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Holly Corporation (HOC)

Q2 2007 Earnings Call

August 9, 2007, 10:00 AM ET

Executives

M. Neale Hickerson - VP of IR

Matthew P. Clifton - Chairman and CEO

Stephen J. McDonnell - VP and CFO

David L. Lamp - EVP of Refining and Marketing

Analysts

Richard Boliva - Deutsche Bank

Daniel Burke - Johnson Rice

Daniel Vetter - JP Morgan Chase

Kenneth Pounds - Nutmeg Securities

Presentation

Operator

Good morning. My name is Crystal, and I will be your conference operator today. At this time, I would like to welcome everyone to the Holly Corporation's Second Quarter 2007 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. I will now turn the conference over to Mr. Neale Hickerson, Vice President of Investor Relations. Please go ahead, sir.

M. Neale Hickerson - Vice President of Investor Relations

Thanks, Crystal. Good morning, everyone. I'd like to welcome you to our second quarter 2007 earnings conference call.

With us this morning are Matt Clifton, Chairman and CEO of Holly Corporation, Dave Lamp, Executive Vice President of Refining and Marketing, Steve McDonnell, Vice President and Chief Financial Officer, and Dean Ridenour, Vice President and Chief Accounting Officer.

We issued a press release this morning at 7am Eastern Time with our second quarter and full year results. This press release can be found on our website, at www.hollycorp.com.

For this morning's conference call, our format will begin with Matt having some overall comments about our financial and operating performance for the quarter and the year. Matt will also have a brief update on our capital projects that are under way. Steve will then follow up with some details around our financial results. The management team will be available for questions at the conclusion of these prepared remarks as time permits.

Before we move to our financial results and comments, as usual, we're required to make the following safe harbor disclosure statement. Also, please note the safe harbor statement in our earnings press release this morning.

The following is a safe harbor statement under the Private Securities Litigation Reform Act of 1995.

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

Although the Company believes that these expectations reflected in these forward-looking statements are reasonable, the Company cannot give any assurances that these expectations will prove to be correct.

Therefore, actual outcomes and results could materially differ from what is expressed, implied or forecast in such statements. The Company assumes no duty to publicly update or revise such statements, whether as a result of new information, future events or otherwise.

And now I'd like to turn things over to Matt Clifton.

Matthew P. Clifton - Chairman and Chief Executive Officer

Thanks, Neale, and I thank everybody for listening in this morning. We are extremely pleased with our second quarter results. Steve will get into the details in a minute, but net income for the quarter was $158 million, with EBITDA reaching slightly over $250 million.

Historically high industry-wide margins, our location advantage product prices, and record production levels at our facilities fueled the best quarter in Holly's history.

The pure gasoline and diesel prices in our markets, due to the tight supply/demand balance in our Rocky Mountain and Southwest markets, combined with lower raw material costs to create historical quarterly average gas and diesel cracks at both plants.

Higher runs at lower cost black wax crudes at Woods Cross and a widening of the discounts for sour crudes run at Navajo, compared to compressed WTI prices versus similar worldwide crudes, helped drive down our raw material costs.

Our folks ran both plants at 99%-plus utilization rate, realizing the full benefit of the 2006 midyear expansion of the Artesia refinery and enabling a virtual full capture of the great margin environment experienced during the second quarter.

As we previously announced, last Friday we reduced crude rates at our Artesia refinery while we addressed the FCC unit malfunction. We expect that we will be starting up the FCC this weekend and will be ramping back to our full crude chart rates within days after that.

We estimate that we will have lost approximately 500,000 barrels of planned crude runs during this unplanned event. We have somewhat mitigated this downtime impact by converting all on-hand intermediate feed stocks in inventory to finish gasoline and diesel to augment our production from the reduced crude runs.

We also will complete certain maintenance activities that were planned for September that would have caused downtime in September.

Although, as in other markets, our margins have reduced substantially in July and August from the lofty levels experienced during the second quarter, we remain extremely bullish on the refining industry fundamentals.

We believe that our nation's extremely tight refined products supply/demand balance, coupled with increasingly stringent product specs and resulting in more complicated refinery operations, will continue to provide a great environment for the industry.

We do, however, recognize that this situation inherently produces more volatility in margins as slight changes in utilization rates and product import levels deviate to move the seesaw in one direction or another.

