venture during the
nine months ended September 30, 2003 and 2002 were $23.8 million and $18.3
million, respectively.
13
HOLLY CORPORATION
Summary financial results for NK Asphalt Partners Joint Venture (unaudited):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands) (In thousands)
Sales (net) .................... $ 28,466 $ 26,147 $ 66,083 $ 59,381
============== ============== ============== ==============
Gross Profit ................... $ 5,351 $ 6,063 $ 11,945 $ 16,106
============== ============== ============== ==============
Income from operations ......... $ 2,194 $ 3,662 $ 3,033 $ 8,386
============== ============== ============== ==============
Net income before taxes ........ $ 1,777 $ 3,196 $ 1,725 $ 7,184
============== ============== ============== ==============
</Table>
<Table>
<Caption>
Two Months Ended
June 30,
-------------------------------
2003 2002
-------------- --------------
(In thousands)
Sales (net) .......................... $ 20,340 $ 16,056
============== ==============
Gross Profit ......................... $ 4,181 $ 3,941
============== ==============
Income from operations ............... $ 2,044 $ 1,950
============== ==============
Net income before taxes .............. $ 1,744 $ 1,680
============== ==============
</Table>
The Company currently has a 70% interest in Rio Grande
Pipeline Company ("Rio Grande"), a pipeline joint venture that transports liquid
petroleum gases to Mexico. On June 30, 2003, the Company, through a wholly-owned
indirect subsidiary, purchased Juarez Pipeline Company's 45% interest in Rio
Grande Pipeline Company, adding to the 25% interest that the Company's
subsidiary already owned. The purchase price was $27.5 million plus $1.1 million
for certain purchase price adjustments. Juarez Pipeline Company is a
wholly-owned indirect subsidiary of The Williams Companies, Inc. The Rio Grande
Pipeline Company, a partnership that is presently owned 70% by the Company and
30% by BP, serves Northern Mexico by transporting liquid petroleum gases
("LPGs") from a point near Odessa, Texas to Pemex Gas ("Pemex") at a point near
El Paso, Texas. Pemex then transports the LPGs to its Mendez Terminal near
Juarez, Mexico.
14
HOLLY CORPORATION
Summary financial results for Rio Grande Pipeline Company Joint Venture
(unaudited):
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands) (In thousands)
Sales (net) ...................... $ 3,105 $ 3,091 $ 9,695 $ 10,140
============== ============== ============== ==============
Income from operations ........... $ 1,088 $ 1,262 $ 3,335 $ 5,641
============== ============== ============== ==============
Net income before taxes .......... $ 1,092 $ 1,266 $ 3,248 $ 5,657
============== ============== ============== ==============
</Table>
<Table>
<Caption>
TWO MONTHS ENDED
JUNE 30,
---------------------------
2003 2002
------------ ------------
(In thousands)
Sales (net) .................. $ 2,119 $ 1,686
============ ============
Income from operations ....... $ 1,146 $ 787
============ ============
Net income before taxes ...... $ 1,150 $ 794
============ ============
</Table>
Note F - Debt
In May 2003, the Company amended its Revolving Credit Agreement with a
group of banks led by Canadian Imperial Bank of Commerce and increased the
commitment from $75 million to $100 million. The Company now has access to $100
million of commitments that can be used for revolving credit loans and letters
of credit. Previously the Company had access to $75 million of commitments, of
which only $37.5 million could be used for revolving credit loans. The Company
used borrowings under its credit agreement to help finance the purchase of the
Woods Cross Refinery and the purchase of an additional 45% interest in the Rio
Grande Pipeline joint venture. The maximum amount borrowed under the Credit
Agreement during the first nine months of 2003 was $50 million. At September 30,
2003, the Company had letters of credit outstanding under the facility of $12.6
million and had $15 million of borrowings outstanding.
Note G - Environmental
The Company expenses environmental costs if they relate to an existing
condition caused by past operations and do not contribute to current or future
revenue generation. Liabilities are recorded when site restoration and
environmental remediation and cleanup obligations are either known or considered
probable and can be reasonably estimated. Recoveries of environmental costs
through insurance, indemnification arrangements or other sources are included in
other assets to the extent such recoveries are considered probable. Consistent
with our accounting policy, the Company recorded $3.9 million for environmental
remediation and cleanup
15
HOLLY CORPORATION
obligations during the nine months ended September 30, 2003, which are included
in Accrued liabilities on the Consolidated Balance Sheet. Costs of future
expenditures for environmental remediation obligations are not discounted to
their present value.
Note H - Stockholders' Equity
On October 30, 2001, the Company announced plans to repurchase up to
$20 million of the Company's common stock. Such repurchases have been made from
time to time in open market purchases or privately negotiated transactions,
subject to price and availability. The repurchases have been financed with
currently available corporate funds. During the nine months ended September 30,
2003, the Company repurchased 43,000 shares at a cost of approximately $894,000
or an average of $20.79 per share. From inception of the plan through October
31, 2003, the Company has repurchased 272,400 shares at a cost of approximately
$4.7 million. No stock repurchases have been made since February 7, 2003.
Note I - Derivative Instruments and Hedging Activities
In 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 through May 2002. These transactions were
designated as cash flow hedges of forecasted purchases. During the nine months
ended September 30, 2002, the Company marked the value of the outstanding hedges
to fair value in accordance with SFAS No. 133 and included $1.5 million of
income in comprehensive income. Gains (losses) on the natural gas hedges were
reclassified from comprehensive income to operating expenses through May 2002
when the forecasted transactions impacted earnings.
The Company's profitability depends largely on the spread between market
prices for refined products and market prices for crude oil. A substantial or
prolonged reduction 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. In December 2002, the Company entered into cash flow hedges relating
to certain forecasted transactions to buy crude oil and sell gasoline in March
2003. The purpose of the hedges was to help protect the Company from the risk
that the refined product margin would decline with respect to the hedged crude
oil and refined products. To effect the hedges, the Company entered into
gasoline and crude oil futures transactions. In March 2003, as the forecasted
transactions occurred, the Company reclassified $108,000 of actual losses from
comprehensive income to cost of sales. The ineffective portion of the hedges
resulted in a $32,000 gain that was also included in cost of sales. During the
nine months ended September 30, 2002, the Company also entered into commodity
derivative contracts to help protect refined product margins (which the Company
defines as the difference between refined product sales prices and the costs for
crude oil and other feedstocks exclusive of depreciation, depletion and
amortization) that while an economic hedge, did not qualify for hedge accounting
treatment. The Company realized a gain of $302,000 which was included in cost of
sales. As of September 30, 2003, there were no hedges outstanding.
16
HOLLY CORPORATION
Note J - Segment Information
The Company has two major business segments: Refining and Pipeline
Transportation. The Refining segment involves 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, Montana Refinery and the
recently acquired Woods Cross Refinery. The petroleum products produced by the
Refining segment are marketed in the southwestern region and the central and
northern Rocky Mountain regions of the United States, 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 49% interest in NK
Asphalt Partners, which manufactures and markets asphalt and asphalt products in
Arizona and New Mexico. Prior to March 2003, the Company's Pipeline
Transportation segment included approximately 1,000 miles of pipeline assets in
Texas and New Mexico. In March 2003, the Company sold the 400 mile Iatan crude
oil gathering system located in West Texas to Plains Marketing L.P. Revenues of
the Pipeline Transportation segment are earned through transactions with
unaffiliated parties for pipeline transportation, rental and terminalling
operations. In June 2003, the Spokane terminal was acquired and added to the
transportation segment. Pipeline Transportation segment revenues do not include
any amount relating to pipeline transportation services provided for the
Company's refining operations. The Pipeline Transportation segment also includes
the equity earnings from the Company's 70% interest in Rio Grande Pipeline
Company (see Note E to the Consolidated Financial Statements), 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, interest charges, recently
sold retail assets acquired in connection with the purchase of the Woods Cross
Refinery, 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/A, as amended, for the year ended July 31, 2002. The Company's
reportable segments are strategic business units that offer different products
and services.
