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Holly Corporation (HOC)

Q3 2007 Earnings Call

November 06, 2007, 10:00 AM EDT

Executives

M. Neale Hickerson - VP of IR

Matthew P. Clifton - Chairman of the Board and CEO

Stephen J. McDonnell - VP and CFO

P. Dean Ridenour - VP and Chief Accounting Officer

Analysts

Rich Voliva - Deutsche Bank Securities

Daniel Vetter - J.P. Morgan

Jeff Deitert - Simmons & Co.

Chi Chow - Tristone Capital

Ann Kohler - Caris & Company

Presentation

Operator

Good morning. My name is Brandy and I will be your conference operator today. At this time I would like to welcome everyone to the Holly Corporation Third Quarter 2007 Earnings Call.

All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will a question-and-answer session. [Operator Instructions].

I would now like to turn the call over to Neil Hickerson. Please go ahead, sir.

M. Neale Hickerson - Vice President of Investor Relations

Well, thank you Brandy. Good morning everyone. I am Neil Hickerson, Vice President of Investor Relations at Holly. I would like to welcome you to our third quarter 2007 earnings conference call.

With us this morning are Matt Clifton, Chairman and CEO of Holly; Steve McDonnell, Vice President and Chief Financial Officer and Dean Ridenour, Vice President and Chief Accounting Officer.

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

For this morning's call we’ll begin with Steve, who will provide financial details around our results, and some comments about the quarter and we'll follow up that with Matt, who will also have the few comments about the quarter end year. Both Matt and Steve will be available for questions at the conclusion of their prepared remarks.

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 relating 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 Steve McDonnell.

Stephen J. McDonnell - Vice President and Chief Financial Officer

Thanks, Neil. My remarks this morning will cover four topics. First, our earnings for the third 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 you have seen from our press release this morning, earnings for the third quarter were $58.1 million or $1.04 per diluted share. This compares to earnings in last year's third quarter of $79.2 million or $1.37 per diluted share. You will note that utilization rates of both our refineries were below normal during the quarter, due unplanned downtime. As we mentioned in our press release, if this downtime had not occurred, results could have been approximately $0.20 higher in the third quarter.

Refining margins for the third quarter were $12.84 per barrel compared to last year's $17.75 per barrel. Let we now note the growth margins by refinery.

During the third quarter, Navajo's gross margin was $10.66 per barrel as compared to $16.09 per barrel last year. While the number is still an estimate, Navajo’s preliminary gross margins for October was approximately $6 per barrel versus $10 per barrel last year.

For our Woods Cross refinery in Utah, our third quarter gross margin was $19.79 per barrel versus $23.60 per barrel last year. Utah's preliminary margin estimate for October was approximately $17 per barrel versus $15 per barrel last year for October.

Let me make a brief comment about our effective tax rate for the quarter and year-to-date. Our effective tax rate for the nine months ended September 30, 2007 was 33%, but the effective tax rate for the quarter was only 24.8%. Methodology we employ in reporting taxes for interim periods is to spread permanent differences that do not vary with income throughout the year as a percentage of the income we expect to earn in that period. Thus at June 30th, the amount of income we expected to earn throughout the remainder of the year was higher than we now expect. In effect, we were over-accrued on taxes at June 30. Effect of bringing the tax accrual down to the appropriate level for the nine months to date resulted in low effective tax rate for the quarter. We would expect our effective tax rate for the fourth quarter to approximate 33%.

Wrapping up our earnings comments for the third quarter, I want to provide our EBITDA numbers for the quarter. Our EBITDA for the third quarter is $83.7 million versus $130.2 million on last year's third quarter. Total EBITDA for the first nine months of the year was $447 million, which was higher than last year's first nine months amount of $330 million and higher than the full year amount for 2006 of $415 million.

Let me now shift to some comments about Holly's balance sheet. Our cash and marketable securities at the end of the third quarter was $310 million. We ended the quarter with $665 million of stockholders equity and no debt. And at current prices of our stock, market capitalization exceeds $3.5 billion.