As others have clearly recognized, this situation over the last two years has continued to provide a margin environment with higher highs and higher lows. In keeping with this view, our Board authorized a $100 million addition to our existing stock repurchase program. Since April 2005, we have bought back approximately $10 million shares, or 16% of the shares then outstanding at the start of the program.

On the capital front, our folks continue to make great progress on the crude flexibility and expansion projects at both of our refineries. Costs of both plant projects remain on budget, and we expect to have our Woods Cross upgrade expansion in operation by the fourth quarter of 2008 and our Artesia expansion mechanically complete at the end of 2008, with ramp up in rates in the first quarter of 2009.

We are also moving forward on an aggressive timeline on our previously announced Salt Lake City to Las Vegas pipeline. We will own a 75% interest, and Sinclair will own a 25% interest, subject to execution of definitive joint venture agreements. The capital cost of the project, including terminals in Cedar City, Utah and Las Vegas, is approximately $300 million, $225 million to Holly's interest.

We believe this is a great project for the growing communities in Southwest Utah and Las Vegas, as well as the Rocky Mountain refiners. We are presently taking all action required to meet our end of 2008 completion date.

We plan to give HEP, an affiliate public transportation logistics MLP, an option to purchase Holly's interest in this Salt Lake City to Las Vegas joint venture pipeline at a purchase price equal to Holly's cost plus 7% interest. This will be an opportunity for HEP to continue its growth trajectory.

Bottom line, we are very optimistic about our future, and we are committing substantial capital to continue to grow earnings while maintaining an extremely strong balance sheet to take advantage of any acquisition opportunities that may develop.

Before I turn this over to Steve, I'd like to commend and thank all of our employees for their great work and tireless efforts in making this quarter the best in our Company's history. I'll turn it over to Steve McDonnell.

Stephen J. McDonnell - Vice President and Chief Financial Officer

Thanks, Matt. My remarks this morning will cover four topics. First, earnings for the second quarter of 2007; second, the strength of our balance sheet and our strong cash position; third, our stock repurchase activity; and fourth, some key current data regarding our ownership interest in Holly Energy Partners.

As Matt mentioned, we obviously had a great second quarter. As you've seen from our earnings release, earnings for the second quarter were a record $158.6 million, or $2.84 per diluted share. This compares to earnings from continuing operations last year of $87.7 million, or $1.51 per diluted share.

These record second quarter earnings were due to strong refining margins and higher volumes. Refining margins for the quarter were $28.36 per barrel, compared to last year's $22.37 a barrel.

Let me now note the gross margins by refinery. During the second quarter, Navajo's gross margin was $27.54 per barrel, as compared to $23.42 per barrel last year. While the number is still an estimate, Navajo's preliminary gross margin for July was approximately $14.50 per barrel, versus $23.00 per barrel last year.

For our Woods Cross refinery in Utah, our second quarter gross margin was $31.22 per barrel, versus $19.83 per barrel last year. Utah's preliminary margin estimate for July is approximately $20.00 per barrel, versus $15.50 per barrel last year.

I mentioned earlier that in addition to strong margins, higher volumes were also a big factor in the second quarter record results. In fact, produced volumes sold were 24% higher in the second quarter of 2007 as compared to 2006. There are three primary reasons for these increased volumes.

First, the 8,000 barrel a day expansion at the Navajo refinery, completed in June of 2006. Second, the 99% plus utilization rates achieved at both of our refineries in the second quarter of 2007. And three, the downtime experienced at our refineries in the second quarter of 2006, tie in ultra low sulfur diesel projects and the expansion at our Navajo refinery.

We are very pleased with the level of our second quarter operating expenses of $51 million, especially when considering record produced volumes in the 99%-plus utilization rates at both of our refineries.

Our G&A expenses for the second quarter of $21.3 million included approximately $3 million of training costs associated with the new ERP system we installed on May 1st. Our incentive compensation expense for the second quarter was $4.2 million.

Lastly, and wrapping up our earnings comments on the second quarter, I want to provide our EBITDA numbers for the quarter. Our EBITDA from continuing operations for the quarter was $252.1 million, versus $146.4 million from continuing operations in last year's second quarter.