17
HOLLY CORPORATION
<Table>
<Caption>
TOTAL FOR
PIPELINE REPORTABLE CORPORATE CONSOLIDATED
REFINING TRANSPORTATION SEGMENTS & OTHER TOTAL
-------------- -------------- -------------- -------------- --------------
(In thousands)
THREE MONTHS ENDED SEPTEMBER 30, 2003
Sales and other revenues ............... $ 404,167 $ 3,535 $ 407,702 $ 4,450 $ 412,152
Income (loss) from operations .......... $ 32,400 $ 2,375 $ 34,775 $ (7,412) $ 27,363
Income (loss) before income taxes ...... $ 33,467 $ 3,216 $ 36,683 $ (8,029) $ 28,654
THREE MONTHS ENDED SEPTEMBER 30, 2002
Sales and other revenues ............... $ 261,250 $ 4,902 $ 266,152 $ 315 $ 266,467
Income (loss) from operations .......... $ 3,515 $ 2,873 $ 6,388 $ (3,491) $ 2,897
Income (loss) before income taxes ...... $ 4,918 $ 3,229 $ 8,147 $ (3,857) $ 4,290
NINE MONTHS ENDED SEPTEMBER 30, 2003
Sales and other revenues ............... $ 1,030,821 $ 11,153 $ 1,041,974 $ 8,377 $ 1,050,351
Income (loss) from operations .......... $ 50,459 $ 23,734 $ 74,193 $ (13,992) $ 60,201
Income (loss) before income taxes ...... $ 66,074 $ 25,114 $ 91,188 $ (14,711) $ 76,477
NINE MONTHS ENDED SEPTEMBER 30, 2002
Sales and other revenues ............... $ 688,581 $ 14,043 $ 702,624 $ 948 $ 703,572
Income (loss) from operations .......... $ 19,662 $ 8,378 $ 28,040 $ (8,296) $ 19,744
Income (loss) before income taxes ...... $ 22,747 $ 9,502 $ 32,249 $ (9,331) $ 22,918
</Table>
<Table>
<Caption>
TOTAL FOR
PIPELINE REPORTABLE CORPORATE CONSOLIDATED
REFINING TRANSPORTATION SEGMENTS & OTHER TOTAL
-------------- -------------- -------------- -------------- --------------
(In thousands)
TWO MONTHS ENDED JUNE 30, 2003
Sales and other revenues ................. $ 223,516 $ 2,121 $ 225,637 $ 3,001 $ 228,638
Income (loss) from operations ............ $ 6,143 $ 2,416 $ 8,799 $ (1,800) $ 6,999
Income (loss) before income taxes ........ $ 6,671 $ 2,464 $ 9,375 $ (2,069) $ 7,306
TWO MONTHS ENDED JUNE 30, 2002
Sales and other revenues ................. $ 163,188 $ 3,369 $ 166,557 $ 89 $ 166,646
Income (loss) from operations ............ $ 5,729 $ 2,054 $ 7,783 $ (1,530) $ 6,253
Income (loss) before income taxes ........ $ 6,435 $ 2,243 $ 8,678 $ (1,706) $ 6,972
</Table>
Note K - Contingencies
In November 2002, the Company settled by agreement litigation brought
in August 1998 by Longhorn Partners Pipeline, L.P. ("Longhorn Partners") against
the Company in a state court in El Paso, Texas and litigation brought in August
2002 by the Company against Longhorn Partners and related parties in a state
court in Carlsbad, New Mexico. Under the settlement agreement, which was
developed in voluntary mediation, in November 2002, the Company paid $25 million
to Longhorn Partners as a prepayment for the transportation of 7,000 barrels per
day of refined products from the Gulf Coast to El Paso for a period of up to 6
years from the date of the Longhorn Pipeline's start-up. Longhorn Partners has
also issued to the Company an unsecured $25 million promissory note,
subordinated to certain other indebtedness, that would become payable with
interest in the event that the Longhorn Pipeline does not begin operations by
July 1, 2004, or to the extent Longhorn Partners is unable to provide the
Company the full amount of the agreed transportation services. In the unaudited
consolidated balance sheet at September 30, 2003, the $25 million settlement is
reflected in Assets as "Other assets - Prepaid transportation."
18
HOLLY CORPORATION
In September 2002, the Federal Energy Regulatory Commission ("FERC")
issued an order in proceedings brought by the Company and other parties against
Kinder Morgan's SFPP, L.P. ("SFPP") relating to tariffs of common carrier
pipelines, which are owned and operated by SFPP, for shipments of refined
products from El Paso, Texas to Tucson and Phoenix, Arizona and from points in
California to points in Arizona. The Company is one of several refiners that
regularly utilize an SFPP pipeline to ship refined products from El Paso, Texas
to Tucson and Phoenix, Arizona. The September 2002 order resolved most remaining
issues relating to SFPP's tariffs on the pipelines to points in Arizona,
including issues related to payments made by the Company for shipments of
petroleum products from El Paso, Texas to Tucson and Phoenix, Arizona
principally for the period from 1993 through July 2000. In January 2003, the
FERC issued an order accepting most of the computations prepared by SFPP
pursuant to the September 2002 order and requiring a change in one item. In
April 2003, the Company received $15.2 million from Kinder Morgan as payment for
the reparations initially ordered by FERC and such amount was included as
reparations payment received in net income in April 2003. In June 2003, the FERC
issued a further order requiring an adjustment in the computations which has
resulted in an additional payment to the Company of approximately $104,000,
which was included in net income for the quarter ended September 30, 2003. The
final FERC decision on this matter is subject to judicial review by the Court of
Appeals for the District of Columbia Circuit, which on November 12 heard oral
argument on the case. In the event SFPP prevails in whole or in part in this
judicial review, the reparations actually owed may be less than the $15.3
million received by the Company with respect to this matter, and in that event
part or all of the amounts received by the Company would have to be refunded. At
the date of this report, it is not possible to predict the result of judicial
review proceedings on this matter in the Court of Appeals for the District of
Columbia Circuit.
Note L - Sale of Pipeline Assets
On March 3, 2003, the Company sold its Iatan crude oil gathering
pipeline system located in West Texas to Plains Marketing L.P. for a purchase
price of $24 million in cash. In connection with the transaction, the Company
and Plains entered into a six and one-half year agreement which commits the
Company to transport any crude oil purchased by the Company in the relevant area
on the Iatan system at an agreed-upon tariff. The sale resulted in a pre-tax
gain for the Company of approximately $16.2 million.
19
HOLLY CORPORATION
Note M - Proposed Merger of Company and Frontier Oil Corporation and Related
Litigation
On March 31, 2003, Frontier Oil Corporation ("Frontier") and the Company
announced an agreement (the "Frontier Merger Agreement") pursuant to which the
two companies would be combined. The combined company would be called Frontier
Oil Corporation and would be headquartered in Houston, Texas. Terms of the
Frontier Merger Agreement provided for the Company's stockholders to receive one
share of Frontier common stock for each share of Holly common stock, plus an
aggregate cash payment of $172.5 million or approximately $11.13 per common
share based on the current number of outstanding Holly shares. The Company has
approximately 15.5 million common shares outstanding, and Frontier has
approximately 26.1 million common shares outstanding. The Company's stockholders
would also retain a non-transferable interest in potential future recoveries in
litigation related to past sales of jet fuel to the United States government.
The transaction was expected to be non-taxable to the shareholders of both
companies, except for the cash consideration and contingent value rights to be
received by Holly stockholders. The Frontier Merger Agreement contained
reciprocal provisions for the payment of $15 million termination fees, plus up
to $1 million of expenses, under certain circumstances. A registration statement
on Form S-4 relating to the merger was initially filed with the Securities and
Exchange Commission on May 13, 2003 by Front Range Himalaya Corporation, and
later amended on June 27, 2003 and August 7, 2003.
On August 20, 2003, Frontier filed a lawsuit in the Delaware Court of
Chancery seeking declaratory relief and damages based on allegations that the
Company repudiated its obligations under the Frontier Merger Agreement. On
August 21, 2003, the Company formally notified Frontier of the Company's
position that pending and threatened toxic tort litigation with respect to oil
properties operated by a subsidiary of Frontier from 1985 to 1995 adjacent to
the campus of Beverly Hills High School constitute a breach of Frontier's
representations and warranties in the Frontier Merger Agreement as to the
absence of litigation or other circumstances which could reasonably be expected
to have a material adverse effect on Frontier. Under the Frontier Merger
Agreement, if a breach occurs and is not timely cured, the Company is not
obligated to close the merger and has the right to terminate the Frontier Merger
Agreement. On September 2, 2003, the Company filed in the Delaware Court of
Chancery its Answer and Counterclaims seeking declaratory judgments that the
Company did not repudiate the Frontier Merger Agreement, that Frontier has
repudiated the Frontier Merger Agreement, that Frontier has breached certain
representations made by Frontier in the Frontier Merger Agreement, that the
Company's obligations under the Frontier Merger Agreement were and are excused
and that the Company may terminate the Frontier Merger Agreement without
liability, and seeking damages in an unspecified amount as well as costs and
attorneys' fees. To the date of this report, the Company's Board of Directors
has not taken action under the provisions of the Frontier Merger Agreement
relating to the Company's rights to terminate the Frontier Merger Agreement or
to change the Board's recommendation with respect thereto. Trial with respect to
Frontier's Complaint and the Company's Answer and Counterclaims is currently
scheduled to begin on December 8, 2003. The Company believes that the claims
made by Frontier in the litigation are wholly without merit and that the
Company's counterclaims are well founded.
20
HOLLY CORPORATION
Note N - Refinery and Retail Assets Acquisition
Effective June 1, 2003, the Company acquired from ConocoPhillips the
Woods Cross Refinery, located near Salt Lake City, Utah, and related assets,
including a refined products terminal in Spokane, WA, and a 50% ownership
interest in refined products terminals in Boise and Burley, Idaho. The assets
were purchased for cash in an amount equal to $25 million less $4.2 million for
certain assumed pension obligations plus $35 million for crude oil, refined
product and other inventories. The Woods Cross Refinery has a crude oil capacity
of 25,000 barrels per day and has operated at close to capacity over the last
three years. The purchase also included certain pipelines and other
transportation assets used in connection with the refinery, 25 retail service
stations located in Utah and Wyoming (which were sold by the Company in August
2003), and a 10-year exclusive license to market fuels under the Phillips brand
in the states of Utah, Wyoming, Idaho and Montana.
Note O - Sale of Woods Cross Retail Assets
In August 2003, the Company sold its retail assets located in Utah and
Wyoming for $7 million less the Company's prorated share of property taxes and
certain transaction expenses of approximately $300,000 plus $1.8 million for
inventories. The sale resulted in a pre-tax loss for the Company of
approximately $393,000. The asset package included twenty-five operating retail
sites and three closed properties that the Company acquired from ConocoPhillips
on June 1, 2003 in the acquisition of the Woods Cross Refinery. The Company will
continue to supply the stations with fuel from its Woods Cross Refinery.