Let me briefly elaborate on our cash balance of $310 million. You will recall that our cash balance at the end of the second quarter was $411 million. For the third quarter, we saw a decline of approximately $100 million. There were two primarily factors causing this decline. First, we made large quarterly income tax payments, more than $55 million in the quarter. And second, we experienced an inventory build of approximately $50 million rising as a result of the unscheduled downtime in our refineries. Most of the inventory build was worked off in October. And we ended October with approximately $400 million in cash.

My third area of comment is regarding our stock repurchase program. During the third quarter, we repurchased 573,000 shares at $36 million or $62.88 per share. Through the first nine months of the year the group purchased 1.3 million shares for a total of $79 million or $59.55 per share. Our total repurchase program which began in 2005, we have now repurchased 10.8 million shares for $386 million dollars, at an average price of $35.62 per share. At the end of September 2007, we had 54.4 million shares outstanding and we have $114 million left under our authorized repurchase program.

Last item I want to talk about before I turn things over to Matt 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, $46.36, our common and subordinated units are worth approximately $328 million.

In October, HEP announced a fourth quarter distribution of $0.715 per unit payable on November 14th. So next week Holly will receive $5.1 million on its common and subordinated units, and $877,000 for its general partner interest. The distribution for the general partner interest includes $642,000 in incentive distributions.

Now I would like to turn it over to Matt Clifton, our Chairman and CEO.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Thanks, Steve. Just a few comments for the quarter and we will open up for questions.

Our third quarter results were clearly affected by industry-wide gross margin reductions from the lofty levels that we were experiencing in the second quarter. We believe our process and capabilities are 90% sour at our Navajo refinery in New Mexico and our Salt Lake City's refinery's ability to process low cost, disadvantaged and dislocated crudes, somewhat cushioned the blow.

As reported, unscheduled downtimes at our facilities, negatively affected our results by $0.20 a share. We would like to acknowledge our employees for safely repairing and restarting our facilities in an expedited manner in order to minimize its effect.

Just a few notes on the status of our major capital project before I open up to questions. At our Woods Cross refinery, our upgrade and expansion project is proceeding a little ahead of schedule with completion expected in the August September ’08 timeframe. This project, as you remember expands the capacity of the refinery by approximately 20%, but more importantly increases the amount of low cost black wax and Canadian heavy crude that we can process there from 15% level currently up to about 30%.

Our Navajo projects in New Mexico are proceeding a little bit behind schedule, but we still anticipate start up in the first quarter of ’09. This project expands our capabilities, our capacity by about 18% and increases our sour crude processing capabilities from 90% to 100%.

We have also contracted for the major unit of our heavy crude processing component of our overall upgrade. We've contracted to build a new ROSE unit which should be completed by August of 2009. This will give us the ability to process up to 50% of our charge or 50,000 barrels a days of heavy Canadian crude processing, once completed, and once we have access to the Cushing area.

Our other major project is the construction of a new pipeline between Salt Lake City and Las Vegas. That project is moving ahead right on schedule, we are well into the permit process, we are acquiring right of ways, have ordered pipe and have ordered tank. We will have construction bids in the early part of ’09 and we anticipate… I am sorry of’08 and we anticipate having that project completed at the end of ’08 or early ’09, and starting up operations in ’09.

With that I think I will turn it back to Neil.

M. Neale Hickerson - Vice President of Investor Relations

And I would like to ask our operator, Brandy, to repeat the instructions for asking questions. We are ready to move to that phase of our call.

Question and Answer

Operator

[Operator Instructions].

Your first question comes from Richard Voliva with Deutsche Bank

Richard Voliva – Deutsche Bank Securities

Thanks. Good morning guys.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Good morning.

Richard Voliva – Deutsche Bank Securities

I had a couple of questions kind of on demand, in the case of both plants, what you're seeing there and then particularly kind of bottom of the barrel issues, asphalt, excuse me, in the kind of, I guess New Mexico, California type area?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Well, our demand has been pretty strong. We have, as you probably know, we have three asphalt terminals that we market asphalt, two in New Mexico and one just outside of Phoenix. We actually market a little more than, quite a bit more than we produce asphalt. So we have kind of an embedded outlet for any asphalt that we produce, and as you might remember we put in the ROSE unit at the start-up early in '06 that reduced the amount of asphalt that we're making at the New Mexico plant. We have seen some slight reduction in demand, I think in the Phoenix area in Arizona over the last year, but then again it hasn’t really negatively affected us, it just kind of backed out some of our third party purchases.