Our total EBITDA for the first six months of this year was $363.5 million. It was greater than our second best full year in 2005 of $300 million, and our first six months this year represents nearly 90% of last year's record full year amount of $414 million. So as you can see, we've had a great first half of 2007.

Our annualized return on capital for the first six months of 2007 was 57%, as compared to 22% in the first six months of 2006.

Now, let me shift to some comments about Holly's balance sheet. Our cash and marketable securities at the end of the second quarter was $411 million. We ended the quarter with $640 million in stockholders equity and no debt. At current prices of our stock, market capitalization exceeds $3.2 billion.

My third area of comments is regarding our common stock buyback program. As announced in our press release this morning, and as Matt mentioned as well, Holly's Board has authorized a $100 million increase in our share repurchase program.

During the second quarter, we repurchased 209,000 shares for $13.8 million, or $66 per share. Through the first six months of 2007, we've repurchased over 750,000 shares for a total of $43 million, or just a little over $57 per share.

Our total repurchase program, that began in 2005, repurchased 10.2 million shares for $350 million, an average price of a little over $34 per share. At the end of July 2007, we had 55 million shares outstanding, and including the $100 million authorization the Board just made, we have $150 million left under our authorized repurchase program.

The last item I want to talk about is to share highlights of Holly's interest in Holly Energy Partners. Holly currently owns a 45% interest in HEP, including the 2% general partner interest. Our interest includes 7 million subordinated units and 70,000 common units. Based on HEP's closing price yesterday of $47.15, our common and subordinated units are worth approximately $333 million.

In July, HEP announced a third quarter distribution of $0.705 per unit, payable August 14th. In the next week, Holly will receive $5 million on its common and sub units and $824,000 for its general partner interest. The distribution for the general partner interest includes $592,000 in incentive distributions.

Now, I'd like to turn it over to Neale to set up our questions.

M. Neale Hickerson - Vice President of Investor Relations

And I'm going to ask Crystal to repeat the procedure for asking questions. Crystal, could you please announce that again?

Question and Answer

Operator

[Operator instructions]

We will pause for a moment to compile the Q&A roster. Your first question comes from the line of Richard Boliva [ph] with Deutsche Bank.

Richard Boliva - Deutsche Bank

Hey, good morning, guys.

Matthew P. Clifton - Chairman and Chief Executive Officer

Good morning.

Richard Boliva - Deutsche Bank

I just wanted to get a little more color, if I could, on the cat cracker, if there's any kind of longer-term damage there. And I can see you're pretty good [ph] on the crude throughputs, but what you kind of think that'll do to your margins, I guess, a little bit for the quarter.

Matthew P. Clifton - Chairman and Chief Executive Officer

I'll let Dave Lamp, our EVP, talk about the first part of the question.

David L. Lamp - Executive Vice President of Refining and Marketing

No, we don't expect any long-term damage. In fact, we have all the parts and everything we need to make the repairs necessary. There was no major damage; it just had catalyst pluggage through the unit that we had to clean up.

Matthew P. Clifton - Chairman and Chief Executive Officer

I think on the second part, Rich, clearly we'll have some reduced overall throughputs. We did mitigate to some extent because we had a substantial amount of intermediate feed stock, so we were able to keep all the other units ramped up to keep our production as high as possible while we had this reduced crude rate.

And then as we come back on with the cat cracker, we'll see how much of the gas and oil that was built up that normally goes to the cat cracker while it was down can be fed to that as we keep rates at ultimate... at the 100%.

Richard Boliva - Deutsche Bank

Do you have excess capacity on that FCC relative to the crude unit?

Matthew P. Clifton - Chairman and Chief Executive Officer

We have slightly some excess capacity there. I think as we get into the winter months, I guess we've got contrary forces. The cut points on diesel kind of shrinks the capacity a bit. The cooler weather increases the blower capacity somewhat. So normally, I think its a couple thousand barrels a day excess capacity.

Richard Boliva - Deutsche Bank

Great, thanks. And then I guess you're pretty much done with turnaround for the year, then?

Matthew P. Clifton - Chairman and Chief Executive Officer

Yes, we are.

David L. Lamp - Executive Vice President of Refining and Marketing

Yes.

Richard Boliva - Deutsche Bank

Okay, great. Thanks very much.