21
HOLLY CORPORATION
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
AND RESULTS OF OPERATIONS
This Item 2, including but not limited to the sections on "Liquidity
and Capital Resources" and "Additional Factors that May Affect Future Results,"
contains "forward-looking" statements. See "Forward-Looking Statements" at the
beginning of Part I.
RESULTS OF OPERATIONS
FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------------- ----------------------------
2003 2002 2003 2002
------------ ------------ ------------ ------------
(In thousands, except per share data)
Sales and other revenues ................................ $ 412,152 $ 266,467 $ 1,050,351 $ 703,572
Operating costs and expenses
Cost of products sold (exclusive of
depreciation,depletion, and amortization) ...... 327,719 224,158 863,305 572,474
Operating expenses (exclusive of
depreciation,depletion, and amortization) ...... 37,390 25,381 93,672 72,155
Selling, general and administrative expenses
(exclusive of depreciation,depletion, and
amortization) .................................. 10,023 6,094 22,335 16,654
Depreciation, depletion and amortization ............. 9,104 7,706 26,029 21,497
Exploration expenses, including dry holes ............ 160 231 623 1,048
------------ ------------ ------------ ------------
Total operating costs and expenses .............. 384,396 263,570 1,005,964 683,828
------------ ------------ ------------ ------------
Gain (loss) on sale of assets ........................... (393) -- 15,814 --
------------ ------------ ------------ ------------
Income from operations .................................. 27,363 2,897 60,201 19,744
Other income (expense)
Equity in earnings of joint ventures ................. 1,860 1,797 1,853 4,362
Interest expense, net ................................ (673) (404) (907) (1,188)
Reparations payment received ......................... 104 -- 15,330 --
------------ ------------ ------------ ------------
1,291 1,393 16,276 3,174
------------ ------------ ------------ ------------
Income before income taxes .............................. 28,654 4,290 76,477 22,918
Income tax provision .................................... 11,104 1,130 29,343 7,999
------------ ------------ ------------ ------------
Net income .............................................. $ 17,550 $ 3,160 $ 47,134 $ 14,919
============ ============ ============ ============
Net income per common share - basic ..................... $ 1.13 $ 0.20 $ 3.04 $ 0.96
Net income per common share - diluted ................... $ 1.09 $ 0.20 $ 2.94 $ 0.94
Average number of common shares outstanding:
Basic ................................................. 15,506 15,555 15,503 15,573
Diluted ............................................... 16,029 15,912 16,012 15,954
</Table>
22
HOLLY CORPORATION
BALANCE SHEET DATA (UNAUDITED)
<Table>
<Caption>
SEPTEMBER 30, DECEMBER 31, JULY 31,
2003 2002 2002
------------ ------------ ------------
(In thousands, except ratio data)
Cash and cash equivalents ...................................... $ 8,493 $ 24,266 $ 71,630
Working capital ................................................ $ (7,930) $ 13,523 $ 59,873
Total assets ................................................... $ 614,666 $ 514,680 $ 502,306
Total debt, including current maturities and borrowing under
the revolving credit agreement ............................. $ 40,714 25,714 34,285
Stockholders' equity ........................................... $ 271,148 $ 229,572 $ 228,556
Total debt to capitalization ratio(1) .......................... 13.1% 10.1% 13.0%
</Table>
(1) The total debt to capitalization ratio is calculated by dividing total
debt including current maturities and borrowings under the revolving
credit agreement, by the sum of total debt including current maturities
and borrowings under the revolving credit agreement, and stockholders'
equity.
OTHER FINANCIAL DATA (UNAUDITED)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
(In thousands) (In thousands)
Sales and other revenues(1)
Refining .......................... $ 404,167 $ 261,250 $ 1,030,821 $ 688,581
Pipeline Transportation ........... 3,535 4,902 11,153 14,043
Corporate and Other ............... 4,450 315 8,377 948
-------------- -------------- -------------- --------------
Consolidated ...................... $ 412,152 $ 266,467 $ 1,050,351 $ 703,572
============== ============== ============== ==============
Income (loss) from operations(1)
Refining .......................... $ 32,400 $ 3,515 $ 50,459 $ 19,662
Pipeline Transportation ........... 2,375 2,873 23,734 8,378
Corporate and Other ............... (7,412) (3,491) (13,992) (8,296)
-------------- -------------- -------------- --------------
Consolidated ...................... $ 27,363 $ 2,897 $ 60,201 $ 19,744
============== ============== ============== ==============
</Table>
23
HOLLY CORPORATION
<Table>
<Caption>
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------------------
2003 2002
-------------- --------------
(In thousands)
Net cash provided by operating activities ................ $ 76,251 $ 34,296
Net cash used for investing activities ................... $ (103,017) $ (23,468)
Net cash provided by (used for) financing activities ..... $ 10,993 $ (5,057)
EBITDA(2) ................................................ $ 103,413 $ 45,603
Net Income ............................................... $ 47,134 $ 14,919
Add provision for income tax .......................... 29,343 7,999
Add interest expense .................................. 1,292 1,934
Subtract interest income .............................. (385) (746)
Add depreciation and amortization ..................... 26,029 21,497
-------------- --------------
EBITDA(2) ................................................ $ 103,413 $ 45,603
============== ==============
</Table>
(1) 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), the recently acquired
Woods Cross Refinery near Salt Lake City, Utah, 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 600 miles (approximately 1,000
miles prior to the sale of pipelines as described in Note L to the Consolidated
Financial Statements) of the Company's pipeline assets in Texas and New Mexico.
Revenues of the Pipeline Transportation segment are earned through transactions
with unaffiliated parties for pipeline transportation, rental and terminalling
operations.
(2) Earnings before interest, taxes, depreciation and amortization - EBITDA is
calculated as net income plus (i) interest expense, (ii) less interest income,
(iii) plus income tax provision, and (iv) plus depreciation, depletion and
amortization. EBITDA is not a calculation based upon generally accepted
accounting principles; however, the amounts included in the EBITDA calculation
are derived from amounts included in the consolidated financial statements of
Holly. EBITDA should not be considered as an alternative to net income or
operating income, as an indication of operating performance of Holly or as an
alternative to operating cash flow as a measure of liquidity. EBITDA is not
necessarily comparable to similarly titled measures of other companies. EBITDA
is presented here because it enhances an investor's understanding of Holly's
ability to satisfy principal and interest obligations with respect to Holly's
indebtedness and to use cash for other purposes, including capital expenditures.
EBITDA is also used by Holly management for internal analysis and as a basis for
financial covenants. EBITDA is reconciled to net income in the second table
above.
24
HOLLY CORPORATION
REFINING SEGMENT OPERATING DATA (Unaudited)
<Table>
<Caption>
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
------------------------------- -------------------------------
2003 2002 2003 2002
-------------- -------------- -------------- --------------
Crude charge (BPD) (1) .................................. 93,160 61,320 76,850 63,140
Sales of all refined products (BPD) (2) ................. 110,564 82,284 95,221 79,301
Average sales price per sales barrel .................... $ 39.71 $ 34.45 $ 39.63 $ 31.77
Sales of produced refined products (BPD) ................ 100,892 69,153 84,232 70,429
Average sales price per produced barrel sold ............ $ 39.51 $ 34.00 $ 39.14 $ 31.36
Sales of purchased refined products (BPD) .............. 9,672 13,131 10,989 8,872
Average sales price per purchased barrel sold ........... $ 41.79 $ 36.83 $ 43.39 $ 34.99
Reconciliation of Sales and other revenues in
Consolidated Financial Statements (Also Note J
to Consolidated Financial Statements):
Sales of all refined products (BPD) ..................... 110,564 82,284 95,221 79,301
Average sales price per sales barrel .................... $ 39.71 $ 34.45 $ 39.63 $ 31.77
Refinery segment sales & other revenues ................. $ 404,167 $ 261,250 $ 1,030,821 $ 688,581
Pipeline transportation segment sales & other revenues... 3,535 $ 4,902 $ 11,153 $ 14,043
Corporate and other sales and other revenues ............ $ 4,450 $ 315 $ 8,377 $ 948
-------------- -------------- -------------- --------------
Consolidated sales and other revenues ................... $ 412,152 $ 266,467 $ 1,050,351 $ 703,572
============== ============== ============== ==============
Sales of produced refined products
Gasolines ............................................. 54.4 % 53.6 % 56.2 % 56.7 %
Diesel fuels .......................................... 23.6 % 21.9 % 22.9 % 21.2 %
Jet fuels ............................................. 7.6 % 10.4 % 8.0 % 10.5 %
Asphalt ............................................... 9.9 % 10.7 % 8.7 % 8.0 %
LPG and other ......................................... 4.5 % 3.4 % 4.2 % 3.6 %
-------------- -------------- -------------- --------------
Total ............................................ 100.0 % 100.0 % 100.0 % 100.0 %
============== ============== ============== ==============
</Table>
(1) Crude charge represents the barrels per day of crude oil processed through
the crude units at the Company's refineries. The Company acquired the
Woods Cross Refinery on June 1, 2003. For the quarter ended September 30,
2003, the crude charge represents the barrels per day of crude charged for
all three refineries. For the nine months ended September 30, 2003, the
crude charge represents the barrels per day charged with four months for
the Woods Cross Refinery included.