Richard Voliva – Deutsche Bank Securities

Fair enough. Thanks. I guess then the other kind of general topic I wanted to tackle was just a little bit on the, if you're seeing anything on the M&A front, acquisition opportunities, that kind of thing? I mean, you had spoken a little bit on the last call about that possibility. So if you have got any update there, I appreciate it. Thanks.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Okay. I think that there is a little more activity, at least there are some things that look like they are coming on out on the horizon. I think we recently heard that Sun would be marketing their Tulsa plant. And as far as we know Valero continues to evaluate whether any units would be sold, refineries would be sold out of their package of assets. So we will continue to look there, we don’t obviously have anything that we are working on right now.

Richard Voliva – Deutsche Bank Securities

Great. Thanks very much.

Operator

Your next question comes from Daniel Vetter with J.P. Morgan.

Daniel Vetter – J.P. Morgan

Good morning.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Good morning.

Daniel Vetter – J.P. Morgan

I was hoping you could comment on how many sulfur credits you sold during the quarter. And I apologize if you mentioned this in your opening remarks. I had to leave the call for a minute?

Stephen J. McDonnell - Vice President and Chief Financial Officer

Dan, we didn’t sell any in the third quarter. And we were in the market in the fourth quarter.

Daniel Vetter – J.P. Morgan

Okay

Stephen J. McDonnell - Vice President and Chief Financial Officer

But we won’t make any comment until we release earnings in early February.

Daniel Vetter – J.P. Morgan

Okay. How is the pricing for those credits? Have you seen demand pick up or have you seen demand fall off as more refineries make the necessary investments to produce low sulfur gasoline?

Stephen J. McDonnell - Vice President and Chief Financial Officer

We have seen the price range from $130 to $150 maybe closer to $145 to $150 for some.

Daniel Vetter – J.P. Morgan

Can you comment on how many barrels per day of black wax you sold at Woods Cross during the quarter?

Stephen J. McDonnell - Vice President and Chief Financial Officer

It was about 4,000 barrels a day we ran at Woods Cross for just a little bit… right around $13 under WTI.

Daniel Vetter – J.P. Morgan

Okay. And then lastly…

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

One thing there, Dan, is that we are one smaller project that we are doing up at Woods Cross is putting in it separate desalter for black wax, that we’re hoping to have done in the early part of February that will allow us to at least process at least another 1,000 or 1,500 barrels a day of black wax at that time, even before the other project comes on at Woods Cross.

Daniel Vetter – J.P. Morgan

And that’s February of 2008, okay.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Yes.

Daniel Vetter – J.P. Morgan

And last, one last if I may. You talked about processing more Canadian heavy at Navajo, and I guess, part of that is dependent upon the availability of that crude in Cushing, and part of it is dependent upon your ability to get that needed heavy from Cushing to Navajo. What's your latest thinking on how you would get the crude from Cushing to Navajo? And would that be the constraint, or would the constraint be the actual availability of that crude at Cushing?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

That’s a good question, Dan. We’ve got two things, one backing up to the availability in Cushing. We’ve got some line space committed on spear head that has an expansion that will come online in the latter part of ’09. So we do have some barrels that we'll be able to bring in on at that timeframe and there are some excess barrels on a spot basis that we think we could pick up. Then we also have contracted, at least committed on some additional space on the Trans-Canadian pipeline project that would be bringing in a lot more barrels of heavy Canadian in the Cushing in the late 2010 timeframe.

As far as access between the New Mexico facility Cushing, we're exploring a couple of options there. One is, working with some outside firms about the possibility of converting some existing lines that traditionally move crude out of the Permian Basin towards Cushing, and reverse that for Canadian crude movements. And also at the same time we are working with Holly Energy Partners to develop in the alternative, a separate project to build a new pipeline between our Lovington, New Mexico facility and Cushing. So we're moving ahead expeditiously with those two alternatives and trying to bring those two ahead to be in a position to have access to Cushing, roughly at the same time that we would have the ROSE unit built in the third quarter to fourth quarter of '09 timeframe.

