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Holly Corp. (HOC)

Q4 2008 Earnings Call

February 17, 2009; 10:00 am ET

Executives

Matt Clifton - Chairman & Chief Executive Officer

Dave Lamp- President

Bruce Shaw - Senior Vice President & Chief Financial Officer

Scott Surplus - Vice President & Controller

Neale Hickerson - Vice President of Investor Relations

Analysts

Jacques Rousseau - Back Bay Research

Jeff Dietert - Simmons & Co.

Chi Chow - Tristone Capital

Daniel Burke - Johnson Rice

Kenneth Pounds - Nutmeg Securities

Operator

Good morning. My name is Barbara and I’ll be your conference operator today. At this time I would like to welcome everyone to the Holly Corporation fourth quarter earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer session. (Operator Instructions)

Thank you Mr. Hickerson, you may begin your conference.

Neale Hickerson

Thanks Barbara and good morning to everyone. I’d like to welcome you to our fourth quarter and full-year 2008 earnings conference call. I’m Neale Hickerson, Vice President of Investor Relations at Holly. With us this morning are Matt Clifton, Chairman and CEO of Holly Corporation; Dave Lamp, President; Bruce Shaw, Senior Vice President and Chief Financial Officer; and Scott Surplus, Vice President and Controller.

We issued a press release this morning announcing our fourth quarter and full year 2008 results. This press release can be found on our website at www.hollycorp.com. For this morning’s call we’ll begin with Bruce, who has prepared remarks and detail around our financial performance. Matt will then have comments on our year and then will provide an update on the capital projects that we have underway. At the conclusion of these remarks, we will take your questions as time permits.

Before we move to our financial results and comments, please note the following Safe Harbor disclosure statement, which falls under the Private Securities Litigation Reform Act of 1995. Also, please note the Safe Harbor statement in our earnings press release this morning.

The statements in this earnings call related to matters that are not historical facts are forward-looking statements. They are based on management’s belief and assumptions using currently available information and expectations and these statements are not guarantees of future performance and do involve certain risk and uncertainties, including those contained in our filings from time to time with the Securities and Exchange Commission.

Although the company believes these statements are reasonable, it cannot give any assurances that these expectations will prove to be correct. Actual outcomes and results could differ from what is expressed, implied or forecast. The company assumes no duty to publicly update or revise such statements whether as a result of new information, future events or otherwise.

Lastly, please note that information presented on today’s call, speaks only as of today, February 17, 2009 and any time sensitive information provided may no longer be accurate at the time of any replay or rereading of our transcript of this call.

Now I’d like to turn things over to Bruce Shaw.

Bruce Shaw

Thank you Neale and good morning everyone. My remarks this morning will cover four areas: First, a reminder of Holly’s reconsolidation of HEP on March 1, 2008; second, our earnings for the fourth quarter and full year 2008; third, a few balance sheet comments and an update on capital spending; and forth, a summary of our ownership value in Holly Energy Partners.

First, I’d like to remind you that Holly reconsolidated Holly Energy Partners as of March 1, 2008. When HEP acquired the pipeline and tankage assets from Holly on March 1, GAAP rules required Holly to reconsider its beneficial interest in HEP. As background, HEP is a publicly traded MLP, in which Holly owns approximately 46%, including our 2% general partner interest.

So effective March 1, 2008, we no longer account for Holly’s interest in HEP under the equity accounting method. Instead, HEP balance sheet items including debt, and HEP revenue and expenses, except for inter company transactions, are included in Holly’s consolidated financial segment.

Accordingly, we have recorded non-Holly interest in HEP as minority interest starting March 1. You will note that we’ve included segment information in our press release that allows you to see the impact of the reconsolidation on key balance sheet and income statement accounts. In addition, we’ll cover more detail in our 10-Q and 10-K filings.