Operator

Your next question comes from the line of Daniel Burke from Johnson Rice.

Daniel Burke - Johnson Rice

Good morning, all

Matthew P. Clifton - Chairman and Chief Executive Officer

Morning.

Daniel Burke - Johnson Rice

I'm curious about the volumes that you're sending out on the Kinder Morgan East Line. Are you maintaining volumes on that line so far this quarter given what looks to be a West Coast market environment that softened a bit more than what you're seeing in sort of the Rockies and Southwest?

Matthew P. Clifton - Chairman and Chief Executive Officer

Yes, we continue to maintain our lines this quarter. As you said, we've seen some depression on the West Coast prices. It falls back into Phoenix, but it's still profitable to move out there, and it's still definitely advantageous in the long term to maintain our pro rata capacity.

Daniel Burke - Johnson Rice

So are the Phoenix CDG prices you're realizing currently at a premium to the spread you're realizing selling into the New Mexico market?

Matthew P. Clifton - Chairman and Chief Executive Officer

I think it fluctuates day to day. I think it's... on average, it's generally quite a bit better. It's probably pretty close to even right now. And the New Mexico markets still are extremely well priced. They're somewhat limited, and we move I guess roughly about 25,000 barrels a day north out of Artesia to the Albuquerque, Santa Fe and Four Corners area, and it would be difficult to really ramp that up substantially.

Daniel Burke - Johnson Rice

Okay, I see. And then switching gears over to Woods Cross, I'll ask the obligatory question on black wax runs. I think you mentioned you were up to 15% in May. Are you maintaining that level, or can you get up above that?

Matthew P. Clifton - Chairman and Chief Executive Officer

It's about our peak volume right now until we install some more equipment for unloading and desalting.

Daniel Burke - Johnson Rice

Okay. And is that the reason it looked like the fuel yield is a little bit higher? Is that black wax, or is it some other tweak to the Woods Cross system?

Matthew P. Clifton - Chairman and Chief Executive Officer

It's mainly... well, some of its black wax, but some of it also we ran through Powder [ph] river during the quarter too, which tends to increase oil. It looks like, Daniel, for the quarter, we were at about 18% of our runs for black wax.

And as Dave said, I think in the latter part of the quarter or the first part of this quarter, there was an incentive to run some Canadian heavy crudes, but the differentials have widened out substantially.

Daniel Burke - Johnson Rice

Okay. Then a last question, just a qualitative one. Particularly up into the Rocky Mountains area, I guess the margins have come in somewhat, but just from a product supply standpoint, does the market seem as though it's now better supplied? Are some of the refineries that were out in that region now back up and running?

Matthew P. Clifton - Chairman and Chief Executive Officer

No, I think it still feels pretty short to us. The demand is pretty strong. We don't really have any trouble moving every barrel we can make.

Daniel Burke - Johnson Rice

Okay, that's the impression I have as well. Thanks.

Matthew P. Clifton - Chairman and Chief Executive Officer

Yes.

Operator

[Operator instructions]

Your next question comes from the line of Daniel Vetter, JP Morgan.

Daniel Vetter - JP Morgan Chase

Morning, guys.

Matthew P. Clifton - Chairman and Chief Executive Officer

Morning.

Daniel Vetter - JP Morgan Chase

I was hoping you could talk about your plans to use the cash on your balance sheet. $400 million is pretty high by historical standards. You announced the share buyback program. If you could just talk about usage of cash going forward, that'd be great.

Matthew P. Clifton - Chairman and Chief Executive Officer

Okay, Dan. I think as we said, we've got primarily three things that we've honed in on and revisit each quarter with the Board. One is obviously we have a fair amount of capital projects going on the upgrades at both plants.

I think roughly... Dave will correct me if I'm wrong... I think we've got about $100 million we're spending, which draws about 250 overall at Artesia, and then we have the 225 commitment on the pipeline between Salt Lake and Las Vegas.

Then in addition to that, we have the buyback program we've been consistently executing since I guess the spring of 2005. And third, we're always wanting to keep our balance sheet as strong as possible to take advantage of opportunities on the acquisitions front.