Daniel Vetter – J.P. Morgan

All right. Thank you.

Operator

Your next question comes from Jeff Deitert with Simmons.

Jeff Deitert - Simmons & Co.

Good morning. The crude discounts have really widened in the fourth quarter relative to the third quarter. Could you summarize what you've seen so far, October, November? And I would guess you are already buying some December crude as well.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

I'll take, I'll start this and Steve can jump in. I think as you said, we've seen widening start in New Mexico and the sweet sour differentials have, which were traditionally in the $400 to $450 have expanded up to $6 and then more recently have spread out to $10 discounts I think for December.

In Woods Cross refinery, we continue to see pretty steep discounts for the Rocky Mountains sweet crude that’s kind of displaced with not enough pipeline space to get out to some of its traditional markets in the mid continent area. The discounts there have been pretty strong. The discount with the black wax crude is really a function of a percent discount to WTI. So, as WTI has increased from the $70 level to the $90, $95 level, we're basically getting about a 25.5% discount. So that’s widening out the spread there. And we've seen heavy Canadian crude discounts, I think recently, as much as $40 a barrel. So there's a strong incentive. And obviously the projects that were installed in Woods Cross are driven to try to take advantage of running more and more of the black wax, and the heavy Canadian crude, which should improve profitability up there.

Jeff Deitert - Simmons & Co.

The Rockies sweet is one that we have trouble tracking. And what are those discounts looking like 4Q versus 3Q?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

I think they have been consistently kind of in the $7 range, I think if I remember right. And Steve has any specific data, but…

Stephen J. McDonnell - Vice President and Chief Financial Officer

I don’t have it compared to the second quarter, Jeff, but I do have it compared to the third quarter this year to the third quarter last year. Total crude costs at Woods Cross averaged about $5.5 or so under WTI in the third quarter of '07. For last year, total crude cost for only like $2.5 to $3 under WTI. And part of that is the fact we're running at about 1,000 barrels more black wax this year than last year. The discount on that was relatively the same this year of $13 under versus last year's $13 but running a little more, had a positive effect and then the rest of it is. Just as you suggested, some of these other crudes are cheaper now than what they were last year and… last year and in the second quarter.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Yes. I think just on an overall basis, I think last year the third quarter Woods Cross crude cost was about $2.50 a barrel under Navajo's crude cost. And Navajo of course runs just about all sour crude. This year that expended up to about $4.50 below Navajo.

Jeff Deitert - Simmons & Co.

Very good. I appreciate your update on the timing for the capital projects. The cost consistent with your previous presentation for Woods Cross around the $100 million and Navajo around $225 million, is that right?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Woods Cross is right in that $100 million range. We haven’t seen any change there. Navajo is probably up in the $10 million range over our initial estimates. About $2.5 million to $3 million of that was the decision on our part to install more rigorous NOX control technology on a new hydrogen plant and the rest was some increased cost the ROSE unit over our initial estimate. So it is up maybe couple of percent on the overall refinery projects from the numbers we’ve put out last year.

Jeff Deitert - Simmons & Co.

Very good. Thank you.

Operator

Your next question comes from Chi Chow with Tristone Capital.

Chi Chow - Tristone Capital

Hi, good morning gentlemen. Steve, could you repeat… I think you mentioned the October margins at both refineries. Could you repeat those figures?

Stephen J. McDonnell - Vice President and Chief Financial Officer

Sure. Chi, the Navajo refinery in October, we experienced around $6 a barrel versus $10 a barrel on last year's October runs. At Woods Cross this year, we saw $17 a barrel, that’s a preliminary estimate, versus last year's $15.

Chi Chow - Tristone Capital

Okay. Then these are realized margins, is that correct?

Stephen J. McDonnell - Vice President and Chief Financial Officer

Correct.

Chi Chow - Tristone Capital

Okay. Are you seeing any tightness in the diesel market, in particular in the Woods Cross market, you know [ph]?