Second, a few comments about our fourth quarter earnings and full year earnings. Earnings for the fourth quarter were $50.6 million or $1.01 per diluted share, as compared to $49.8 million or $0.90 per diluted share for the fourth quarter of 2007. Our pretax income of $79.1 million was up $3.9 million versus the fourth quarter of ‘07. This small increase resulted primarily from a higher gross margin on our Navajo refinery that was offset by higher sulfur credit sales that benefited last year’s fourth quarter.

Navajo’s gross margin per barrel averaged $10.88 per barrel for the quarter, versus $7.95 per barrel for the same quarter last year. For our Woods Cross Refinery, our gross margin per barrel averaged $16.62 in the quarter versus $17.28 per barrel for the same quarter last year.

Though Woods Cross processed approximately 6,000 barrels a day of black wax crude oil during the quarter and close to 7,000 barrels a day of black wax in December, the benefit realized per barrel was smaller relative to the fourth quarter of ‘07 and the first three quarters of 2008 since the discount is a straight percentage of a lower WTI price.

The increase in our operating expenses was $5.7 million quarter-to-quarter. If you exclude HEP’s operating expense of approximately $10.5 million, operating expense decreased by about $4.8 million, due primarily to lower utility expenses including a one-time refund receipt. The increases in G&A and DD&A expenses, relative to those incurred in the fourth quarter of ‘07 were mainly due to inclusion of expenses for HEP.

For the year, net income was $121 million and EBITDA was $262 million. This was significantly lower than the $334 million of net income and $529 million of EBITDA we generated in a record year in 2007. The decrease was due to lower gross margins in the first half of 2008 and lower volumes processed in 2008 versus 2007. I do want to point out however that we finished the year strong with over 75% of our net income and EBITDA generated in the second half of the year.

January has given 2009 a stronger start than we saw last year, as higher gasoline cracks have supported higher gross margins, especially in our West Coast related markets. Our preliminary January estimates show Navajo gross margins stronger than we experienced on average in the fourth quarter, and Woods Cross gross margins somewhat weaker given the typical seasonal demand slowdown for the refined products in its markets and a lower realized spreads on black wax crude given the low price of WTI.

I do want to remind you that we are currently completing the plant maintenance turnaround at the Navajo refinery this month. During this turnaround, we are also finishing phase one of the Navajo project work and expect the refinery to be able to run up to 100,000 barrels a day of WTS, after tie-in and commissioning of the new units. Matt will have an update on capital projects later in his remarks.

Third, let me cover a few balance sheet items and update you on capital spending. At the end of the fourth quarter, we had $96 million of cash and marketable securities, including $5 million for HEP, and no Holly debt and no drawings under Holly’s $175 million revolving credit facility.

The main driver of our change in cash for the quarter versus the third quarter of 2008 was the change in payables, net of receivables balance, given the rapid fall in refined product and crude oil prices from September through December.

WTI decreased in price by roughly 60% during this period from over $100 a barrel in September, to about $40 a barrel in December and our float on payables, net of receivables, decreased by a similar percentage. This resulted in an approximate $120 million decrease in cash. Receivables as a percentage of payables remained relatively constant period-to-period.

Our capital expenditures for the quarter were $111 million net of HEP CapEx and taking in to account contributions from our UNEV joint venture partner. Assuming the UNEV construction stays on schedule, we continue to project our capital spending for 2009 to be in the $350 million range. As you know, the UNEV project is in the final stage of the BLM permitting process.

Since we anticipate that the permit to proceed will now be received some time during the second quarter of 2009, we are evaluating whether to maintain the current completion schedule for UNEV of early 2010 or whether from a commercial perspective it would be better to delay completion until the fall of 2010. If we choose to delay it could shift $75 million to $100 million of CapEx from 2009 to 2010.

Though currently we have adequate liquidity with cash generated from operations, cash on hand, and our un-drawn credit facility, we will be monitoring margins and capital spending closely and take appropriate action to provide additional liquidity if needed.

Please recall that HEP has an option to purchase our interest in the UNEV pipeline once completed and we expect to grant a similar option to HEP on the crude pipelines. If HEP chooses to exercise these options then its decisions will depend in large part on the state of the capital markets at the time and Holly would get over $300 million of this CapEx back.