We don't know whether that will come to fruition or not, but at least it seems like some of the larger companies are at least now focusing or talking about focusing on optimizing their asset slate, and maybe some opportunities will develop. I think clearly, as we've said I guess for the last couple of years, the right acquisition at the right price will probably be our number one option

But to date, that hasn't been there, basically because of valuations we've had trouble getting there, or the plants that have been for sale just weren't a logical fit for us, either they were large refineries on the East Coast or the Gulf Coast that really wouldn't fit into where we think our strengths are.

Daniel Vetter - JP Morgan Chase

Could you just expand a bit on what you would consider a logical fit? So it sounds like you're more interested in inland refineries as opposed to coastal refineries? And would you prefer refineries in the markets you already know and operate in, or are you open to acquiring refineries in other markets?

Matthew P. Clifton - Chairman and Chief Executive Officer

I think we're open to other markets. I think ideally, if we could find something in or adjacent to the markets that we participate in, that would be the best way to leverage some of our expertise and to have some synergistic effects, so that would be our first choice.

I don't think we'd rule out anything, but a large merchant refinery on the Gulf Coast just doesn't seem like something that would make a lot of sense for us. It wouldn't be capitalizing on the expertise that we've got.

I think the other thing we look for with having the affiliation with Holly Energy Partners, the logistics MLP, to the extent that any refineries that come for sale that have assets that could be dropped into an MLP at a higher valuation, that would increase the likelihood of us maybe getting to the values that are being commanded in today's market.

Daniel Vetter - JP Morgan Chase

Great. Thank you.

Matthew P. Clifton - Chairman and Chief Executive Officer

You're welcome.

Operator

Your next question comes from the line of Kenneth Pounds with Nutmeg Securities.

Kenneth Pounds - Nutmeg Securities

Great quarter, gentlemen. You just did an amazing job, and your operating rates were quite something. I was off and on a little bit; did you mention what your utilization was projected for the next two quarters?

Matthew P. Clifton - Chairman and Chief Executive Officer

We haven't mentioned that. Basically, we think, on average, we'll probably have a 5,000-barrel downward effect for the quarter due to the outage that we've... or the reduced rates that we had with this cat cracker problem last week.

So I think that'll have a downward effect, obviously, on the quarter utilization rates, but other than that, I think once we're back on... and we expect that to be next week, when we ramp up fully... then we plan to run all out again for the rest of the quarter and the rest of the year.

Kenneth Pounds - Nutmeg Securities

Could you remind us again what your target is for when these projects are completed by the fourth quarter of '08 as far as throughput?

Matthew P. Clifton - Chairman and Chief Executive Officer

Yes. I might let Dave give you the details on that.

David L. Lamp - Executive Vice President of Refining and Marketing

Well, at Woods Cross, we're planning on expanding from 26 to 31, and at Navajo, we're planning on expanding from roughly 83, 85 to the 100,000.

Kenneth Pounds - Nutmeg Securities

Okay, great. And now, will the Woods Cross capability be changed to take more sour?

David L. Lamp - Executive Vice President of Refining and Marketing

Yes. What we'll be doing there is increasing to about 15,000 our opportunity crude, as we call it, either black wax or a combination of black wax and Canadian crude. So we'll have about 50% of our crude slate, after the modifications are done, will be at these depressed price crudes.

Kenneth Pounds - Nutmeg Securities

All right. Some of the other refineries, in their calls, have mentioned their goal is really to get Canadian crude down to the Gulf, down farther away into that region. Could there be a problem in the future of availability of Canadian crudes or other heavy and sour crudes, or do you think there will be plenty for everyone to go around?

David L. Lamp - Executive Vice President of Refining and Marketing

Well, it's our opinion that there will be plenty. Obviously, that depends on the absolute price of crude, though.

Kenneth Pounds - Nutmeg Securities

Right. Okay. Well, excellent quarter. Thank you.

David L. Lamp - Executive Vice President of Refining and Marketing

Thank you.

Operator

At this time, there are no further questions. Mr. Hickerson, are there any closing remarks?

M. Neale Hickerson - Vice President of Investor Relations

Well, we'd just like to thank everyone for listening to this quarter's call, and we look forward to visiting with everyone again next quarter. Thanks a lot, everyone.

Operator

This concludes today's Holly Corporation second quarter 2007 earnings conference call. You may now disconnect.

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