Stephen J. McDonnell - Vice President and Chief Financial Officer

It’s strengthening here, as we get into early November.

Chi Chow - Tristone Capital

And what is the issue up there? It seems like it's very tight right now. Anything that you can point to?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Chi, diesel prices have been barely strong in the Woods Cross area pretty much for the last couple of years. I think this time of the year… though I haven’t kept track or have data on what other refineries in the Rockies are doing. I know there was some downtime in the billings of plants, I think. But generally, putting aside any unscheduled downtime affects overall production. You’ll see some slowing of crude runs in the winter just due to a reduction in the gasoline demand. And than as crude runs go down, diesel production is of course reduced. So that might be part of the story now. But seems like there were some problems with either Exxon or Conoco plants billings that might have been affecting things up there.

Chi Chow - Tristone Capital

Okay. And what was the production issue at Woods Cross in the third quarter?

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Basically, we had a couple of things there. One, we had a, I think it was in July, we had to take our crude unit down to de-coke the main here. And then we had a… actually we had third party contractor outside the plants hit the power line into the refinery in September I think that caused a day or two outage at the plant. We got that back lined out but in that event, we had some disruption apparently of some trace in our main crude tower which limited our production for the remainder of September. And then we took that down in late October very briefly and fixed that problem.

So it was a couple of events there that affected things. I think we also, while we took the crude heater down for decoking, we did a reform or regeneration there to get that out and running.

Chi Chow - Tristone Capital

Okay. And that carried into October you mentioned.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

In October, we were still down I think running, averaging like 22.5 a day I think during October, if remember right. And then right at the end of October, we took the crude unit down for a day or two and it's back up running very well now at full capacity.

Chi Chow - Tristone Capital

Okay. Thanks, Matt.

Operator

[Operator instructions].

Your next question comes from Ann Kohler with Caris & Company.

Ann Kohler - Caris & Company

Good morning. Just a couple of questions regarding some of the pipeline projects. One, if you could just update us on the expected capital cost of the product pipeline to Las Vegas and then also, I would assume from the… for the pipeline, crude pipeline from Cushing to Navajo that you are looking at, I would assume that if you did go via the HEP route, and having to construct that line yourself, you would do that in a similar fashion to the product line. In other words you at Holly would foot the bill for that and then upon completion, basically spin it or sell it, I guess, sell it like HEP.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Okay, Ann, on the first question, our capital estimates on the Salt Lake to Vegas project including the two terminals, one in Cedar City, St. George area and one in North Las Vegas are still in the $3 million on a 100% basis, I think it's $300 million. And currently it looks like we'll be taking that 75% interest in that, with Sinclair taking a 25%. So we’ll be basically 75% or $225 million to Holly, 75% interest.

As far as the Cushing line, I think at this time what probably will be our expectation is that Holly would probably carry that project through construction, unless there’s some other more desirable opportunities that present itself between now and when we pull the trigger on that.

Ann Kohler - Caris & Company

And I would assume on that pipeline project you're looking sort of making a decision I would assume here by the end of next year, to time it with the start up of that ROSE unit.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Yes. What we’ll be doing is between now and probably the end of this year, we're currently proceeding with preliminary engineering on the pipeline itself and honing it on the exact route. And at the same time, as I’ve said, we're continuing some dialogue with some third party companies about a possible conversion of the line. But we're trying to be in a position that at the beginning of ’08 to know which direction we're going and to pursue that, that if we are into a new build, you have roughly about a year’s worth of permit work that we'd be moving ahead with if we go that route at the beginning of ’09.

Ann Kohler - Caris & Company

Great. Thank you very much. I appreciate it.

Matthew P. Clifton - Chairman of the Board and Chief Executive Officer

Okay.

Operator

At this time there are no further questions. I will turn the call back to Neale Hickerson for closing remarks.

M. Neale Hickerson – Vice President of Investor Relations

Well, we want to thank everybody for listening today to today’s call and we certainly look forward to visiting with everybody for our fourth quarter and full year results in the early part of next year. Thanks a lot, everyone.

Operator

This concludes today’s Holly Corporation third quarter 2007 earnings call. You may now disconnect.

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