Last, a few highlights of our HEP ownership. With HEP units trading at $28 per unit or in that range, our subordinated and common units are worth about $200 million. This doesn’t include the value of our general partner interest. On February 13, HEP paid its recently announced distribution of $0.765 per unit, for which Holly received $5.6 million for its common and subordinated units, plus approximately $1.3 million for its GP interest, which includes $1.1 million of incentive distributions.

With that, I will turn things over to Matt for an update on major projects and other overall comments.

Matt Clifton

Thanks Bruce and thanks everybody for listing in. Looking back over 2008, we like the entire industry had an extremely challenging first half, as rapid and unprecedented rise in crude oil depressed gasoline demand and gas cracks, while creating deep negative spreads for non-transportation products. These negative effects more than offset the positive impact of high diesel cracks throughout the year to dramatically pull down financial results for the first half.

In the second half of the year as crude oil plunged, cracks for non-transportation products dramatically improved, increasing capture rates, while diesel cracks remained strong and improved gasoline cracks in the fall added value to lift gross margin and to correspondingly, significantly improve our financial results.

Looking forward, as Bruce said we not only start 2009 with better cracks than the beginning of 2008, but we should benefit from our recently completed profitability improvement projects at Woods Cross and our soon to be completed similar projects at the Navajo refinery.

At Woods Cross we finished our expansion and our feedstock flexibility project and are now optimizing the operation of our new units. This positions us to increase ultra low sulfur diesel fuel production from approximately 30% to over 40%, double our capacity to run lower priced, black wax and heavy Canadian crude oils, and expand our overall production by almost 20%.

At our Navajo refinery, we will be completing our major turnaround this week. We are in our expansion, and phase one process additions and upgrades are being tied in. We expect to be at 100,000 barrels a day of capacity after the startup of our new hydrocracker, hydrogen plant and sulfur recovery unit in March. These upgrades again increase our ultra low sulfur diesel production from around 33% to well over 40%, allow us to run 100% West Texas sour type crudes and expand our capacity by 15,000 barrels a day.

From a refinery project standpoint, this leaves only the completion of our new sulfur de-asphalting unit and some upgrades to our smaller crude unit in Navajo. These remain on schedule with a target mechanical completion date of late third quarter 2009. These enhancements to the Navajo refinery will provide the capability to run up to 40,000 barrels a day of heavier, lower priced oils such as Canadian heavy crudes.

A pipeline project to build a new 75 mile, 16 inch pipeline to provide direct pipeline access to crude oil from cushioning also remains on budget with a Q4 2009 completion date. Pipe has been ordered, engineering is complete, and write-aways have been substantially secured.

The above described 2009 upgrades and additions will provide added profit potential and position our Navajo, Woods Cross refineries as top tier competitors in the markets that they serve. On our Salt Lake to Las Vegas pipeline project, as Bruce said, we are in our final stages of our permit approval process. We currently are constructing new terminals in Cedar City, Utah and North Las Vegas. Our pipe has been delivered at various staging locations along the pipeline route, and we have secured virtually all of the required runaways.

With the expectation of a late spring permit approval, we are evaluating moving the construction of the pipeline to early spring of 2010 rather than the summer of 2009 for commercial reasons and to ensure an adequate build season. This removes $75 million to $100 million of CapEx from 2009 to 2010, while only moving the startup date from early 2010 to the fall of 2010.

With most of our oil refinery enhancements complete by the end of Q1 2009, a strong balance sheet, and further feedstock flexibility and accessibility improvements coming online by the end of 2009, we believe we are well positioned to meet today’s challenges.

With that, I’ll turn it back to Neale.

Neale Hickerson

And I’d like to turn things back to Barbara to repeat the procedure to ask questions. We are ready to move into that phase of our call.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Jacques Rousseau, Back Bay Research; your line is open.