(2) In addition to revenues from sales of refined products, the refining
segment includes other miscellaneous revenues amounting to $241,000,
$459,000, $626,000, and $787,000, respectively.
RESULTS OF OPERATIONS - THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2003
COMPARED WITH THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2002
Summary
Net income for the three months ended September 30, 2003 was $17.6
million ($1.13 per basic share and $1.09 per diluted share) compared to net
income of $3.2 million ($.20 per basic and diluted share) for the three months
ended September 30, 2002. For the nine months ended September 30, 2003, net
income was $47.1 million ($3.04 per basic share and $2.94 per diluted share)
compared to $14.9 million ($.96 per basic share and $.94 per diluted share) for
the nine months ended September 30, 2002.
25
HOLLY CORPORATION
Net income before taxes for the third quarter ended September 30, 2003
increased by $24.4 million as compared to the prior year's third quarter
primarily due to approximately $42.0 million in improved refined product margins
(which the Company defines as the difference between refined product sales
prices and the costs for crude oil and other feedstocks exclusive of
depreciation, depletion and amortization), offset by $17.3 million of higher
operating, depreciation and administrative costs.
Net income before taxes for the nine months ended September 30, 2003
increased by $53.6 million compared to the nine months ended September 30, 2002
due to the $15.3 million reparation payment received as discussed in Note K to
the Consolidated Financial Statements, the $16.2 million gain on the sale of
pipeline assets as discussed in Note L to the Consolidated Financial Statements,
and approximately $56.3 million in higher refined product margins, offset by
$31.7 million of higher operating, depreciation and administrative costs.
Three Months Ended September 30, 2003 Compared with Three Months Ended September
30, 2002
For the third quarter of 2003, the Company's net income was $17.6
million compared to net income of $3.2 million in the third quarter of 2002. The
$24.4 million net increase in income before taxes for the quarter ended
September 30, 2003 as compared to the prior year's third quarter was due to
approximately $42.0 million in improved refined product margins offset by $17.3
million of higher operating, depreciation and administrative costs.
Revenues from the sale of refined products and other revenues increased
to $412.2 million in the third quarter of 2003 from $266.5 million in the third
quarter of 2002 due principally to the operations of the recently acquired Woods
Cross Refinery, and, to a lesser degree, to higher refined product sales prices
and higher refined product volumes sold. For the quarter ended September 30,
2003, refined product sales volumes increased and refined product margins
increased compared to the prior year's third quarter.
Cost of products sold for the third quarter of 2003 as compared to the
same quarter of 2002 increased by $103.6 million to $327.7 million primarily
reflecting the operations of the recently acquired Woods Cross Refinery, and to
a lesser degree, higher costs of crude oil.
Operating expenses increased $12.0 million to $37.4 million in the third
quarter of 2003 from $25.4 million in the third quarter of 2002 primarily due to
the operations of the recently acquired Woods Cross Refinery, and to a lesser
degree, higher utility costs, higher environmental costs and increased
compensation expense.
Selling, general and administrative expenses increased $3.9 million to
$10.0 million in the third quarter of 2003 from $6.1 million in the third
quarter of 2002 primarily due to the operations of the recently acquired Woods
Cross Refinery, and to a lesser degree, increases in compensation expense. Also,
in September the company expensed $2.1 million of costs previously deferred in
connection with the proposed merger with Frontier Oil Corporation.
Depreciation, depletion and amortization expenses increased $1.4 million
to $9.1 million for the three months ended September 30, 2003 from $7.7 million
for the three months ended September 30, 2002 due to higher depreciation expense
in connection with recent capital projects at the Navajo Refinery and the Woods
Cross Refinery acquisition.
26
HOLLY CORPORATION
Nine Months Ended September 30, 2003 Compared with Nine Months Ended September
30, 2002
Net income for the nine months ended September 30, 2003 was $47.1
million compared to $14.9 million for the nine months ended September 30, 2002.
The $53.6 million net increase in income before taxes for the nine months ended
September 30, 2003 compared to the nine months ended September 30, 2002 was due
to the $15.3 million reparation payment received as discussed in Note K to the
Consolidated Financial Statements, the $16.2 million gain on sale of pipeline
assets as discussed in Note L to the Consolidated Financial Statements, and
$56.3 million of higher refined product margins, offset by $31.7 million of
higher operating, depreciation and administrative costs.
Revenues from the sale of refined products and other revenues increased
to $1.050 billion in the first nine months of 2003 from $703.6 million in the
first nine months of 2002 due principally to the operations of the recently
acquired Woods Cross Refinery, and, to a lesser degree, to higher refined
product sales prices. Total product sales volumes and refined product margins
for the nine months ended September 30, 2003 increased from the levels for the
nine months ended September 30, 2002.
Cost of sales for the nine months ended September 30, 2003 increased to
$863.3 million from $572.5 million for the nine months ended September 30, 2002.
The $290.8 million increase was primarily due to the operations of the recently
acquired Woods Cross Refinery, and, to a lesser degree, to higher costs of crude
oil, and higher production volumes.
Operating expenses increased $21.5 million to $93.7 million in the first
nine months of 2003 from $72.2 million in the first nine months of 2002
primarily due to the operations of the recently acquired Woods Cross Refinery,
and, to a lesser degree, to higher utility costs, higher environmental costs,
increased insurance costs and increased compensation expense.
Selling, general and administrative expenses increased $5.6 million to
$22.3 million in the first nine months of 2003 from $16.7 million in the first
nine months of 2002 primarily due to the operations of the recently acquired
Woods Cross Refinery, and to a lesser degree, increases in corporate development
costs associated with the consideration of various strategic alternatives and
increases in compensation expense offset by decreases in costs associated with
legal proceedings. Also, in September the company expensed $2.1 million of costs
previously deferred in connection with the proposed merger with Frontier Oil
Corporation.
Depreciation, depletion and amortization expenses increased $4.5 million
to $26.0 million for the nine months ended September 30, 2003 from $21.5 million
for the nine months ended September 30, 2002, due to the recent acquisition of
the Woods Cross Refinery and to a higher depreciation expense in connection with
recent capital projects.
Equity in earnings of joint ventures declined substantially to $1.9
million for the nine months ended September 30, 2003, from $4.4 million in
income for the nine months ended September 30, 2002. The $2.5 million decline
resulted primarily from lower earnings at the asphalt joint ventures offset by
higher earnings at the Rio Grande joint venture, primarily because of the
Company's increased ownership percentage.
27
HOLLY CORPORATION
LIQUIDITY AND CAPITAL RESOURCES
Cash and cash equivalents decreased by $15.8 million during the nine
months ended September 30, 2003. The reduction in cash was due to $52.6 million
in capital expenditures, principally for the Navajo Refinery's gas oil
hydrotreater and refinery expansion projects, $55.8 million expended to acquire
the Woods Cross Refinery, retail assets and inventories, and $28.7 expended for
the purchase of an additional 45% interest in the Rio Grande joint venture,
offset by cash inflows from operating activities of $76.3 million, $15 million
in net borrowings under the company's credit agreement, $24 million of proceeds
from the sale of pipeline assets, and $8.5 million in proceeds from the sale of
retail assets. Cash flows provided by operating activities included receipt of
$15.3 million of reparation payments from Kinder Morgan.
On October 30, 2001, the Company announced plans to repurchase up to
$20 million of the Company's common stock. Such repurchases have been made from
time to time in open market purchases or privately negotiated transactions,
subject to price and availability. The repurchases have been financed with
currently available corporate funds. During the nine months ended September 30,
2003, the Company repurchased 43,000 shares at a cost of approximately $894,000
or an average of $20.79 per share. From inception of the plan through October
31, 2003, the Company has repurchased 272,400 shares at a cost of approximately
$4.7 million. No stock repurchases have been made since February 7, 2003.
In December 2001, an agreement was reached among the Company, the
Environmental Protection Agency, the New Mexico Environment Department, and the
Montana Department of Environmental Quality with respect to a global settlement
of issues concerning the application of air quality requirements to past and
future operations of the Company's refineries. The Consent Decree implementing
this agreement requires investments by the Company currently expected to total
between $15 million and $17 million over a period expected to end in 2009, of
which approximately $7 million has been expended to date, for the installation
of certain state of the art pollution control equipment at the Company's New
Mexico and Montana refineries.
In May 2003, the Company amended its Revolving Credit Agreement with
a group of banks led by Canadian Imperial Bank of Commerce and increased the
commitment from $75 million to $100 million. The Company now has access to $100
million of commitments that can be used for revolving credit loans and letters
of credit. Previously the Company had access to $75 million of commitments of
which only $37.5 million could be used for revolving credit loans. At September
30, 2003 the Company had letters of credit outstanding under the facility of
$12.6 million and had $15 million borrowings outstanding.
On June 1, 2003, the Company acquired from ConocoPhillips the Woods
Cross Refinery, located near Salt Lake City, Utah, and related assets, including
a refined products terminal in Spokane, WA, and a 50% ownership interest in
refined product terminals in Boise and Burley, Idaho. The assets were purchased
for cash in an amount equal to $25 million less $4.2 million for certain assumed
pension obligations plus $35 million for crude oil, refined product and other
inventories.
28
HOLLY CORPORATION
On March 3, 2003, the Company sold its Iatan crude oil gathering
pipeline system located in West Texas to Plains Marketing L.P. for a purchase
price of $24 million in cash. In connection with the transaction, the Company
and Plains entered into a six and one-half year agreement which commits the
Company to transport any crude oil purchased by the Company in the relevant area
on the Iatan system at an agreed upon tariff. The sale resulted in a pre-tax
gain for the Company of approximately $16.2 million.