Jacques Rousseau - Back Bay Research

Thank you. Good quarter gentlemen. Question for you; it looks as though the asphalt business had a very strong quarter. I was wondering if you could give some color on the business and if you can put any amounts around what it earned in the quarter. That would be great. Thank you.

Matt Clifton

Well, I’ll start Jacques, by just kind of the EBITDA and then I’ll pass it on to Dave or to Matt to comment on the business. EBITDA for the quarter for the asphalt business was about $9 million.

Matt Clifton

And you’re right Jacques; we saw a substantial improvement in the second part of the year compared to the first. In particular asphalt prices strengthened quite a bit, by the time crude oil started to move in the opposite direction, so we saw a widening of spreads there that really helped us, in particular in the fourth quarter.

Jacques Rousseau - Back Bay Research

Were there any other non-refining businesses that put up earnings in the quarter that typically does not occur? I’m just trying to tie out my numbers. It seems as though there was something there.

Bruce Shaw

Not of any real significance Jacques. The asphalt piece is the most significant piece. As you know we had a good number of sulfur credit sales in ‘07 and that market just wasn’t there in ‘08. So the most significant piece, the vast majority of it is the asphalt business.

Matt Clifton

We did have, Jacques. I think it was noted in our press release. We set up a data room early this summer on selling the little bit of E&P properties that Holly owned and awarded the bid process I guess around the late summer and finally closed that in the end of October. So that was a $6 million gain that was realized on the sale of those properties.

Jacques Rousseau - Back Bay Research

Thank you very much.

Operator

Your next question is from Jeff Dietert of Simmons; your line is open.

Jeff Dietert – Simmons & Co.

Good morning, Jeff Dietert with Simmons. Can you her me okay.

Matt Clifton

Sure Jeff.

Jeff Dietert – Simmons & Co.

I was wondering if you could help us think about first quarter throughput at Navajo. With the maintenance activity that is underway, I’m sure you built some inventory in anticipation of the maintenance. What levels of throughput should we look for in the first quarter and did you build enough inventory to meet your sales contracts or would you expect to be buying product in the first quarter during the maintenance outage?

Dave Lamp

Sure Jeff. This is Dave Lamp. The run rate we achieved in January was approximately 60,000 barrels a day, a little bit lower than that and in the first half of February we were running at about 29,000, 28,000. When we come out of turnaround, we should ramp up to about 78,000, 80,000 barrel range to run off gasoline inventory and that will happen through the month of March. As the hydrocracker comes on, that will accelerate and we should be towards the 95,000, 100,000 barrels a day rate in April 1.

Jeff Dietert – Simmons & Co.

With the expansions both at Salt Lake and Navajo, you’ve got the potential to run at quite a bit higher rates than you have historically. How will you think about running those plants? Will you run them based purely on the LP results or will you try to match production with demand? Could you give us some color there?

Dave Lamp

We generally run to what the LP tells us to run, properly modeled with the incremental product tiers in there. So we kind of match the two together with that type of philosophy.

Jeff Dietert – Simmons & Co.

Thank you for your comments.

Operator

Your next question comes from the line of Chi Chow with Tristone Capital; your line is open.

Chi Chow - Tristone Capital

Good morning, it’s Chi Chow at Tristone. Matt, what are your current thoughts on the ability to drop down the HOC financed assets into HEP this year?

Matt Clifton

Chi, I think that we’ve seen some improvement. Obviously the MLP market got pretty beat up. For the last several quarters we saw yields as high as 18% I think on HEP. So we did see some improvement there and are kind of opportunistically looking at opportunities as they arise on the equity side in particular, as windows to drop those down.

I think as Bruce said, as those projects are complete and roughly we have in round figures of about $100 million of pipeline related projects around Navajo and the Cushing connection and some intermediate pipelines that would be available, to be dropped down pretty soon in 2009, by the middle of the year I guess and then the Vegas project later into 2010.

So I think it’s just going to be looking up the capital market spend and seeing if HEP is able to acquire those things. I think at the current equity yields, the numbers still work, maybe not as a robust a multiple as we have seen back in 2006, but I think the economic is still kind of work for both sides.

Chi Chow - Tristone Capital

Have the credit markets opened up at all for HEP?

Bruce Shaw

Chi we’re seeing a lot more activity in the high yield markets on the debt side, as well as the equity markets here in kind of the first part of 2009, so the markets are back open, would be open to HEP, but we’ll continue to monitor them as we think the yield on the equity as well as the cost for the debt becomes more reasonable.

Matt Clifton

What we did Chi, as you probably know is, when we did the drop down in March, we basically pulled the $170 million of the $180 million purchase price. HEP did that under their revolver and then we locked in rates for five years, at something under 6% I believe. So I think there’s opportunities in it. As Bruce said, the debt market seems to be opening up somewhat. It’s not quite at the price level that we would be too interested in right now, but it’s definitely moving in the right direction.

Chi Chow - Tristone Capital

Great. A question on CapEx; so the $350 million for ‘09, that includes or that assumes that you have stayed on the current schedule, is that correct?

Bruce Shaw

That’s right, Chi.

Chi Chow - Tristone Capital

So any movement on delaying UNEV would move the $350 million down by $75 million to $100 million, is that correct?

Matt Clifton

That is correct.

Chi Chow - Tristone Capital

And what’s the timing? Do you have a feel for timing on the ‘09 CapEx for the quarter?

Bruce Shaw

Chi, we don’t forecast it by quarter, but it is going to be more heavily weighted in the first half of the year than the second half of the year.

Chi Chow - Tristone Capital

Okay great, and then one real quick other question. On your cash balance, do you have a breakout between cash, short-term and long-term securities, Bruce?

Bruce Shaw

Yes Chi, we’ve got; roughly half of it is in cash and the majority would be in short-term investments, short-term securities. I think we’ve got about $6 million or so in long-term securities, but all of that cash is accessible on an immediate basis. So it doesn’t matter how it’s split up in terms of how quickly we can access it, that’s the rough split up.

Chi Chow - Tristone Capital

Thanks a lot.

Operator

Your next question comes from the line of Daniel Burke of Johnson Rice; your line is open.

Daniel Burke - Johnson Rice

Good morning. Could you remind me of the duration of your current black wax contracts, and then it seems like absolute differentials have held up pretty well here as outright crude prices have declined. Does that influence how you’re going to think about either inking additional deals for long-term, heavy and/or black wax supply? Does it make you more likely to just stay spot?

Matt Clifton

Well we currently have two contracts for black wax. One is a five year deal that started in 2007, in that time frame, and it goes through 2011, 2012. That was for 5,000 barrels; we aren’t quite producing at that higher rate yet. We have another contract that was a year contract, 2007 to 2008, that has expired, for about 2500 barrels and that one we are in the process of renewing on some kind of split of contract versus posted price.

Posted price right now is running far below the contract price, so those negotiations are ongoing. We will probably get some kind of split between the two, that’s where I think we’ll end up or some kind of color that yet encourages some production of black wax, additional production, but also gives us protection on both sides.

Daniel Burke - Johnson Rice

Okay great. Then a second question; if you do elect to delay the UNEV pipeline slightly, does that have any implications here over the next 18 months or so I suppose on what level of throughput that you’re able to realize at Woods Cross? How does that factor into the decision to potentially defer?

Matt Clifton

I think the area where we’ll have an opportunity post UNEV to run at higher rates is in the wintertime. Gasoline demand obviously falls off in the Rockies in the winter and Vegas is a good outlet and in fact over the last month or two months, the price in Vegas, even if trucking from Salt Lake to Vegas, was pretty attractive.

So I think our decision basically is if we were able to get the pipeline done and in place prior to the winter of 2009, then it made a lot of sense to be able to keep throughput rates up through the winter and move more products to Las Vegas. Since the permit has kind of dragged on a little bit longer than we’d thought, it’s looking like it is going to be difficult to have that done and in place by the wintertime.