The Company believes its internally generated cash flow together with
its Credit Agreement should provide adequate resources to fund planned capital
projects, scheduled repayments of the Senior Notes, continued payment of
dividends (although dividend payments must be approved by the Board of Directors
and cannot be guaranteed) and the Company's current liquidity needs.
Cash Flows from Operating Activities
Cash flows provided by operating activities for the first nine months of
2003 were $76.3 million. For the comparable nine month period of 2002, cash
provided by operating activities was $34.3 million. The $42.0 million increase
in cash provided by operating activities for the first nine months of 2003 as
compared to the first nine months of 2002 was primarily due to an increase in
operating income, principally resulting from higher refined product margins,
gain on the sale of assets of $16.2 million, and $15.3 million of reparation
payments received as discussed in Note K to the Consolidated Financial
Statements. In the first nine months of 2003, changes in working capital items
provided $19.6 million as compared to the first nine months of 2002 when changes
in working capital used $2.1 million.
Cash Flows from Financing Activities
Cash flows provided by financing activities were $11.0 million for the
nine months ended September 30, 2003, as compared to $5.1 million used in the
same period of the prior year. During the first nine months of 2003, the Company
incurred net borrowing under its credit facility of $15 million, incurred
$185,000 in debt issuance costs in connection with increasing the size of its
credit facility, spent $894,000 to repurchase 43,000 shares of common stock,
paid $3.4 million in dividends and received $481,000 upon the exercise of
options to acquire 31,200 shares of common stock. During the first nine months
of 2002, the Company spent $2.5 million to repurchase 153,400 shares of its
common stock, paid $3.3 million in dividends and received $1.3 million upon the
exercise of options to acquire 99,800 shares of common stock.
Cash Flows Used for Investing Activities and Capital Projects
Cash flows used for investing activities were $103.0 million for the
nine months ended September 30, 2003, as compared to $23.5 million for the same
period of 2002. Cash expenditures for property, plant and equipment for the
first nine months of the current and prior years were $52.6 million and $31.2
million respectively. Most of the increase is due to the Navajo Refinery's gas
oil hydrotreater and expansion projects. Also in the nine months ended September
30, 2003, the Company spent $55.8 million to acquire the Woods Cross Refinery,
retail assets and inventories, $28.7 million for the purchase of an additional
45% interest in the Rio Grande joint venture and $3.3 million for investments in
the asphalt joint venture. The Company's net cash flow used for investing
activities was reduced during the first nine months of 2003 by a $4.9 million
distribution to the Company from the asphalt joint venture, by $24 million in
proceeds from the sale of a crude oil gathering pipeline system located in West
Texas
29
HOLLY CORPORATION
as discussed in Note L to the Consolidated Financial Statements and by $8.5
million in proceeds from the sale of retail assets as discussed in Note O to the
Consolidated Financial Statements. During the first nine months of 2002, the
Company's net cash flow used by investing activities was reduced by a $2 million
distribution to the Company from the Rio Grande Pipeline joint venture, an $8.5
million distribution to the Company from the asphalt joint venture and by
$460,000 in proceeds for the sale of a 1% interest in the asphalt joint venture,
offset by $3.3 million in investments in the asphalt joint venture.
In November 1997, the Company purchased a hydrotreater unit for $5.1
million from a closed refinery. This purchase gave the Company the ability to
reconstruct the unit at the Navajo Refinery at an estimated savings of
approximately $20.0 million as compared to the purchase cost of a new unit. From
November 1997 through October 2003, in addition to the purchase of the
hydrotreater unit, the Company spent approximately $60.4 million on relocation,
engineering, equipment fabrication, and construction related to the hydrotreater
and expansion projects. The construction of the hydrotreator project was
completed in July 2003 and the Company expects that the expansion project will
be completed in December 2003. The remaining costs to complete the expansion
project are estimated to be approximately $14.2 million. The hydrotreater will
enhance higher value light product yields and expand the Company's ability to
produce additional quantities of gasolines meeting the present California Air
Resources Board ("CARB") standards, which have been adopted in the Company's
Phoenix market for winter months beginning in late 2000, and to meet the
recently adopted EPA nationwide low-sulfur gasoline requirements scheduled to
begin in 2004. In 2001 the Company completed the construction of a new
additional sulfur recovery unit, which is currently utilized to enhance
high-sulfur crude processing capabilities and will provide sufficient capacity
to recover the additional extracted sulfur that will result from operation of
the hydrotreater.
Contemporaneous with the hydrotreater project, the Navajo Refinery is
making necessary modifications to several of the Artesia processing units for
the first phase of Navajo's expansion, which will increase crude oil refining
capacity from 60,000 BPD to approximately 75,000 BPD. The first phase of the
expansion is expected to be completed in December 2003. Additional air emission
permits have been obtained to implement needed modifications at Navajo's
Lovington, New Mexico refining facility, which is operated in conjunction with
the Artesia facility. It is envisioned that these necessary modifications to the
Lovington facility will also be completed in December 2003. The permits received
by Navajo to date for the Artesia facility, subject to possible minor
modifications, should also permit a second phase expansion of Navajo's crude oil
capacity from an estimated 75,000 BPD to an estimated 80,000 BPD, but a schedule
for such additional expansion has not been determined. The Company's estimate of
the total cost of the hydrotreater project and the first phase expansion
project, not including the $5.1 million original purchase price for the
hydrotreater unit, has increased to approximately $74.6 million from the
Company's original estimate of approximately $56 million due to the increased
costs and scope of certain refinery infrastructure upgrades, added refining
capacity and sulfur recovery capabilities, and increased actual costs of
previously estimated portions of the projects.
30
HOLLY CORPORATION
Effective June 1, 2003, the Company acquired from ConocoPhillips the
Woods Cross Refinery located near Salt Lake City, Utah and related assets. The
assets were purchased for $25 million less $4.2 million for certain assumed
pension obligations plus $35 million for crude oil, refined product and other
inventories. The Woods Cross Refinery has a crude oil capacity of 25,000 barrels
per day and has operated at close to capacity over the last three years. The
purchase also included certain pipelines and other transportation assets used in
connection with the refinery, 25 retail service stations located in Utah and
Wyoming, and a 10-year exclusive license to market fuels under the Phillips
brand in the states of Utah, Wyoming, Idaho and Montana. The retail service
stations were subsequently sold by the Company in August 2003 for $7 million
less the Company's prorated share of property taxes and certain transaction
expenses of approximately $300,000 plus $1.8 million for the value of the
inventories.
The Company leases from Mid-America Pipeline Company more than 300 miles
of 8" pipeline running from Chaves County to San Juan County, New Mexico (the
"Leased Pipeline"). The Company owns and operates 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 leased 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, additional pump stations
could further increase the pipeline's capabilities.
Contractual Obligations and Commitments
The following table presents long-term contractual obligations of the
Company in total and by period due. These items include the Company's long-term
debt based on maturity dates and the Company's operating lease commitments. The
Company's operating leases contain renewal options that are not reflected in the
table below and that are likely to be exercised.
<Table>
<Caption>
PAYMENTS DUE BY PERIOD
---------------------------------------------------
LESS THAN
CONTRACTUAL OBLIGATIONS TOTAL 1 YEAR 2-3 YEARS 4-5 YEARS OVER 5 YEARS
---------- ---------- ---------- ---------- ------------
(In thousands)
Long-term debt (stated maturities) ...... $ 25,714 $ 8,571 $ 17,143 $ -- $ --
Operating leases ......................... $ 23,291 $ 6,091 $ 11,976 $ 4,937 $ 287
</Table>
In July 2000, Navajo Western Asphalt Company ("Navajo Western"), a
wholly-owned subsidiary of the Company, and a subsidiary of Koch Materials
Company ("Koch") formed a joint venture, NK Asphalt Partners, to manufacture and
market asphalt and asphalt products in Arizona and New Mexico under the name
"Koch Asphalt Solutions - Southwest." Navajo Western contributed all of its
assets to NK Asphalt Partners and Koch contributed its New Mexico and Arizona
asphalt and manufacturing assets to NK Asphalt Partners. All asphalt produced at
the Navajo Refinery is sold at market prices to the joint venture under a supply
agreement. The Company is required to make additional contributions to the joint
venture of up
31
HOLLY CORPORATION
to $3,250,000 for each of the next seven years contingent on the earnings level
of the joint venture. In the event that Holly fails to make the required
contributions, Holly may lose its voting rights during such default and the
other partner could cause the partnership to bring a proceeding to collect the
unpaid contributions plus interest at the prime rate plus 2%.
As part of the Consent Decree filed December 2001 implementing an
agreement reached among the Company, the Environmental Protection Agency, the
New Mexico Environment Department, and the Montana Department of Environmental
Quality, the Company is required to make investments at the Company's New Mexico
and Montana refineries for the installation of certain state of the art
pollution control equipment currently expected to total between $15 million and
$17 million over a period expected to end in 2009, of which approximately $7
million has been expended.
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/A, as amended, for the fiscal year
ended July 31, 2002.