So it doesn’t make a lot of sense or there isn’t a lot of benefits in finishing it up, heading into spring, when demand takes off and we have a tough time keeping up with demand in the local markets. So that’s why we are reevaluating and see whether it wouldn’t be more prudent to just have it constructed so that it’s completed going into the winter of 2010.

Daniel Burke - Johnson Rice

Okay great. That’s useful. Thanks.

Operator

(Operator Instructions) Your next question comes from the line of Kenneth Pounds from Nutmeg Securities; your line is open.

Kenneth Pounds - Nutmeg Securities

Good morning gentlemen, a very good quarter. I had a question regarding Flying J. They have a refinery I guess what is sauntered now in the Salt Lake market. Is that and maybe some problems from some of your other competitors benefiting you?

Matt Clifton

Well actually Flying J has two refineries, and one was in Bakersfield, California. That’s actually the one that is down. The other refinery is I think a 25,000 barrel a day refinery in Salt Lake. They are running that as normal, I think just on a cash basis; buying crude on a cash basis.

So from the Salt Lake perspective we haven’t seen much decrease in production out of that plant. In our Navajo refinery area, which is down in the Southwest, I mean Flying J also owned a pipeline named Longhorn that brought product in from the Gulf Coast into the El Paso market and then into the Phoenix and New Mexico markets that we compete in. That has been if not shut down, has been at severely reduced rates versus the prior periods when Flying J was in a healthier position.

So we have seen some benefits clearly in the Southwest Navajo markets from the reduced flows off Longhorn.

Kenneth Pounds - Nutmeg Securities

But, that was a controversial pipeline too, right? Weren’t you kind of fighting the building of that pipeline at Longhorn, years past into your market; I remember that, yes. Okay great, you talked a little bit about black wax, is there some worries about reduced supply given all the drilling rigs that are being stacked and maybe some of the oil companies out there having financial problems like a Berry or a Venoco or some of those other oil companies that are in that area and that we’re doing a lot of drilling?

Matt Clifton

They’re definitely rigs that have gone down. Both Berry and Newfield have cut rigs recently, but they still have some operating in the trend to increase production. As Newfield would tell you, and Berry generally says is that this is one of the lowest risk plays they have around the world because the reserves are well proven. So I mean that’s the message we hear from them. So I think if we can structure the right type of contracts that encourage them to produce, we can manage through that situation.

Bruce Shaw

The only other thing I’d add is from the crude oil availability standpoint, we are within weeks of starting up a pipeline’s a joint venture between HEP and Plains, whereby their plains have built a new pipeline from the Wyoming border into Salt Lake and that basically de-bottlenecks the ability to bring a lot more Canadian, in particular Canadian heavy crude, into the Salt Lake area. So though we might see some reduced production in the area immediately adjacent to the plant, we will be accessing or have the ability to access a lot more barrels from Canada and from further points east.

Kenneth Pounds - Nutmeg Securities

Sometimes there’s quite good discounts in Wyoming suite too. I guess you’d have access to that now?

Matt Clifton

That’s true, yes.

Kenneth Pounds - Nutmeg Securities

Right. Thank you.

Operator

Your next question comes from the line of Daniel Burke of Johnson Rice; your line is open.

Daniel Burke - Johnson Rice

Yes, I apologize if I missed this earlier, but one last thing. Did you or can you quantify that utility refund?

Bruce Shaw

The utility refund I believe was about $6 million, Daniel.

Daniel Burke - Johnson Rice

Okay. I apologize if I missed that earlier. Thanks. That’s it for me.

Bruce Shaw

Sure.

Operator

And as there are no further questions in queue, I’d like to turn the call back over to Mr. Neale Hickerson.

Neale Hickerson

We appreciate everyone listening today and we look forward to sharing our results with you next quarter. Thanks a lot everyone.

Operator

This concludes today’s conference call. You may now disconnect.

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