The proposed Longhorn Pipeline, which is owned by Longhorn Partners
Pipeline, L.P. ("Longhorn Partners"), is an additional potential source of
pipeline transportation 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. 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. Although most construction has been completed,
the Longhorn Pipeline will not begin operations until the completion of certain
agreed improvements and pre-start-up steps. Published reports indicate that
construction in preparation for start-up of the Longhorn Pipeline continued
until late July 2002, when the construction activities were halted before
completion of the project. The latest public statements from Longhorn Partners
indicate that Longhorn Partners is seeking additional financing to complete the
project and that no specific date for commencement of operations is currently
set. The proposed operation of the Longhorn Pipeline is also the subject of a
pending appeal in the United States Court of Appeals for the Fifth Circuit of a
decision by the federal district court in Austin, Texas that allows the Longhorn
Pipeline to begin operations when agreed improvements have been completed. This
appeal seeks a ruling that would reverse the federal district court's decision
and require a full environmental impact study before the Longhorn Pipeline is
allowed to operate.
If the Longhorn Pipeline operates as currently proposed, lower
requirements for capital investment permitted by the direct route could allow
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 (which the
Company defines as the difference between refined product sales prices and the
costs for crude oil and other feedstocks exclusive of depreciation, depletion
and amortization) in El Paso and related markets. However, any effects on the
Company's markets in Tucson and Phoenix, Arizona and Albuquerque, New Mexico
would be expected to be limited in the next few years because current common
carrier pipelines from El Paso to these markets are now running at capacity and
proration policies of these pipelines allocate only limited capacity to new
shippers. Although the Company's results of operations might be adversely
impacted and 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 enhancements to operational
32
HOLLY CORPORATION
efficiency, the Company's position in El Paso and markets served from El Paso
could withstand a period of lower prices and refined product margins that might
result from operation of the Longhorn Pipeline as currently proposed.
As a result of the Company's settlement in November 2002 of litigation
with Longhorn Partners on November 26, 2002 the Company prepaid $25,000,000 to
Longhorn Partners for the shipment of 7,000 BPD of refined products from the
Gulf Coast to El Paso in a period of up to 6 years from the date the Longhorn
Pipeline begins operations if such operations begin by July 1, 2004. Under the
agreement, the prepayment would cover shipments of 7,000 BPD by the Company for
approximately 4 1/2 years assuming there were no curtailments of service once
operations began. The Company plans to make use of the prepaid transportation
services to ship purchased refined products on the Longhorn Pipeline to meet
obligations of the Company to deliver refined products to customers in El Paso.
These transportation services are expected to be of benefit to the Company
because the Company believes that most or all of such refined products shipped
by the Company on the Longhorn Pipeline would take the place of products that
would otherwise have been purchased by the Company from other suppliers.
At the date of this report, it is not possible to predict whether and,
if so, under what conditions, the Longhorn Pipeline will ultimately be operated,
nor is it possible to predict the overall impact on the Company if the Longhorn
Pipeline does not ultimately begin operations or begins operations at different
possible future dates. Under the terms of the November 2002 settlement agreement
that terminated litigation between the Company and Longhorn Partners, the
Company would have an unsecured claim for repayment of the Company's $25,000,000
prepayment to Longhorn Partners for transportation services in the event the
Longhorn Pipeline did not begin operations by July 1, 2004 or announced that it
would not begin operations by that date.
In August 2003, the Defense Energy Support Center ("DESC"), a part of
the United States Department of Defense, awarded contracts to the Company for
sales of military jet fuel for the period October 1, 2003 through September 30,
2004. The Company's total contract award, which is subject to adjustment based
on actual needs of the DESC for military jet fuel, was approximately 85 million
gallons as compared to the total award for the 2002-2003 contract year of
approximately 130 million gallons. Because of the pendency of the proposed
merger with Frontier Oil Corporation at the time of the bidding for these
contracts, the Company was no longer eligible for favorable small refiner status
in the bidding process. In consequence of the Company's ineligibility for small
refiner status in this bidding process, the Company's final bid prices were less
and the volumes for which the Company was the successful bidder were smaller
than in the case of military jet fuel contracts in prior years, when the Company
was eligible for small refiner status. The Company estimates that the result of
its ineligibility for small refiner status in the 2003-2004 contract year will
be a reduction in net income of approximately $1 to $2 million for the twelve
months ending September 30, 2004.
Proposed Merger of Company and Frontier Oil Corporation and Related Litigation
On March 31, 2003, Frontier Oil Corporation ("Frontier") and the
Company announced an agreement (the "Frontier Merger Agreement") pursuant to
which the two companies would be combined. The combined company would be called
Frontier Oil Corporation and would be headquartered in Houston, Texas. Terms of
the Frontier Merger Agreement provided for the Company's stockholders to receive
one share of Frontier common stock for each share of Holly common stock, plus an
aggregate cash payment of $172.5 million or approximately $11.13 per
33
HOLLY CORPORATION
common share based on the current number of outstanding Holly shares. The
Company has approximately 15.5 million common shares outstanding, and Frontier
has approximately 26.2 million common shares outstanding. The Company's
stockholders would also retain a non-transferable interest in potential future
recoveries in litigation related to past sales of jet fuel to the United States
government. The transaction was expected to be non-taxable to the shareholders
of both companies, except for the cash consideration and contingent value rights
to be received by Holly stockholders. The Frontier Merger Agreement contained
reciprocal provisions for the payment of $15 million in termination fees, plus
up to $1 million of expenses, under certain circumstances. A registration
statement on Form S-4 relating to the merger was initially filed with the
Securities and Exchange Commission on May 13, 2003 by Front Range Himalaya
Corporation, and later amended on June 27, 2003 and August 7, 2003.
On August 20, 2003, Frontier filed a lawsuit in the Delaware Court of
Chancery seeking declaratory relief and damages based on allegations that the
Company repudiated its obligations under the Frontier Merger Agreement. On
August 21, 2003, the Company formally notified Frontier of the Company's
position that pending and threatened toxic tort litigation with respect to oil
properties operated by a subsidiary of Frontier from 1985 to 1995 adjacent to
the campus of Beverly Hills High School constitute a breach of Frontier's
representations and warranties in the Frontier Merger Agreement as to the
absence of litigation or other circumstances which could reasonably be expected
to have a material adverse effect on Frontier. Under the Frontier Merger
Agreement, if a breach occurs and is not timely cured, the Company is not
obligated to close the merger and has the right to terminate the Frontier Merger
Agreement. On September 2, 2003, the Company filed in the Delaware Court of
Chancery its Answer and Counterclaims seeking declaratory judgments that the
Company did not repudiate the Frontier Merger Agreement, that Frontier has
repudiated the Frontier Merger Agreement, that Frontier has breached certain
representations made by Frontier in the Frontier Merger Agreement, that the
Company's obligations under the Frontier Merger Agreement were and are excused
and that the Company may terminate the Frontier Merger Agreement without
liability, and seeking damages in an unspecified amount as well as costs and
attorneys' fees. To the date of this report, the Company's Board of Directors
has not taken action under the provisions of the Frontier Merger Agreement
relating to the Company's rights to terminate the Frontier Merger Agreement or
to change the Board's recommendation with respect thereto. Trial with respect to
Frontier's Complaint and the Company's Answer and Counterclaims is currently
scheduled to begin on December 8, 2003. The Company believes that the claims
made by Frontier in the litigation are wholly without merit and that the
Company's counterclaims are well founded.
Other legal proceedings that could affect future results are described
in Part II, 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 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 eliminating the exposure would
outweigh the benefit.
The Company's profitability depends largely on the spread between market
prices for refined products and market prices for crude oil. A substantial or
prolonged reduction in this spread could have a significant negative effect on
the Company's earnings, financial condition
34
HOLLY CORPORATION
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. In December 2002, the Company entered into
cash flow hedges relating to certain forecasted transactions to buy crude oil
and sell gasoline in March 2003. The purpose of the hedges was to help protect
the Company from the risk that the refined product margin would decline with
respect to the hedged crude oil and refined products. To effect the hedges, the
Company entered into gasoline and crude oil futures transactions. Gains and
losses reported in other comprehensive income were reclassified into income when
the forecasted transactions affected income. As of September 30, 2003, there
were no hedges outstanding.
At September 30, 2003, the Company had outstanding unsecured debt of
$25.7 million and had $15 million of 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 less than two years and such debt represents approximately 13.1% of
the Company's total capitalization. As the interest rates on the Company's bank
borrowings are reset frequently based on either the bank's daily effective prime
rate, or the LIBOR rate, interest rate market risk is very low. The Company used
borrowings under its credit agreement to help finance the purchase of Wood Cross
Refinery and the purchase of an additional 45% interest in the Rio Grande joint
venture. The maximum borrowing under the credit agreement during the first nine
months of 2003 was $50 million. 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 one percent change in the market interest rate over
the next year would not materially impact the Company's earnings or cash flow
since the interest rates on the Company's long-term debt are fixed and the
Company's borrowings under the Credit Agreement, if any, 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 one percent
change in the market interest rate over the next year would not materially
impact the Company's financial condition since the average maturity of the
Company's long-term debt is less than two years, such debt represents
approximately 13.1% of the Company's total capitalization, and the Company's
borrowings 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. Shortly
after the events of September 11, 2001, the Company completed a security
assessment of its principal facilities. Several security measures identified in
the assessment have been implemented and others are in the process of being
implemented. Because of recent changes in insurance markets, insurance coverages
available to the Company are becoming more costly and in some cases less
available. So long as this current trend continues, the Company expects to incur
higher insurance costs and anticipates that, in some cases, it will be necessary
to reduce somewhat the extent of insurance coverages because of reduced
insurance availability at acceptable premium costs.
35
HOLLY CORPORATION
NEW ACCOUNTING PRONOUNCEMENTS
In June 2001, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standard ("SFAS") No. 142 "Goodwill and Other
Intangible Assets" which 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, are immediately subject to the provisions of this statement. The Company
adopted the standard effective August 1, 2002 and there was no material effect
on its financial condition, results of operations, or cash flows.
In June 2001, FASB issued SFAS No. 143 "Accounting for Asset Retirement
Obligations" which 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 adopted the standard effective August 1, 2002 and there was no
material effect on the Company's financial condition, results of operations, or
cash flows.
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. SFAS No. 144 is effective for fiscal years beginning after December 15,
2001, with early adoption permitted. The Company adopted the standard effective
August 1, 2002 and there was no material effect on its financial condition,
results of operations, or cash flows.
In June 2002, FASB issued SFAS No. 146 "Accounting for Certain Costs
Associated with Exit or Disposal Activities" which nullifies Emerging Issues
Task Force ("EITF") 94-3 and requires that a liability for a cost associated
with an exit or disposal activity be recognized when the liability is incurred
and establishes fair value as the objective for initial measurement of
liabilities. This differs from EITF 94-3 which stated that liabilities for exit
costs were to be recognized as of the date of an entity's commitment to an exit
plan. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. The Company adopted the standard on January
1, 2003, and there was no material effect on its financial condition, results of
operations, or cash flows.
In December 2002, FASB issued SFAS No. 148 "Accounting for Stock-Based
Compensation--Transition and Disclosure," an amendment of SFAS No. 123. This
statement provides alternative methods of transition to SFAS 123's fair value
method of accounting for stock-based employee compensation. In addition, this
statement amends the disclosure requirements of SFAS 123 to require disclosures
in both annual and interim financial statements about the method of accounting
for stock-based employee compensation and the effect of the method used on
reported results. SFAS 148's amendment of the disclosure requirements is
effective for interim periods beginning after December 15, 2002. SFAS 148's
amendment of the transition and annual disclosure requirements of SFAS 123 is
effective for fiscal years ending after December 15, 2002. See Note D to the
Consolidated Financial Statements for the effect of this standard on the
Company's financial condition, results of operations, or cash flows.
36
HOLLY CORPORATION
In January 2003, the FASB issued Interpretation No. 45, "Guarantor's Accounting
and Disclosure Requirement for Guarantees, including Indirect Guarantees of
Indebtedness of Others" ("FIN 45"). FIN 45 requires an entity to recognize a
liability for the obligations it has undertaken in issuing a guarantee. This
liability would be recorded at the inception of a guarantee and would be
measured at fair value. Certain guarantees are excluded from the measurement and
disclosure provisions while certain other guarantees are excluded from the
measurement provisions of the interpretation. The Company adopted the standard
on January 1, 2003 and there was no material effect on its financial condition,
results of operations, or cash flows.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"). FIN 46 requires an entity to consolidate
a variable interest entity if it is designated as the primary beneficiary of
that entity and if the entity does not have a majority of voting interests. A
variable interest entity is generally defined as an entity where its equity is
unable to finance its activities or where the owners of the entity lack the risk
and rewards of ownership. The provisions of FIN 46 apply at inception for any
entity created after January 31, 2003. For an entity created before February 1,
2003, the provisions of this interpretation must be applied at the beginning of
the first interim period beginning after June 15, 2003. The Company is not the
primary beneficiary of any variable interest entities, and accordingly, the
adoption of FIN 46 by the Company on July 1, 2003 had no material effect on the
Company's financial condition, results of operations, or cash flows.
In May 2003, FASB issued SFAS No. 150 "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity." This statement
establishes standards for how an issuer classifies and measures certain
financial instruments with characteristics of both liabilities and equity. This
statement will result in a more complete depiction of an entity's liabilities
and equity and will thereby assist investors and creditors in assessing the
amount, timing, and likelihood of potential future cash outflows and equity
share issuances. This statement is effective for financial instruments entered
into or modified after May 31, 2003 and otherwise is effective at the beginning
of the first interim period beginning after June 15, 2003. It is to be
implemented by reporting the cumulative effect of a change in an accounting
principle for financial instruments created before the issuance date of the
statement and still existing at the beginning of the interim period of adoption.
Restatement is not permitted. The Company adopted the standard on July 1, 2003
and there was no material effect on its financial condition, results of
operations, or cash flows.
The American Institute of Certified Public Accountants has issued an
Exposure Draft for a Proposed Statement of Position, "Accounting for Certain
Costs and Activities Related to Property, Plant and Equipment," which would
require major maintenance activities to be expensed as costs are incurred. As of
September 30, 2003, the Company had approximately $7.8 million of deferred
maintenance costs, all relating to refinery turnarounds in prior periods, which
are being amortized over various benefit periods. The current monthly
amortization is $799,000. If this proposed Statement of Position had been
adopted in its current form, as of September 30, 2003, the Company would have
been required to expense, as of September 30, 2003, $7.8 million of deferred
maintenance costs and would be required to expense all future turnaround costs
as incurred.
37
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."
Item 4. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
The Company's principal executive officer and principal financial
officer have evaluated, as required by Rule 13a-15(b) under the Securities
Exchange Act of 1934 (the "Exchange Act"), the Company's disclosure controls and
procedures (as defined in Exchange Act Rule 13a-15(e)) as of the end of the
period covered by this quarterly report on Form 10-Q. Based on that evaluation,
these officers concluded that the design and operation of the Company's
disclosure controls and procedures are effective in ensuring that information
required to be disclosed by the Company in the reports that it files or submits
under the Exchange Act is recorded, processed, summarized and reported, within
the time periods specified in the Securities and Exchange Commission's rules and
forms.
(b) Changes in internal control over financial reporting.
During the period covered by this quarterly report on Form 10-Q, there
was no change in the Company's internal control over financial reporting
identified in connection with the Company's evaluation of its disclosure
controls and procedures required by Exchange Act Rule 13a-15(b) that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control over financial reporting.
38
HOLLY CORPORATION
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
On August 20, 2003, Frontier Oil Corporation ("Frontier") filed a
lawsuit in the Delaware Court of Chancery seeking declaratory relief and damages
based on allegations that the Company repudiated its obligations under an
agreement (the "Frontier Merger Agreement") announced in late March 2003 under
which Frontier and the Company would be combined. On August 21, 2003, the
Company formally notified Frontier of the Company's position that pending and
threatened toxic tort litigation with respect to oil properties operated by a
subsidiary of Frontier from 1985 to 1995 adjacent to the campus of Beverly Hills
High School constitute a breach of Frontier's representations and warranties in
the Frontier Merger Agreement as to the absence of litigation or other
circumstances which could reasonably be expected to have a material adverse
effect on Frontier. Under the Frontier Merger Agreement, if a breach occurs and
is not timely cured, the Company is not obligated to close the merger and has
the right to terminate the Frontier Merger Agreement. On September 2, 2003, the
Company filed in the Delaware Court of Chancery its Answer and Counterclaims
seeking declaratory judgments that the Company did not repudiate the Frontier
Merger Agreement, that Frontier has repudiated the Frontier Merger Agreement,
that Frontier has breached certain representations made by Frontier in the
Frontier Merger Agreement, that the Company's obligations under the Frontier
Merger Agreement were and are excused and that the Company may terminate the
Frontier Merger Agreement without liability, and seeking damages in an
unspecified amount as well as costs and attorneys' fees. To the date of this
report, the Company's Board of Directors has not taken action under the
provisions of the Frontier Merger Agreement relating to the Company's rights to
terminate the Frontier Merger Agreement or to change the Board's recommendation
with respect thereto. Trial with respect to Frontier's Complaint and the
Company's Answer and Counterclaims is currently scheduled to begin on December
8, 2003. The Company believes that the claims made by Frontier in the litigation
are wholly without merit and that the Company's counterclaims are well founded.
The status of this matter as of September 12, 2003, the original filing date of
the Company's transition period report on Form 10-Q for the period August 1 to
December 31, 2002, is set forth in the Company's report on Form 10-Q/A for the
period August 1 to December 31, 2002.
In the Company's pending lawsuit in the United States Court of Federal
Claims against the Department of Defense relating to claims totaling
approximately $298 million with respect to jet fuel sales by two subsidiaries in
the years 1982 through 1999, the judge before whom the case is pending issued in
late October 2003 a ruling that denied the Government's motion for partial
summary judgment on all issues raised and granted the Company's motion for
partial summary judgment on most of the issues raised by the Company. The ruling
on the motions for summary judgment in the Company's case does not constitute a
final ruling for the Company as to the Company's claims but instead the judge's
ruling is expected to be followed by substantial discovery proceedings and then
a trial on factual issues. Additionally, in late October and early November, two
other judges of the United States Court of Federal Claims certified issues for
interlocutory appeal to the United States Court of Appeals for the Federal
Circuit (the "Court of Appeals") in cases relating to jet fuel sales of two
other refining companies. The rulings by the United States Court of Federal
Claims judges in these two cases were favorable to the position of the refining
company in one case and favorable to the position of the Government in the other
case. The Court of Appeals has not yet ruled as to whether it will agree to hear
the proposed appeals at this stage in the proceedings. If the Court of Appeals
agrees to hear appeals on the certified issues in these related cases, rulings
on the certified issues could substantially affect the Company's claims. It is
not possible at the date of this report to predict the outcome of further
39
HOLLY CORPORATION
proceedings in the Company's case or the impact on the Company's case of any
decisions by the Court of Appeals in related cases, nor is it possible to
predict what amount, if any, will ultimately be payable to the Company with
respect to the Company's lawsuit. The status of this matter as of the original
filing dates of prior reports for periods after July 31, 2002 is described in
the Company's reports on Form 10-Q/A, as amended, for the fiscal quarters ended
October 31, 2002, January 31, 2003 and April 30, 2003 and on Form 10-Q/A for the
transition period August 1 to December 31, 2002.
In September 2002, the Federal Energy Regulatory Commission ("FERC")
issued an order in proceedings brought by the Company and other parties against
Kinder Morgan's SFPP, L.P. ("SFPP") relating to tariffs of common carrier
pipelines, which are owned and operated by SFPP, for shipments of refined
products from El Paso, Texas to Tucson and Phoenix, Arizona and from points in
California to points in Arizona. The Company is one of several refiners that
regularly utilize an SFPP pipeline to ship refined products from El Paso, Texas
to Tucson and Phoenix, Arizona. The September 2002 order resolved most remaining
issues relating to SFPP's tariffs on the pipelines to points in Arizona,
including issues related to payments made by the Company for shipments of
petroleum products from El Paso, Texas to Tucson and Phoenix, Arizona
principally for the period from 1993 through July 2000. In January 2003, the
FERC issued an order accepting most of the computations prepared by SFPP
pursuant to the September 2002 order and requiring a change in one item. In
April 2003, the Company received $15.2 million from Kinder Morgan as payment for
the reparations initially ordered by FERC and such amount was included as
reparations payment received in net income in April 2003. In June 2003, the FERC
issued a further order requiring an adjustment in the computations which has
resulted in an additional payment to the Company of approximately $104,000,
which was included in net income for the quarter ended September 30, 2003. The
final FERC decision on this matter is subject to judicial review by the Court of
Appeals for the District of Columbia Circuit, which on November 12, 2003 heard
oral argument on this case. In the event SFPP prevails in whole or in part in
this judicial review, the reparations actually owed may be less than the $15.3
million received by the Company with respect to this matter, and in that event
part or all of the amounts received by the Company would have to be refunded. At
the date of this report, it is not possible to predict the result of judicial
review proceedings on this matter in the Court of Appeals for the District of
Columbia Circuit. The status of this matter as of the original filing dates of
prior reports for periods after July 31, 2002 is described in the Company's
reports on Form 10-Q/A, as amended, for the fiscal quarters ended October 31,
2002, January 31, 2003 and April 30, 2003 and on Form 10-Q/A for the transition
period August 1 to December 31, 2002.
In October 2002, the Company filed a motion to intervene and protest
with the FERC with respect to a September 2002 petition for declaratory order
filed by SFPP. SFPP's filing concerns its proposal to expand the capacity of its
common carrier pipelines running from El Paso to Tucson and Phoenix by
approximately 54,000 BPD. The Company's protest asked the FERC to rule that the
costs of the proposed expansion should be reflected only in pipeline
transportation rates for use of the proposed additional capacity rather than in
rates for use of both the proposed additional capacity and the current capacity
of these pipelines. In January 2003, the FERC issued an order that, along with
addressing other issues, did not accept the Company's position. In March 2003,
the Company filed with the FERC a request for rehearing on this matter. In July
2003, the FERC issued an Order on Rehearing that denied the Company's request
for rehearing. The Company expects to take no further action with respect to
SFPP's September 2002 petition for declaratory order. The status of this matter
as of the original filing dates of prior reports for periods after July 31, 2002
is described in the Company's reports on Form 10-Q/A, as amended, for the fiscal
quarters ended October 31, 2002, January 31, 2003 and April 30, 2003 and on Form
10-Q/A for the transition period August 1 to December 31, 2002.
40
HOLLY CORPORATION
In August 2003, the United States Environmental Protection Agency
("EPA") asserted that the Company is liable for monetary penalties totaling
approximately $240,000 under the Consent Decree approved and entered by the
United States District Court for the District of New Mexico in March 2002 to
implement a settlement of issues concerning the application of federal and state
air quality requirements to past and future operations of the Company's
refineries. The proposed monetary penalties relate to a number of flaring
incidents at the Artesia, New Mexico refinery after March 2002 reported to the
EPA by the Company. The Company believes that most of the incidents should not
be subject to penalties under the terms of the Consent Decree. The Company has
been in discussions with the EPA, which are not yet concluded, with respect to
the interpretation and application of the terms of the Consent Decree to the
flaring incidents and as to the amount of penalties that would be appropriate.
The status of this matter as of September 12, 2003, the original filing date of
the Company's transition period report on Form 10-Q for the period August 1 to
December 31, 2002, is set forth in the Company's report on Form 10-Q/A for the
period August 1 to December 31, 2002.
41
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.2.1 By-laws of Holly Corporation dated March 9, 2001
3.2.2 Amendment to By-laws of Holly Corporation dated
September 30, 2003
31.1 Certification of Chief Executive Officer.
31.2 Certification of Chief Financial Officer
32.1 Certification of Chief Executive Pursuant to 18
U.S.C. Section 1350
32.2 Certification of Chief Financial Officer Pursuant to
18 U.S.C. Section 1350
(b) Reports on Form 8-K:
On May 13, 2003, a Current Report on Form 8-K dated May 12,
2003 was filed under Item 5 Other Events and under Item 7 (c)
Financial Statements and Exhibits concerning the Amendment to
the Merger Agreement dated May 12, 2003 amending the Agreement
and Plan of Merger dated March 30, 2003 among the Company,
Frontier Oil Corporation ("Frontier"), Front Range Himalaya
Corporation, Front Range Merger Corporation and Himalaya
Merger Corporation The Merger Agreement was previously filed
on the Company's current report on Form 8-K filed on April 2,
2003. Exhibits included were the Amendment to the Merger
Agreement dated May 12, 2003 and the Contingent Value Rights
Agreement dated May 12, 2003.
On May 21, 2003, a Current Report on Form 8-K dated May 20,
2003 was filed under Item 5 Other Events concerning the
Company's announcements that the waiting period under the
Hart-Scott-Rodino Antitrust Improvements Act had expired,
satisfying one of the conditions to the completion of the
pending merger of Frontier and the Company and that the
Federal Trade Commission approved the Company's pending
acquisition from ConocoPhillips of the Woods Cross Refinery.
On June 2, 2003, a Current Report on Form 8-K was filed under
Item 5 Other Events and under Item 7 (c) Financial Statements
and Exhibits concerning the Company's announcement that it had
acquired from ConocoPhillips the Woods Cross refinery, located
near Salt Lake City, Utah, and related assets and that it had
amended its Credit and Reimbursement Agreement with a group of
banks headed by the Canadian Imperial Bank of Commerce, and
increased the commitment level thereunder. Exhibits included
the Company's press release issued June 2, 2003.
On June 4, 2003, a Current Report on Form 8-K dated June 1,
2003 was filed under Item 2 Acquisition or Disposition of
Assets and under Item 7 Financial Statements and Exhibits
concerning the acquisition of assets from ConocoPhillips of
its Woods Cross refinery located near Salt Lake City, Utah.
Exhibits included the Asset Purchase and Sale Agreement, dated
December 20, 2002, between the Company and ConocoPhillips
(incorporated by reference to Exhibit 10.1 to the Company's
Quarterly Report on Form 10-Q/A, as amended, for the quarterly
period ended
42
HOLLY CORPORATION
January 31, 2003) and Amendment No. 7, dated as of May 15,
2003, to Amended and Restated Credit and Reimbursement
Agreement, dated April 14, 2000, as amended, among the
Company, certain of its subsidiaries, CIBC and other lenders.
On June 12, 2003, a Current Report on Form 8-K was filed under
Item 7 (c) Financial Statements and Exhibits and Item 9
Regulation FD Disclosure, concerning the Company's earnings
release for the three months and nine months ended April 30,
2003
On June 30, 2003, a Current Report on Form 8-K was filed under
Item 5 Other Events and Item 7 (c) Financial Statements and
Exhibits concerning the Company's purchase of an additional
45% share of Rio Grande Pipeline Company.
On July 30, 2003, a Current Report on Form 8-K was filed under
Item 8 Change in Fiscal Year concerning the Company's change
from a July 31 fiscal year-end to a December 31 fiscal
year-end.
On August 21, 2003, a Current Report on Form 8-K was filed
under Item 5 Other Events and Item 7 (c) Financial Statements
and Exhibits concerning the filing by Frontier of a lawsuit
against the Company.
On August 22, 2003, a Current Report on Form 8-K was filed
under Item 5 Other Events and Item 7 (c) Financial Statements
and Exhibits concerning the Company's delivery of a notice of
material adverse effect to Frontier in connection with pending
merger of the Company and Frontier.
On August 26, 2003, a Current Report on Form 8-K was filed
under Item 5 Other Events and Item 7 (c) Financial Statement
and Exhibits concerning the Company's sale of Utah and Wyoming
retail assets.
On September 2, 2003, a Current Report on Form 8-K was filed
under Item 5 Other Events and Item 7 (c) Financial Statements
and Exhibits concerning the Company's filing of an answer and
counterclaims against Frontier in litigation brought against
the Company by Frontier.
43
HOLLY CORPORATION
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: November 13, 2003 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)
44